Should you use home equity to buy a second home?
Second homes aren't only for rich people. They
have become mainstream, whether they're used for vacations or for
More than 9 million dwellings in this country are
second or third homes, accounting for about 6 percent of residential
sales. Three-quarters are considered vacation homes and the rest
are investment properties or undeveloped land, according to a 2002
survey by the National Association of Realtors.
You don't have to have a pile of cash on hand to
buy a vacation house. You can use the equity in your primary residence
to help pay for a second (or third) home. Make sure you explain
to your lender what you're doing, and you might want to consult
with a tax adviser, too.
"There are so many variables, so many moving pieces,"
says Anthony Hsieh, president of HomeLoanCenter.com. "But the
high-level perspective is you need to see how much equity you do
have in your existing home and what are the benefits of pulling
out equity in your existing home vs. borrowing. It's always about
the cheapest cost of borrowing."
It's not always easy to identify the cheapest cost
of borrowing, and that explains why communication is so important.
The lender needs to know which house will be your primary residence
and which will be secondary. In most cases, you will find that the
interest rate on an owner-occupied home will be about three-eighths
of a percentage point lower than for a nonowner-occupied house.
With today's low rates, that means you might be able to get a loan
for 5.5 percent on your primary residence and have to pay 5.875
percent on the loan for the second home.
"That argument automatically gives you
more motivation to get as large of a loan as possible on your primary
residence because it's the cheapest cost of borrowed money,"
Equity is equity
Many borrowers resist this line of reasoning because they want to
build equity in the home they live in. It seems instinctually like
the smart thing to do. "But in reality, equity is equity --
it doesn't matter which house," Hsieh says.
So if you have a lot of equity in your primary residence
and you want to buy a vacation home, it might make sense to refinance
the mortgage on the primary home for more than the current loan
balance. That's called a "cash-out refi" because you borrow
more than the current balance, pay off the current loan and get
the remainder in cash. You can use the cash extracted from your
primary home's equity to make a down payment on your second home,
or even to buy it outright.