If you’ve found a destination you love and return to year after year, buying a property there can be a good investment. But how are you going to pay for it? While saving for your vacation home is the most financially responsible thing to do, it’s not the most practical. If you’re ready to buy now and own a primary residence, a home equity loan can be a great way to make your dreams a reality. Using your home equity as collateral, this type of loan can either cover a down payment on a vacation home or make a cash purchase, depending on where you want to buy and the equity which you have available.

How a Home Equity Loan Works

A home equity loan is based on the the equity you have built up in your home. Equity is determined by the current value of your home minus the amount you owe on your mortgage. Your net worth can fluctuate because home values ​​depend on market conditions, such as available inventory and changes in the area.

A home equity loan uses this equity as collateral for the amount you wish to borrow. Generally, you cannot borrow the entire amount of available equity. Home equity loans are considered secured loans because they have physical collateral and come with attractive interest rates.

The process of getting a home equity loan is similar to applying for your first loan. mortgage. The value of the house must be established using a assessmentthen the conditions are decided. Home equity loans are paid in a manner lump sum in cash and must be repaid over time according to a fixed schedule.

In addition to the amount you borrow, you will pay interest on the loan, closing costs which cover the preparation of the loan, assembly costsAnd registration fees. Some lenders offer the option of paying pointsor interest paid in advance, at closing. This can reduce your overall refund amount but will increase your closing costs. You can choose how many points to take, if any, from your lender.

How to Buy a Vacation Home with a Home Equity Loan

The beauty of home equity loans is their flexibility. Since they are paid as a lump sum and repaid over time, they can be used for any purpose, including purchasing a vacation home. You can use the money from a home equity loan to purchase your vacation home: as an all-cash purchase or as a substantial down payment.

Most home equity loans will only allow you to borrow a percentage of your total equity. Even if your home is fully paid off, you won’t necessarily have access to its full market value. The amount a lender might offer will be based (at least partially) on the combined loan-to-value (CLTV) ratio 80 to 90% of the appraised value of the home.

For example, let’s say your house is worth $500,000 and you owe $200,000. To find the maximum CLTV ratio, multiply the value of your home ($500,000) by 90% (0.9), then subtract your current debt balance ($200,000). The rest ($250,000) is the maximum amount you could probably borrow with a home equity loan.

What you do with the money depends on what you want to buy. If you’re aiming for a small lake house or a modest cabin in the woods, $250,000 may be enough to purchase the property, essentially making your home equity loan function as a mortgage for your vacation home. If you’re considering purchasing a property outside of the United States, an all-cash offer can make it easier for you to purchase a property and allow you to forgo working with a lender for the remainder of the purchase price.

If you are aiming for a beach house or a mountain retreat, you may need to use your lump sum as a large down payment for your property. This can offer you better rates and terms for the required mortgage. Have a little extra money to cover repairs and renovations, property managers When you are not occupying the house, secondary home insurance is also wise.

Advantages and disadvantages

Whether you pay all cash or use your home equity loan as a down payment for a vacation home, there are risks associated with using your home equity. Since home equity loans are a second mortgage, you’ll need to budget for an extra payment in your monthly budget. Since you are using your primary residence as collateral, your lender will place a second privilege on your house. If you fail to make your loan payments, then your lender can potentially take your home.

When calculating your monthly budget with your home equity loan, factor in the added costs of a second home. You may need to hire a property manager to monitor the house while you are away. Home insurance may also be higher. Are you buying near the beach or a lake? Flood Or hurricane insurance maybe in order. If you do not consider rent your property when you don’t use it, the entire weight of responsibility will fall on your shoulders and your budget.

In the plus column, a home equity loan usually has very reasonable rates and a fixed repayment schedule. A home equity loan may be easier to obtain than a new mortgage for your second property.

The essentials

A home equity loan is one of the most flexible forms of financing if you already own a home. Buying a vacation home is an important decision and not without risks. Before purchasing a vacation home, make sure your monthly budget can handle a mortgage and home equity loan. Also consider the additional costs of vacation ownership: insurance, property management, repairs and renovations, etc. Your home equity loan could provide you with purchasing power in a highly competitive market.