Have you been dreaming of a second home? If so, you’re not alone. There are an estimated 7.15 million second homes in the U.S. housing supply. Whether you want to become a snowbird, buy a home in your preferred vacation spot, or purchase your first rental property, you would be joining a small (but significant) group of multi-homeowners.
However, financing this dream can be a challenge: qualifying for a mortgage is more challenging for a second property, including a larger down payment and more stringent credit requirements. Fortunately, as an existing homeowner, you have an asset that can help you achieve your goal: your primary residence. There are several ways to leverage your equity for more property. One popular option is getting a cash-out refinance to buy a second home.
How a cash-out refinance works
To start, let’s review the basics of cash-out refinancing. When you get a cash-out refinance, you replace your existing mortgage with a larger loan and pocket the difference. How much funds you can access will depend on the amount of equity you have in your home.
A cash-out refi differs from a traditional rate-and-term refinance because, well, you’re taking additional cash out. However, just like with a regular refinance, you’ll restart the clock on your amortization schedule and change your rate based on market conditions.
Qualifying for a cash-out refinance to buy second home
Regardless of how you plan to use the proceeds, when you apply for a cash-out refinance, your mortgage lender will look at a few things:
- Credit score – For a traditional cash-out refinance, you’ll need a score of at least 640. However, FHA lenders and programs for veterans may be able to go much lower.
- DTI – Your DTI, or debt-to-income ratio, which is the percentage of your monthly income that services debt, including home loans, credit cards, and any other obligations, cannot exceed 50%. It’s easier to get a loan with a DTI under 43%.
- LTV/Home equity – Traditional lenders will require you to have plenty of equity left over after you take out the loan. It’s common to be able to borrow up to 80% of your home value.
Your lender may also look at additional factors, such as the cash reserves you have on hand to make your mortgage payment if you lose your income.
Should you use a cash-out refinance to buy a new home?
Now that you should have a good idea of whether you can qualify for a cash-out refinance, let’s talk about whether or not you should.
Benefits of using a cash-out refinance to buy your second home
Let’s kick things off with the positives of this financing solution:
- Lower interest rates – Compared to other options on the market, a cash-out refinance offers lower interest rates, which can keep the overall costs of acquiring your new property down.
- Access to a large amount of cash – Depending on the value of your home and your current mortgage balance, you can access a hefty sum with a cash-out refinance.
- Streamlined monthly payments – Instead of keeping track of multiple mortgage payments, you can keep your existing home and your new property under one monthly bill. This is simply more convenient than dealing with separate payments.
Drawbacks of using a cash-out refinance to buy your second home
Leveraging your primary home to buy another property comes with certain risks and disadvantages, and it isn’t for everyone. Here are some special considerations to keep in mind:
- Current mortgage rates – The largest factor in this decision can be the current rate environment. If you, like many homeowners, refinanced when rates were very low, replacing your existing mortgage with today’s much higher rates could be very financially taxing.
- Closing costs and fees – Although a cash-out refinance comes with lower rates, the closing costs and fees are percentages of a larger total amount than other products (your current mortgage plus any additional cash out), which can make them a costly piece of the puzzle.
- Potential for losing your home – If you cannot keep up with your new, larger monthly payment after refinancing, you could be at risk of losing both your primary home and your second property. Be sure not to take on more than you can afford.
How to use cash-out refinance to buy a second home
If you’ve gotten a mortgage before, you already know how the process works – a cash-out refinance will be very similar.
1. Make sure you have enough equity
Before moving forward, make sure that your equity will cover your budget for a new home. Determine your loan-to-value (LTV) ratio by dividing your loan balance by your home’s current appraised value. Your lender will order an appraisal as part of your process, but you can use Zillow or Redfin to estimate.
Top tip: Remember that you will not be able to take out the entire value of your home, and act accordingly.
2. Compare lenders to find the best offer
Just like with your first mortgage, lenders will bring different offers to the table. Shop around to see who will get you the most favorable terms. Consider whether you want a traditional, 30-year mortgage, or a different term length. Additionally, explore the benefits of a fixed rate versus a variable rate.
Top tip: Prequalifying with multiple lenders should not affect your credit score, but stop short of authorizing a hard inquiry until you’re ready to move forward to keep your FICO in peak shape.
3. Apply and close on your cash-out refinance
Once you have selected your lender, you’ll need to complete the same process you went through for your first mortgage. Your bank will verify your financial information and order an appraisal to confirm the value of your home. Because a cash-out refinance does not carry the urgency of a purchase contract, this process may take longer than when you bought your first home: generally 6-8 weeks.
4. Find the right second home and make an offer
This is the fun part! With your refinance proceeds in hand, you’ll be free to shop for your ideal second property. You can use your home equity wealth to buy a new home outright in cash or make a down payment (provided you are able to qualify for a second mortgage).
Alternative ways to finance a new home
If buying a home using a cash-out refinance is not for you, there are other options for using your home equity to finance your next property. All these options will keep your original mortgage rate in place, which can be particularly important during an expensive rate environment:
- Home equity loan – Also known as a second mortgage, this tool typically comes with a predictable, fixed-rate payment.
- Home equity line of credit (HELOC) – The most popular home equity financing tool, a HELOC allows you to access your equity with a line of credit, similar to a credit card. You pay interest only on the portion of the line that you use.
- Home equity investment – Differentiated by a lack of monthly payments, more flexible credit score requirements, and a lack of income requirements, this solution gives you a lump sum of cash in exchange for a share of your future home appreciation.
- DSCR loan – This specialized financing tool is made for real estate investors. DSCR lenders evaluate the money-making potential of a property. If you plan to use your second home as a rental property, a DSCR loan could be an option.
Final thoughts
Your home wealth offers a world of opportunity when it comes to accomplishing a range of financial goals, including buying a second home. If you want to buy a second home with your equity – without affecting your current mortgage or adding a monthly payment – consider a Home Equity Investment (HEI) from Point.
Frequently Asked Questions
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