Getting a HELOC on a second home can be done, but consider your options
The average homeowner gained $13,900 between the first and second quarter of 2023, according to CoreLogic.
If you own a second home or vacation property in a desirable location, you might be contemplating how to leverage that asset. You’ll be pleased to know that taking out a HELOC on a second home is usually an option.
However, the rules for these types of loans can vary somewhat from those governing your primary residence. Here’s what you can expect.Check your home equity loan options. Start here
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What is a HELOC?
Home equity lines of credit, or HELOCs, essentially allow you to borrow against the equity you’ve built up in your home.
It’s similar to a credit card in that it’s a revolving line of credit, meaning you can draw from it up to a certain limit and repay it over time. Your home serves as collateral for the loan, securing the borrowed amount.
How does a HELOC work?
Once you apply for a HELOC and get approved, the lender sets a credit limit based on the appraised value of your home and your financial profile.
This credit limit is the maximum amount you can borrow. During the draw period, which typically lasts for about 5 to 10 years, you can borrow up to this limit. Some lenders may offer you special checks or even a card to access these funds, and you only pay interest on the amount you’ve drawn.
After the draw period ends, the repayment period begins. This is the time frame within which you need to pay back both the principal loan balance and interest payments on whatever you’ve borrowed. The repayment period can vary, but it’s often around 10 to 20 years. Unlike during the draw period, you can’t borrow additional funds during the repayment period.
Can I get a HELOC on a second home?
Yes, you can get a HELOC on a second home, provided you meet the lender’s guidelines.
This means that you don’t have to sell your vacation home to access the equity it’s built up. Instead, you can tap a second home’s value using a cash-out refinance, home equity loan, or home equity line of credit (HELOC).Check your home equity loan options. Start here
Cashing out on a second home can be more appealing than refinancing the mortgage loan on your primary home or reducing its equity. Using your second home lowers the risk of being in a negative equity position with your primary residence should the market take a downturn.
Fortunately, many lenders and banks now offer home equity lines of credit for second homes. The guidelines are a little more stringent than when you take out a loan on your primary home, but it can be done.
How to get a HELOC on a second home
A HELOC can be used to finance a second home or any other property you own. Making sure you meet all the requirements is the first step in getting a HELOC on a second home.Check your HELOC or home equity loan options. Start here
Specific HELOC requirements will vary by lender, but here are some common hurdles you can expect to meet:
- Higher credit score (often 680 to 700 or more)
- Debt-to-income ratio below 43%
- Owning the property for at least one year
- Loan-to-value ratio (LTV of at least 85%)
- Home appraisal
- Cash reserves
The good news is that second-home mortgage rules are more lenient than those for investment properties. So it will be easier to find lenders offering home equity loans and HELOCs on your vacation home than on an investment or rental property.
Benefits of a HELOC on a Second Home
A HELOC on a second home can present several advantages, providing you with financial flexibility and possibly some unexpected benefits.
There are numerous examples of homeowners using a HELOC on a second home successfully. Whether it’s for home improvements that increase the property value, funding a new business venture, or managing unexpected medical expenses, a HELOC can provide the necessary capital.
You may have access to a sizable sum of money through a home equity line of credit, which you can use as you need it. This may be helpful in an emergency situation or with large expenses like debt consolidation, home renovations, or educational costs.
Lower interest rates
A HELOC frequently has interest rates that are significantly lower than those of credit cards or personal loans because your home serves as security for the loan. Over the course of the loan, this may save a lot of money.
Potential tax advantages
The interest paid on a HELOC may, under certain conditions, be tax deductible. This holds true if substantial home improvements are made with the money. To determine if you are eligible for these benefits, it is essential to speak with a tax advisor.
Risks and drawbacks of a HELOC on a second home
Despite its potential benefits, a HELOC on a second home does carry certain risks and drawbacks that need to be considered.
One of the biggest risks associated with a HELOC is the potential for foreclosure. Your second home is used as collateral for the loan, so if you are unable to make your HELOC payments, the lender has the right to foreclose on it.
Variable interest rates
The majority of HELOCs have variable rates, which means that they may rise over time. This can cause your payments to go up and your financial burden to grow in ways you didn’t expect.
Closing costs and other fees
Just like your original mortgage loan, obtaining a HELOC involves closing costs and other fees, which can add up. These costs can include application fees, appraisal fees, and annual fees, among others.
Impact on credit score
When you apply for a HELOC, lenders will perform a hard inquiry on your credit report, which can lower your credit score slightly. Also, having a lot of debt from a HELOC can affect your debt-to-income ratio and make it harder to get other types of credit.
Why are HELOC rules different for second homes?
Prior to the housing downturn of 2008, homeowners could easily tap into home equity — and with very little equity at that. But after 2010, mortgage lenders began to pull back on those loose guidelines. Instead of loaning up to 100% of your home’s equity with relatively few credit requirements, many lenders stopped offering home equity loans of any type on second homes.Find your lowest HELOC rate. Start here
Why? Unlike your primary residence, home loans for vacation properties are a higher risk for lenders.
- Your primary residence is considered to have the least risk when it comes to real estate. The home where you live is most likely the one debt that gets paid, regardless of tough times
- Vacation homes are considered riskier. If times get tough, homeowners are more likely to forego those mortgage payments when money is short
On top of that, second mortgages, including HELOCs and home equity loans, are already considered higher-risk. That’s because these loans fall into a second lien position (behind your first mortgage), meaning they could get paid less or not at all in the event of a foreclosure.
