Can I get a second mortgage if my house is paid off?
Yes, it is possible to get a home equity loan on a paid-off house. In fact, if you do not currently have a mortgage you are in a strong equity position, which makes getting a loan on a house you own even easier.
Homeowners who do not have a mortgage do have 100% equity, which they can borrow from. Loan options include a home equity loan and home equity line of credit (HELOC). As with all loans, there are risks involved with taking equity out of a paid-off house. Getting a home equity loan or HELOC creates debt that will be secured by the value of your home. Can you use a paid-off house as collateral? Absolutely, when a paid-off house is used as collateral. However, failure to repay the loan according to the terms of the loan agreement could result in the lender foreclosing and taking possession of your home.
While it's important to understand the risks of having a mortgage, there are benefits to a home equity loans and HELOCs, including using the money to make home improvements that could increase the value of your home.
Read on to learn more about getting a loan on a house you own.
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How to qualify for a second mortgage
There are several eligibility requirements for a home equity loan (second mortgage), which include:
Credit score. Most lenders require a credit score in the mid 600s. Some lenders may require a higher score and some lenders may accept a lower score.
Debt-to-income (DTI) ratio. Your DTI ratio is a comparison between your income and your monthly debt payments.
Loan-to-value (LTV) ratio. This ratio is calculated by the mortgage lender during the mortgage loan application process and is used to assess lending risk. If the LTV is too high, the loan is considered high risk and the offered interest rate will be higher, or the loan will be denied.
Options for taking equity out of a paid-off house
There are several options for taking equity out of a paid-off house:
Home equity loan. A home equity loan is provided in a lump sum payment at closing, which is repaid based on a fixed interest rate. If you utilize the loan for home improvements, you can deduct the interest from your taxable income and lower your tax expenses.
Home equity line of credit (HELOC). A HELOC is a type of “revolving” credit that features a credit limit and a variable interest rate. When you get a HELOC you'll only pay interest on the amount of the loan you use, not the entire credit line you're approved for.
Cash-out refinance. A cash-out refinance is typically done by homeowners who already have a mortgage and want to get a lower rate and cash in-hand. Homeowners who do not have a mortgage can still get a new mortgage and receive a cash disbursement of the extra funds (based on your home equity) at closing.
Sale-lease back program. Also known as a rent-back agreement, this program involves a homeowner selling their home to a real estate company or an investor who lets the seller live in their former home and rent or lease back their property by paying rent to the new owner. Because the seller has money from their home sale, they'll have more cash on hand. These agreements are typically short-term and require the sale of your home.
Shared equity agreement. Also known as shared equity financing, this requires an investor to put up the money for the down payment to purchase a home in which the occupant will live. The occupant may eventually buy-out the investor's share in the home or the home is sold and the proceeds shared according to the agreement between the two parties.
Benefits of taking equity out of a paid-off home
Here are several benefits of getting a loan on a house you own, including:
Easier to get approved. Having a paid-off home puts you in a strong position to be approved for a home equity loan. As long as you have a good credit score, you are likely to be offered a favorable interest rate and loan terms.
Access to a large amount of funds. Because you have ample equity, lenders are more likely to lend at the upper loan limit.
Spending flexibility. You can use the money any way you choose.
Avoid capital gains taxes. Home equity loans aren't calculated into capital gains taxes when you sell the home.
Potential tax benefits for making home improvements. According to the IRS, home equity loan and HELOC interest is tax deductible if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan.
Risks of taking equity out of your paid-off home
Home will be used as collateral. This means that failure to repay the loan could put your home in foreclosure by the lender.
Costs. All loans come with closing costs, as well as the expense of making monthly loan payments.
Temptation to overspend. Having money in-hand makes it tempting to spend it on luxury items and other purchases that we're not in your original plan.
What to consider before tapping into your home's equity
Taking on any type of mortgage-related loan is a big responsibility, especially if you do not currently have a mortgage. Here are some factors to consider prior to signing for a loan:
The amount you want to borrow. Homeowners who have no mortgage should carefully consider the reason for getting a mortgage and borrowing from their home equity. Be clear about how much money you need and the way you intend to use it.
What you can afford month-to-month. When considering home equity loan options and uses for a home equity loan a loan representative will calculate your debt-to-income (DTI) ratio, which is a comparison between your income and your monthly debt payments. A high DTI ratio indicates to lenders high risk for not being able to afford a mortgage loan. A low DTI ratio indicates to lenders that you are low risk and can likely afford to make monthly mortgage payments in addition to paying your current debts.
Alternatives. If major home renovations or a knock-down-and-rebuild are your goal, you may want to consider a construction loan. For smaller renovation projects a home equity loan or HELOC for home improvements may work better for you. Most of all, consider whether you really need a mortgage to get the money. Personal loans are another option and your home will not be used as collateral. The good news is, with so much equity available to you there are many alternatives to choose from.
FAQs
How much equity can I take out of my paid-off home?
If you're looking for a home equity loan on paid off house, most lenders will let homeowners with no mortgage borrow up to 85% of their home equity. For example, if your home is worth $500,000, you may borrow up to $425,000 ($500,000 x 85%).
How can I apply for a second mortgage?
Home equity loans and HELOCs are both types of second mortgages that are easy to apply for. Start by talking to a representative at your local credit union or bank about interest rates, terms, and your goals for the funds. For example, a CU SoCal loan officer can help you figure out how much of a HELOC you can get.
Does having a paid-off house improve your chances at getting a second mortgage?
Yes, having a paid-off house means you have 100% equity and a proven record of successfully paying off your mortgage debt. Getting a loan on a house you own is easier than if you have an existing first mortgage.
Is taking out a second mortgage a good idea?
Taking out a home equity loan second mortgage or a HELOC second mortgage can be a good idea if you can afford to make the monthly loan repayments.
Can you use a paid-off house as collateral to buy another house?
Yes, a home equity loan or HELOC can be used to buy a second home or investment property. If you do not have the cash on hand to purchase a second home, applying for a HELOC to buy a second home could be a good option and easier than applying for a traditional mortgage. Home equity loans can also be used to make a downpayment on another house.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
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