Equity as Cash
You can only purchase a new property with equity if you actually have significant equity in the original property. This is accomplished through market appreciation (where the property gains value based on an upswing in the housing market), mortgage reduction or a large down payment on the original property. To purchase a new property with equity, you'll need to get a home equity loan or line of credit in addition to your first mortgage (if you have one) on the original property. Borrowers should be very careful to consider how their loan-to-value ratio will be affected when taking out additional mortgages on existing properties. Tapping equity should be done with great care, and maxing out equity on a house is never recommended.
Sometimes a lender will be able to complete the equity line on the existing property and the purchase of the new property at the same time. This process will be smoother and may offer a reduction in fees, as you'll be eliminating the fees that a second mortgage broker will charge. The best-case scenario is to own the existing property outright (free and clear) so as not to put the original house at risk if the housing market tanks. If you have mortgages on both properties and run into financial difficulties, you could wind up losing both to foreclosure. Contact your original lender to inquire about a simultaneous refinance and purchase.
Borrowers must consider the change in their monthly outgo when taking on two properties. Not only will borrowers need to add an additional payment for the new property, they will need to account for the increase in their mortgage payments on their existing property. Ambitious real estate investors should think carefully before tapping equity. Considerations should include: monthly cash flow, housing market changes, economic health in general, mortgage rates and changes in lifestyle.
Based in Eugene, Ore., Duncan Jenkins has been writing finance-related articles since 2008. His specialties include personal finance advice, mortgage/equity loans and credit management. Jenkins obtained his bachelor's degree in English from Clark University.