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Dear Real Estate Adviser,
I own my home outright, valued at $799,000. If I buy a second home, should I use the equity or cash on hand for the down payment?
— Garry

Dear Garry,
Owning your home outright gives you a lot more down-payment flexibility when buying that second home.

Without tying up your cash reserves, the least expensive option to finance a second home is probably taking out a home equity line of credit, or HELOC, on the first one for a down payment on the second. These deals close fast and often cost less than mortgage money because you’re really only using your own money. Many HELOCs do have nominal “early closure fees” of $400 or so if you close out the line within the first three to five years.

Keep some reserves if you pay cash

If you decide to make a hefty down payment using your cash in hand, be sure you have some liquid cash reserves put aside for emergencies. If you buy the second home in cash, you will incur what are called “passive losses” since your mortgage payment write-offs will be nonexistent.

The mortgage option

As for a mortgage on the second home, interest rates should be substantially lower if you kick in a high down payment (20 to 30 percent). Plus, you’ll pay off the loan faster. If you have some provable cash reserves for emergencies, the loan on the second home should be a cinch. Shop around to find competitive mortgage rates.

Problems of absenteeism

You don’t say whether you plan to rent out the second home for part of the year, but it’s worth noting that banks view would-be landlords and vacation-home buyers as riskier customers because they won’t be present year-round. And that subjects those borrowers to higher interest rates.

If you don’t live there year-round, you’ll be subject to different insurance, tax and rental-income reporting considerations and different loan conditions. Be sure to research the challenges. If that second home is not in a convenient or desirable location for seasonal tourists, it may be harder to rent — and to finance.

Maintain the place

Also, if you were to buy a second home that’s a long distance from the first, consider that you’ll be away from one of the properties much of the time and you’ll need someone to maintain the place or check on any tenants. As a rule of thumb, budget about 1 percent of that second home’s purchase price for annual maintenance and up to another 0.5 percent if buying a very old home.

Of course, one advantage of not using or collateralizing your first home to buy the second is that you’ll still have a fully paid-for home in the event of a hard market crash or other dire devaluation scenario.

Good luck with your purchase!

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