Using the equity you've built up in your current house to buy a second home may not be either the worst or best idea you've had. It depends on your financial situation and your plans for the second home. Any second home will increase your total debt and monthly payments. You'll have to weigh the benefits of a second home against the very real costs of monthly payments.
Consider Your Second Home
Using your home equity can be a good idea if you want to buy a place now for your eventual retirement, a vacation spot you can rent for additional income or a vacation house as an investment you'll sell eventually -- ideally at a profit. Using your equity for a second home, though, can exhaust your potential financing for emergencies.
Using Equity Line of Credit
A home equity line of credit may be a good option for a down payment on a second home. You usually can get a credit line that allows you to pay interest only or just a small amount on the balance, but you'll have to pay off the balance at the end of the term, usually 5 to 15 years. This may help you get a lower rate on your second home mortgage with a bigger down payment.
Pay Off the Second Home
If you have enough equity in your first home to pay cash for a second home, and can afford the higher payments with an increased basic mortgage, you'll be assured of always having a free place to live. If you also can rent that paid-for second home, you'll add to your income. Remember, though, that a rental will require more maintenance and will change your tax status on the second home.
Figure Debt Ratio
Figure your debt to income ratio before making a decision. Add up all your debt payments, mortgage, car, credit card and other loans. Divide your monthly income by that total, then divide your income just by your housing payments. Your total debt ratio should be under 36, housing ratio under 28. Make the same calculations adding the higher debt by using your existing equity; if the ratios are still in the 36/28 area you can safely use your equity.
Using Your Emergency Funds
Using all your existing equity for a second home can be bad if it eliminates the equity as a source of emergency funding. A home equity line of credit is a good source for home improvements, big medical bills or other unexpected expenses. If you exhaust your equity for a second home, you won't have that to fall back on.
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