A guide to using home equity to buy your next home

white and brown concrete building under blue sky during daytime

If you’ve built up enough home equity, you can use it to buy your next home.

Even in today’s tough seller’s market, home equity is a powerful tool for buyers. Use this guide to learn how to estimate your home equity and the various ways you can use it to fund your next down payment.

What you’ll learn:

  • Home equity is the difference between how much you owe toward your home loan and how much your home is worth
  • You can use the equity in your current home to purchase your next one
  • You can liquidate your equity with a home equity loan, HELOC, or cash-out refinance
  • Once you buy your next house, you can sell your first one or rent it out to pay off the equity loan

What is home equity?

Home equity is the amount of your house that you own. In other words, it’s your home’s appraised value, minus how much you owe on your mortgage. For instance, if you just bought a $300,000 home with a 20% down payment, then your equity in that property is $60,000.

As you pay down your loan and as property values rise, your home equity increases. Thanks to recent surges in the housing market, homeowners with mortgages enjoyed a 29.3% increase in their equity in 2021. In fact, the average year-over-year home equity gain in 2021 was $55,000.

How to buy your next home with home equity

Many homeowners rely on their home equity to buy their next home before selling their current one or to purchase a second property (whether as a vacation getaway or an investment).

For example, let’s say you want to buy a new home for $350,000, but you don’t have enough in savings for a 20% down payment. You can take out a loan against your current home’s equity and put that money toward the down payment (and avoid mortgage insurance in the process).

Home equity loans are an attractive option because they generally have low interest rates and are easier to get than personal loans. This is because they present less risk to the lender, since your home serves as collateral. Here’s what that process looks like:

Determine how much equity you have in your home

You can get a vague idea of your home’s value by looking up your property on an online listing site or home evaluator—but these tools aren’t exact.

For a more precise figure, contact your real estate agent and ask for a competitive market analysis. Your agent will then estimate how much your home is worth by comparing it to similar properties nearby, while also factoring in your house’s size, condition, and any recent home improvements.

To determine your total equity, take that value estimate, then subtract your remaining mortgage loan amount. 

Keep in mind that your lender will eventually require a home appraisal to determine your home’s value. But getting an estimate now will still help you weigh your home equity loan options.

Decide which type of home equity loan to get

There are several different ways to use your home equity to fund a down payment. Each loan type has its pros and cons, so be sure to speak with a mortgage professional or your Flyhomes loan officer before making a decision.

aerial view photography of white house near swimming pool
There is more than one type of home equity loan. Each has its pros and cons but they are both available to you as a way to buy your next home

Home equity loan

A home equity loan is a lump-sum loan that allows you to convert your home’s equity into liquid cash that you can use for a down payment on your next house. You receive funds equal to the equity value of your home, then repay it with interest. 

This loan functions as a second mortgage on your current home that you repay over five to 15 years, depending on your loan terms. Or, if you’re buying before selling, you can repay the loan once you’ve sold your current home.

Home equity loans typically have fixed interest rates, which means your monthly payments remain stable.

Home equity line of credit 

A home equity line of credit (also called a HELOC) allows you to withdraw money up to a specific limit, within a certain amount of time. Similar to a home equity loan, your lender will make funds available to you, determined by the amount of equity you have in your home. But instead of it being a lump sum, it is a credit line that you can borrow from as needed and only repay what you use. 

As you pay off what you’ve borrowed, your line of credit resets so you can borrow again. In this way, a HELOC functions somewhat like a credit card. Typically, you must repay the entire HELOC within 10 to 20 years.

Also like a credit card, HELOCs allow you to make payments either solely on your accrued interest, or on accrued interest plus principal.

However, unlike home equity loans, a HELOC’s interest rates are variable, meaning they fluctuate with the market. This means your monthly payments may fluctuate as well.

Cash-out refinance

A cash-out refinance increases your current mortgage amount and is typically limited to 80% of your current home’s value. When your home appreciates, you can increase your loan amount to account for the higher price of the home and keep the cash difference between what you’ve already paid off and the new, higher loan amount. 

Since this is a refinance, you will have to pay closing costs, which can be 2-5% of the new loan amount. It will also change the mortgage interest rate you pay, so this option is better taken when rates are low.

Homeowners typically use this option if they’re looking to buy an investment property rather than their next primary residence.

Reverse mortgage

A home equity conversion mortgage (HECM) allows homeowners age 62 or older to buy a new home and finance it with a reverse mortgage, all in one transaction. You can receive funds as a lump sum, a line of credit, or monthly payments.

The upside to a reverse mortgage is that you don’t need to make monthly payments. Instead, you repay the loan when you sell or leave the home. The downside is that the interest still accrues in the meantime.

With an HECM, you must sell your current home first. This can be difficult if you can’t afford temporary housing and storage while you hunt for your next home.

All-in-one short-term loan program

This is a convenient alternative for those looking to buy their next home before selling their current one.

For example, Flyhomes’ Buy Before You Sell program gives you a short-term loan so you can make a competitive cash offer on a home you love. While you settle into your new place, our team sells your first home at top dollar. Next, we set you up with a long-term loan, or you can choose your own mortgage lender. 

MacBook Pro, white ceramic mug,and black smartphone on table
The sale of your first home should be able to pay off the home equity loan you used to make a down payment on your next one but it depends on how much equity you actually have

Apply for a loan and close on your next home

Your next step is choosing a mortgage lender (be sure to shop around for the best rates) and beginning the pre-approval process.

Your lender will likely need certain financial documents, typically:

  • Tax returns from the last two years
  • W-2 forms from the last two years
  • Bank statements
  • Pay stubs
  • Current mortgage statements

Your lender will also look at your credit score and your debt-to-income ratio (DTI). (The ideal credit score for a home equity loan is 620 or higher, and the ideal DTI is 43% or lower.)

If your credit score is low, you may still be able to get a home equity loan, especially if you’ve built up substantial equity over the years. Expect higher interest rates, though.

Next, your lender will schedule a professional home appraisal to see how much your home is worth in today’s market.

After pre-approval, you can begin bidding on homes. Once a seller accepts your offer, you’re ready to move forward and close on the home equity loan. And remember, the FTC’s Cooling-Off Rule lets you safely cancel the loan within three days after closing.

Once you’re ready to move into your new home, you can sell your first property and pay off the home equity loan—or you can rent it out and use the income for loan repayment. 

Wrapping up

It may sound complicated, but using your home equity can be a great way to finance your next property purchase. And now that you understand the different types of home equity loans and what to expect during the loan application process, you’re ready to take action!

FAQ

Is it worth buying a second property with equity?

It depends on your goals and your financial situation. If you’re using the equity to buy an investment property, make sure the rental income can cover the loan and all other rental expenses. If you’re purchasing a vacation home, your income should be high enough to pay both mortgages.

How do you use equity as a down payment?

You can tap into your home equity with a home equity loan, a HELOC, a cash-out refinance, or a short-term loan program. Each of these options allows you to liquidate a portion of your equity so you can use it for a down payment on your next property.

How do you leverage a house to buy another?

If you have enough equity in your home, you can take out a loan against it to buy another house. Once you’ve settled into your new house, you can sell your former one to pay off the home equity loan.

About the author: Jenny Rose Spaudo is a Florida homeowner as well as a freelance journalist, content strategist, and copywriter specializing in real estate, PropTech, and investing. Her clients include Edward Jones, Flyhomes, Knock, and PropStream, and her writing regularly appears in publications like Business Insider and GOBankingRates. Visit her website and connect with her on LinkedIn.

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