With the dual risk factors of a second mortgage on a second home, lenders are naturally more reserved about offering these loans and charge higher interest rates when they do.
How to apply for a HELOC on a second home
Getting a second home HELOC is comparable to getting a regular HELOC. Once you’ve determined you’re a good candidate for a HELOC, follow these steps to apply:
- Choose a lender: Do research on different lenders, looking at their interest rates, fees, customer service, and HELOC terms.
- Begin the application process: Once you’ve decided on a lender, you’ll need to complete their application process, which usually entails filling out a form outlining your financial situation.
- Gather paperwork: You will almost certainly be required to provide documentation such as tax returns, pay stubs, a list of your debts and assets, and information about your second home.
- Wait for approval and a home appraisal: After you submit your application, the lender will assess your eligibility and schedule an appraisal to determine the value of your second home. This appraisal will determine the amount of credit that is available through your HELOC.
When choosing a lender for a HELOC on a second home, you should think about their reputation, competitive interest rates and terms, loan amount and equity requirements, fees and costs, and the quality of their customer service.
Alternatives to a HELOC on your second home
Fortunately, even though there are stricter requirements, you won’t be forced into just one loan option in order to access the equity in your second home.
From a home equity loan to a home equity line of credit or a cash-out refinance, you have options. Whether or not you should opt for a cash-out refinance or a home equity loan will depend on your specific situation.
|Feature||HELOC||Home Equity Loan||Cash-Out Refinance||Personal Loan|
|Interest rate||Variable rates||Fixed||Fixed or variable||Fixed or variable|
|Collateral required||Yes (your home)||Yes (your home)||Yes (your home)||Usually none|
|Draw period||5-10 years||N/A||N/A||N/A|
|Repayment period||10-20 years||5-30 years||Remaining mortgage term||1-7 years|
|Use of funds||Any||Any||Any||Any|
|Loan amount||Based on home equity||Based on home equity||Up to 80% of home value||Usually up to $50,000|
|Closing costs||Yes||Yes||Yes||Usually, none|
|Impact on mortgage||None||None||Replaces existing mortgage||None|
|Risk of foreclosure||Yes||Yes||Yes||No|
Home equity loans
A home equity loan is generally preferred over a HELOC in situations where you have a one-time expense and want the certainty of fixed monthly payments. For instance, if you’re undertaking a significant home renovation project and you know exactly how much it will cost, a home equity loan can be advantageous. The fixed interest rate means your payments will be consistent over time, making budgeting easier.Verify your home equity loan options. Start here
Additionally, a home equity loan can be a good choice if you’re uncomfortable with the variable interest rates associated with a HELOC. Fluctuating rates could make your payments less predictable, which isn’t an issue with a home equity loan’s fixed rates.
People also often opt for home equity loans when consolidating high-interest debts, like credit card balances. The lump sum allows you to pay off those debts immediately, and the typically lower, fixed interest rate of a home equity loan can save you money in the long term.
In essence, if you prefer predictability and have a specific, large expense in mind, a home equity loan might be more aligned with your needs than a HELOC.
Cash-out refinance loans
A cash-out refinance is a new loan that replaces your current mortgage, allowing you to borrow more than your existing mortgage balance and receive the difference as a lump sum of cash.
If you have an above-market rate on your current mortgage, cash-out refinancing could help you withdraw equity and reduce your interest costs at the same time. Because a cash-out refinance is a “first mortgage” or “traditional mortgage,” it will typically have a lower interest rate than a home equity loan or line of credit, both of which are second mortgages.Check your cash-out refinance eligibility. Start here
Just note that the rules for a cash-out refinance on a second home will be more stringent than those for cashing out a primary residence. Expect higher interest rates, increased equity requirements, and higher minimum credit scores. In addition, closing costs are typically higher for cash-out refinancing than for a second mortgage.
Personal loans are a popular means of borrowing cash quickly. Similar to cash-out refinancing and HELOCs, personal loans provide cash to be used for just about anything, including home improvements, school tuition, paying down credit card balances, and general debt consolidation — all without having to use your second home as collateral and risk foreclosure. But personal loans often carry higher interest rates. This is why they are often considered a last resort for homeowners.
FAQ: HELOC on a second home
Both a HELOC and a home equity loan are based on the value of your home. However, a HELOC gives you a credit line that you can use as needed, while a home equity loan gives you a lump sum of money.
Yes, you can get a HELOC on a second home even if you already have a mortgage on it, as long as the home has enough equity.
HELOCs typically have a “draw period” of 5–10 years during which you can draw money and pay interest only. After this time, you’ll have to repay the principal and interest during the “repayment period,” which typically lasts between 10 and 20 years.
Interest on a HELOC is tax-deductible only if the money is used to buy, build, or make major changes to the home that is used as collateral for the loan.
Yes, a lender has the right to reduce or freeze your HELOC under specific circumstances. Common reasons include a significant decrease in the value of your home or changes in your financial circumstances.
Don’t forget to shop around for interest rates
Buying a vacation home means you can enjoy the financial benefits of owning real estate as well as having a great place to vacation with your family.
Mortgage borrowers will find different lending standards for different types of property, depending on the lender and the mortgage program.
Remember to always shop and compare loan options for your specific needs and financial goals. If you can’t find a lender that can help you, try a smaller, local bank or credit union.Time to make a move? Let us find the right mortgage for you