How to Come Up with the Down-Payment to Buy a Vacation Home or Rental Property with a HELOC or Cash Out Refinance on Your Primary Residence

Many Americans turn to a home equity line of credit (HELOC0 or a cash out refinance on their first mortgage to do home improvement projects or consolidate debt. But have you ever considered pulling equity out of your home to come up with the down payment to buy a vacation home or rental property?

Whether you want to buy a second home or a rental property, you can use your equity with either loan product to at least come up with the down payment. Below is more information about how to use a HELOC or first mortgage refinance to purchase a second home.

HELOC

A HELOC is a second mortgage that is a line of credit using some of the equity in your home. You can use this second mortgage to make the down payment at least on your rental home or vacation home.

There are many advantages to using a HELOC for this purpose. First, a HELOC will come with a much lower interest rate than what you can get with a personal loan, because the loan is secured by your residence.

Second, the loan is usually easy to get because you are tapping your own money. If you are paying your bills on time as well as your home loan, you can usually qualify and close on a HELOC in a few weeks.

Third, a HELOC has lower fees and closing costs than other types of home loans, such as the refinance of a first mortgage.

Using a HELOC is also mostly preferable to pulling money out of a 401k or IRA because in both cases you will pay taxes and penalties.

A HELOC may be the best choice for you if you are happy with the rate on your first mortgage. It does not usually pay to do a cash out refinance and take on a higher first mortgage interest rate. If you are happy with your first mortgage interest rate, the HELOC is the way to go.

If you decide to pull money out of your home with a HELOC to make the down payment for your second home, just remember that you are putting your primary residence on the line. If you do not make the payment on the second home, you can lose everything.

Cash Out Refinance

If you have a first mortgage interest rate that is above market rates, you may consider doing a refinance of your first mortgage and taking out cash. This may be the way to go if you can save at least .5% on your mortgage rate. Keep in mind that if you pull out cash with a refinance, you are putting your house on the line, the same as a HELOC. If you do not make the payments, you can lose your home as well as your second home. You also will pay more closing costs if you refinance your first mortgage than with a HELOC, but it still can be a good choice for buyers with a higher first mortgage interest rate.

Advantages of Using Equity to Buy A Second Home or Rental Property

Having cash available from a HELOC or refinance can come in handy when you want to buy homes that are in foreclosure, short sales or at auction. In these cases, you need to have the full cash amount available when the sale is accepted. This will give you more flexibility that you would not have if you are buying a second home with a mortgage. The turnaround especially for a HELOC is quick and you can get the funds much faster than it takes to get a second home mortgage.

Disadvantages of Using Equity to Buy A Second Home or Rental Property

If you pull out cash to buy another property, your bank is going to own more of your home again. It will take years to rebuild that equity and longer to pay off the loan. This means if you have a major expense, such as a new roof, you may not have the cash available when you need it.

Having a longer payout period to pay off the loan means you are paying more in interest over time. If your plan for retirement is to have your home loan paid off, you may need to reevaluate your finances. Plus, having money invested in real estate can be a good thing, but it is illiquid and takes time to pull out.

But for many Americans, using equity in their first home is the least expensive way to make a down payment on a second or to buy it outright.