How To Tap Equity in a Vacation Home
You may find yourself in a situation where your vacation property has risen in value and you’d like to turn that equity into cash for other purposes.
There are a few ways to do this. It’s not quite as easy as getting cash from your primary residence, but it’s entirely possible.
Here’s how to tap the equity in a vacation property.
Conventional Cash-Out Refinance on the Vacation Home
The most straightforward way to tap equity is a cash-out refinance.
You open a larger loan than what you owe and receive the difference in cash.
You can get up to 75% of the home’s current value with a conventional loan.
For example, you owe $200,000 on a vacation property that is now worth $500,000. You could get a new loan up to $375,000. This new loan would pay off the current one and give you $175,000 in cash minus closing costs.
However, there are drawbacks to this strategy:
You lose your current mortgage rate
Your payment will rise
The new loan comes with high closing costs
Rates are high
A Warning About Vacation Property Cash-Out Rates
Conventional vacation home loans from Fannie Mae and Freddie Mac used to come with similar rates as primary homes. But in early 2023, these agencies significantly increased costs.
Now, financing a second home isn’t as cheap as it used to be.
For example, someone with a 720 score would pay more than 4% of the loan amount (4 points) for a cash-out refinance on a second home. That’s over $15,000 in points.
What’s worse is that lenders typically can’t raise your rate enough to absorb those fees. You have to pay them out of pocket or wrap them into the new loan.
Knowing that conventional cash-out vacation property loans aren’t ideal, are there alternatives?
HELOC on a Vacation Home
Most lenders allow a home equity line of credit (HELOC) only on a primary residence. However, local banks and credit unions may allow a HELOC on a vacation or investment property.
Inquire with small credit unions located near the property. They may have a specialty product for the area, especially in popular vacation destinations.
If they don’t allow vacation homes, ask if the lender allows investment property HELOCs. See if you can classify the property as a rental home (most vacation property owners rent it out some part of the year).
Vacation or rental property HELOCs may offer lower loan-to-value maximums or come with higher rates, but they may be a better value than taking on a new cash-out refinance.
Portfolio Loan
What’s a portfolio loan? Most lenders sell off loans to the secondary market. A portfolio lender keeps loans in its portfolio, takes payments, and services the loan itself.
A portfolio lender creates its own lending rules and is not subject to guidelines or pricing handed down by Fannie Mae or Freddie Mac.
This can result in better rates and terms than are available with a conventional loan.
Check around with large and small banks, mortgage lenders, mortgage brokers, and credit unions for vacation home loans they may offer.
Keep in mind that any lender may offer portfolio loans alongside conventional financing. It’s worth checking with many lenders to see their vacation property cash-out options.
STR Loan
If you regularly rent out your property, you might qualify for a Short Term Rental (STR) loan that allows cash-out.
There are many types of STR loans, and many require adequate income on the property.
DSCR Loan: A debt service coverage ratio loan qualifies the property based on whether rental income covers the payment. Some lenders offer cash-out DSCR loans.
Hard Money: These loans are a form of short-term financing and should only be used if you plan to fix up and sell the property quickly. Hard money loans don’t work as permanent financing.
Private Loans: An individual financier or a lending group may be willing to fund your cash-out loan to earn interest. This option requires legwork to find the right person or group.
Tax Returns Show Rental Income on a Vacation Property
If you decide on a conventional loan, know that Fannie Mae and Freddie Mac allow rental income to appear on tax returns for a vacation property. It won’t automatically disqualify the property as a vacation home.
However, you must plan to use the home personally for “some portion of the year” which many define as 10% of the amount of time it’s rented.
Showing income on tax returns can benefit you if you plan to classify the property as an STR or portfolio investment property.
Cashing out a Vacation Property Can be a Savvy Move
Home equity is great, but it doesn’t do you much good unless you can tap it for financial goals.
See if you’re eligible for a lending option to tap the equity in your vacation property.
