Use a cash-out refinance to buy a second home
Equity from your existing home can be a great way to buy a vacation home or investment property.
Many homeowners cash out their home equity to make a down payment on their next property. Others may have enough equity to pay the entire purchase price of their second home in cash.
If you want to use a cash-out refinance to buy a second home, here’s what you should know.
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Using a cash-out refinance to buy a second home or investment property
One way to buy a vacation home or a real estate investment is by using the home equity you’ve already built up in your existing property.
When you tap your home’s value via a cash-out refinance, you can use the funds for any purpose. That includes making a down payment on your second home or paying for it outright in cash.
With a cash-out refinance, you can borrow up to 80% of your existing home’s value and use the funds to buy a new house.
Note: Equity includes the part of your home’s value that you’ve already paid off and any gains from appreciation. If you owe $150,000 on a home that’s valued at $300,000, you’d have $150,000 — or 50% — in equity.
Should I get a cash-out refinance to buy a second home?
There are a few basic things you should know before you apply for a cash-out refi:
- Cash-out refinancing replaces your current mortgage balance with a larger loan. This will likely mean a higher monthly payment
- Technically, you’re using your home equity as collateral for a loan and not simply withdrawing it
- Your eligibility for a new loan depends on your home equity and your credit score
- If you want to buy and then sell or refinance one of the homes, consider a bridge loan instead
- In some cases, a home equity loan or HELOC might be a faster and more affordable way to borrow against home equity
To find out whether you’re eligible for a cash-out refinance — and how much money you could access — connect with a lender and talk about your options.
How much money can you get with a cash-out refinance?
At first, it may seem that the equity issue is simple. You own a house worth $300,000, and you’ve paid the mortgage balance down to $150,000. Your current equity is $150,000. So, can you really get a lump sum of $150,000 from a lender?
The short answer is, no.
Lenders generally allow cash-out refinance loans up to 80% of your home’s value. They will see a property value of $300,000 and subtract 20% ($60,000). That will leave around $240,000 you can borrow.
First, this $240,000 loan will be used to pay off your existing loan of $150,000. The remaining money — $90,000, in this case — represents the cash available to receive at closing.
Conventional cash-out refinances and FHA cash-out refinances both follow the 80% LTV rule.
Only the VA cash-out refinance allows higher loan amounts, up to 100% of your home value in some cases. However, you must be a veteran, active duty service member, or part of another military-affiliated group to be eligible for the VA program.
Cash-out refinance requirements
Taking a cash-out refinance to buy an investment property or second home is one of the best ways to put your equity to use, and it’s a common home buying strategy for real estate investors.
While lenders establish their own rules when it comes to eligibility for a refinance loan, there are some general cash-out rules that borrowers can expect to see.
Home equity of 20% or more
Homeowners will need more than 20% equity in their primary residence to qualify for a cash-out refinance. You typically have to leave 20% of the home’s value untouched, which means that you can only cash out the amount of equity you have above that threshold.
Leaving 20% equity in the home also has an advantage: the borrower dodges Fannie Mae and Freddie Mac’s private mortgage insurance (PMI) requirement.
However, an FHA loan will require FHA mortgage insurance premiums (PMI) even with 20% equity left in the home.
Credit score of 620 or higher
On a traditional mortgage refinance, you may qualify with a minimum credit score of 580 via the FHA loan program. But with a cash-out refi, you’ll typically need a credit score of 620 or higher no matter which loan program you use — whether an FHA, VA, or conventional cash-out refinance.
Debt-to-income ratio of 43% or less
Many mortgage lenders require a borrower’s debt-to-income ratio to be less than 43%. Your DTI is the amount of monthly expenses divided by your total monthly income. It shows your cash flow which predicts your ability to repay the loan.
So if you pay $2,000 each month for household expenses and your mortgage payment, and your income is $5,000 per month, then your DTI is 40%.
Borrowers with lower DTIs tend to pay lower interest rates.
Loan-to-value ratio of 80% or less
Your loan-to-value ratio (LTV) is a comparison of your current mortgage with the appraised value of your home. It’s another way to measure equity.
If your existing loan balance is $140,000 and your home appraises for $200,000, then your LTV would be 70%.
Lenders use LTV to determine whether or not to approve a refinance loan.
Other common cash-out requirements
Additionally, most homeowners will need to provide verification of income and employment, as well as a new appraisal that verifies the value of their real estate. Lenders may also ask about your cash reserves.
And, there will be refinance closing costs which could be anywhere from 3% to 6% of your new loan’s amount. Some borrowers pay closing costs with part of their cash out.
How soon can you get a cash-out refinance loan?
Many homeowners wonder how long they have to hold their current mortgage before they’re eligible for a cash-out refinance.
If you have a conventional, FHA, or VA mortgage, most lenders require a six-month waiting period after closing on the first mortgage before taking out a cash-out refinance.
With FHA and VA loan programs, you’re also eligible for a Streamline Refinance, and you’ll generally need to wait for 210 days before refinancing. However, these loans do not allow cash back at closing.
A USDA refinance could require a six- to 12-month waiting period, and USDA loans never allow cash-out. Read more about refinancing waiting periods here.
