By Aly J. Yale / Photo Illustration by Fortune; Original
When you own a home, you have the opportunity to build equity, which is the value of your home, minus any loan balances you have against it. You can increase your home equity by making improvements to your house, paying down your mortgage, or even just sitting back as your home’s value appreciates over time.
Once you have equity, you can turn it into cash using a home equity loan. These loans are types of second mortgages that allow you to borrow against your equity and get a portion of it back in cash. You then repay the loan via monthly payments—often over many years.
How home equity loans work
Home equity loans let you borrow against the value of your home that you own outright, and convert it into a lump sum, cash payment. You can then use those funds however you wish.
Getting a home equity loan works much like getting a traditional mortgage. You will fill out an application, submit financial documents like bank statements, pay stubs, tax returns, and W-2s and then close on your loan. One way that home equity loans do differ from applying to a traditional mortgage: You may not owe closing costs, though it depends on the lender you choose.
To qualify for a home equity loan, you’ll usually need:
- A 680 credit score or higher
- A debt-to-income (DTI) ratio of 45% or less
- At least 10% to 20% equity in your home
Once approved for a home equity loan, you’ll receive the funds a few days after closing. You will begin repaying the loan back immediately—via fixed monthly payments.
Can I take out a home equity loan to buy a second home?
The short answer is yes, you can use a home equity loan to buy a second home. Since the proceeds from a home equity loan can be used for any purpose, that means you can use the money to buy additional real estate if you wish to.
Doing so comes with risk, though. As Adam Spigelman, a senior vice president at Planet Home Lending, explains, “You can use a home equity loan to buy another property—just be sure you’re comfortable with using your home to secure it.”
Here’s a look at the full pros and cons of using a home equity loan to buy a second house.