How to Use a Cash-Out Refinance to Buy a Second Property

Are you interested in buying a house in addition to your primary residence? If you do not have the cash available for a down payment, borrowing the funds is one way to fast forward your timeline. Before taking out a high-interest loan, consider a cash-out refinance on your existing property. In this article, we examine using a cash-out refinance to buy another home and what you should know whether it is a second home, vacation home, or investment property.

Why would I use a cash-out refinance versus another option?

Any type of refinance replaces your current mortgage with a new one. In the case of a cash-out refinance, you leverage the equity in your home to take out another mortgage and receive a lump sum of cash at closing. You could then use the cash for the down payment on the second property. Your new mortgage has an updated rate, term, and a higher balance. To obtain a cash-out, your lender will look at your credit, income, debt load, and equity.

How much cash can I get from a cash-out refinance?

The amount of cash you can access is based on the equity in your home. Equity is the difference between your home’s value and any outstanding loans on it. Lenders use a ratio called loan-to-value (LTV) to determine your eligibility and how much equity you can access. A standard LTV is 80 percent, meaning you can borrow up to 80 percent of your home’s value.

What kind of property can I purchase using a cash-out refinance?

When you have equity in your primary residence, you can use it any way you choose. Investing in another piece of real estate can give you an excellent return on your investment. The money you take out of your primary residence as a down payment can help you get attractive loan terms to buy another property. However, the type of property can affect loan terms such as rates and down payment requirements, based on the amount of risk a lender perceives.

Cash-out refinance to buy a second home

By definition, a second home is:

• For personal use

• Where you live part-time, even if it is only a few times per year

• Located at least 50 miles away from your primary residence

If it is within 50 miles, it has a higher chance of being an investment property with stricter requirements than a loan for a second home.

Besides primary residences, second homes have the most flexible underwriting and down payment guidelines. You can typically get by with a 20 percent down payment. Obtaining your down payment from your home's equity can help get you on the path to owning a second home.

Cash-out refinance to buy a vacation home

A vacation home is similar to a second home, but has differences:

• For personal use

• Where you live part-time, even if it is only a few times per year

• May be rented occasionally to help cover costs

It is common for vacation homeowners to use the property a couple of times a year, and when they are not using it, they rent it out, using the income to cover the mortgage payments. You will typically need a higher down payment for a vacation home than a second home if you plan to rent the property out when it is not in use. Your lender will just need to make sure you can afford both mortgage payments if you still have a loan on your primary residence.

For example, if you live in the Midwest but buy a vacation property in Florida, you may use it a few times a year and even let family use it. The times when it is not occupied, though, you may rent it out to cover the cost of your mortgage, HOA dues, and upkeep.

Cash-out refinance to buy an investment property

There are a few defining characteristics of an investment property:

• Not for personal use

• Generates income or takes advantage of tax benefits

If you are ready to level up from investing in stocks and bonds and want to move into real estate, a cash-out refinance to buy a rental property can be a great way to get started. Since a mortgage helps you leverage your investment, you can buy a property that is worth much more than you invest in it. That may provide you with a more significant return on investment (ROI).

The condition of the property and your intention for it will determine what you need to qualify for the loan. For example, if you are buying a run-down property, you will need a much larger down payment, or possibly all cash, versus purchasing a home that is turnkey and ready to rent to tenants. You will likely need a 25 percent or higher down payment for a rental property. Ask your lender if you can use the potential rental income from the property to qualify.

Is a cash-out right for you?

A cash-out can be a great way to get the money you need to buy a second home, vacation home, or investment property. Whether you are looking to invest in a property for income purposes, a quick profit, or you want the luxury of owning a second home, using the equity in your first home can help you have a great return on your investment.