Cash-out refinance to buy an investment property
Using a cash-out refi to buy an investment property can save on interest compared to using an investment property loan.
Keep in mind that investment property loans have higher interest rates than primary home loans. If you take a cash-out refi on your primary residence and use it to buy an investment property, you’re paying a lower interest rate than you would if you financed it outright.
In terms of real estate investing, you can use real estate equity to immediately buy a second home or to purchase a new investment property.
As soon as you close the cash-out refi, you can use those funds as a down payment on another home — or to buy the house outright — if you plan to keep the current home as your primary residence.
That means you’ll keep living in the house you’re cashing out, and use the second home only as a vacation property or a way to earn rental income.
Cash-out refinance to buy a second home
You can use a cash-out refinance on your primary residence to buy a second home or vacation home. But you can’t use it to buy a new primary residence and then immediately move out of the home you refinanced.
How come? There aren’t any restrictions on the use of cashed-out funds, right?
That’s usually true, but cash-out refinancing and HELOCs generally have a clause that says you expect to remain in the property for at least a year.
This means you cannot get a check at closing and buy a new primary home the following week. That would be a violation of the mortgage terms. Violate the rules, and the lender has the right to call the loan and demand immediate repayment.
For details and specifics speak with lenders about your options.
Alternatives to cash-out refinance for buying a second home
Cash-out refis aren’t the only way to borrow against your home equity.
Another loan option may better meet your needs, especially if you’d like to keep your existing mortgage in place while also accessing equity.
Home equity loans
A cash-out refinance does two things: It replaces your current mortgage and generates cash back from equity.
If you’d like to keep your current loan while borrowing against your equity, consider a home equity loan.
These usually come with fixed rates and payments like a personal loan. But since you’re using home equity as collateral, interest rates should run lower than personal loan rates.
You can also use a home equity line of credit, or HELOC, to pull equity out of a home. There are typically few upfront costs. It’s like a credit card. During the first few years of the loan term, you can take money out as needed and pay it back.
However, a HELOC has several drawbacks.
First, the interest rate is likely to be adjustable rather than fixed like a home equity loan rate.
Also, a second mortgage typically has a higher interest rate than a first mortgage. How much higher depends on your credit history, the new loan amount, location, and equity.
Finally, you have to watch HELOC balances to avoid steep monthly costs.
HELOCs are typically structured with two phases:
- The drawing phase: You can draw money out and put money back in. You make interest-only payments on the balance
- Repayment period: You can no longer draw money out and must repay the balance over the remaining term of the loan. If you have a big HELOC balance, the result can be large monthly repayment costs.
While cash-out refinancing and HELOCs may not be structured to help with the purchase of a second home, that’s not the case with bridge loans. A bridge loan is specifically designed to help you move equity from one residence to the next.
The great attraction of a bridge loan is that it’s intended to be short-term financing. It might be outstanding for just a few months. You don’t have to make monthly payments.
There are also downsides. Bridge loans often have higher interest rates — maybe two percent above typical mortgage rates. Also, there can be a lot of upfront fees.
Still, a bridge loan will do the job if you want to buy a replacement home. When you sell your current residence, the bridge loan will be paid off at closing. The cost does not carry over to the new property.
Cash-out refinance to buy investment property or a second home: FAQ
Yes, you can use the equity in your current home to buy a second home. Many people do this by taking a cash-out refinance on their house and using the withdrawn money to make a down payment on a second home. But you could also borrow against your equity to buy a second property with a home equity loan or line of credit (HELOC).
When you do a cash-out refinance, you usually have to leave 20 percent equity in the home. This rule limits the size of your new loan. For example: If your home is worth $250,000, and you owe $150,000 on the existing mortgage the most cash you could get out would be $50,000. ($50,000 + $150,000 = $200,000, which is 80 percent of $250,000.)
It’s possible to use a cash-out refinance on your home to buy an investment property. You could use the withdrawn money to make a down payment or buy the investment property with cash. And you can do this as soon as the refinance closes. However, you still have to meet your lender’s minimum credit score requirements for refinancing. And you’ll likely need a fair amount of equity in your current home, as lenders usually require15 to 25 percent down to purchase an investment property.
If you plan to buy a vacation home or an investment property, you can buy as soon as your refinance closes and you have the cash in hand. However, you cannot buy a separate primary residence using a cash-out refinance and then move into it right away. That’s because lenders usually require you to stay in your current home for at least a year if you’re getting cash out on it. But you could convert your primary residence into a rental and get a cash-out loan based on non-owner-occupied mortgage rates and rules.
If you’re using a cash-out refinance, you’ll get the funds once the loan closes. Closing a refinance takes about 35 to 45 days on average.
Yes, you can pull equity out of a rental property using a cash-out refinance. In fact, it’s a common investment strategy. You just need to have enough equity to leave at least 25 percent in the property. And you’ll also need to meet the underwriter’s credit requirements.
Yes, you should be able to write off mortgage interest on a cash-out refinance as long as you use the money to buy, build, or improve a home. But you should always work with a qualified tax preparer to make sure.
Shop cash-out refinance rates today
Mortgage lenders will work with you to find the best way to borrow against your existing home equity.
Be sure to shop around with a few lenders to make sure you’re getting the best rate and terms on your new home loan.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.