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While it is possible to buy a second home without a down payment, the scenarios in which you can do so are quite rare.

Traditional zero-down payment programs may not be available to you because you’re no longer a first-time homebuyer. Lenders are also generally hesitant to offer second home mortgages with low down payments. The down payment requirements for a second home are usually 10% or more.

But you may be in luck: Sometimes you can figure out how to buy a second home with no down payment. Read on to learn:

•   What does buying a second home involve?

•   What are the usual down payment requirements for a second home?

•   How can you buy a second home with no down payment?

Note: SoFi mortgage loans require a down payment.

What to Know About Buying a Second Home

Buying a second home comes with a different set of guidelines and rules than purchasing your first home. You’re no longer considered a first-time homebuyer, which disqualifies you from many down payment assistance programs. However, your situation will be treated differently depending on how you want to use the property. Consider the following possibilities:

Moving into the Second Home

If your plan is to keep your first home as a rental property and move into the second home, you may have some options. A mortgage loan may be available in one of two ways.

•   USDA loans in approved areas have zero-down payment options. You’re allowed to get a second home with a zero-down USDA loan if you meet certain requirements involving citizenship, income, and other factors. You must live in the property as your principal residence, and you cannot have a USDA loan on your first property. In addition, you must financially qualify for both homes. To count rental income for the first home, USDA requires 24 months of rental income history.

Note: SoFi does not offer USDA loans at this time. However, SoFi does offer FHA, VA, and conventional loan options.

Other qualifiers for this kind of loan include:

•   The current home no longer meets your needs for certain reasons (for example, if your family is growing and you live in a two-bedroom home, you’re relocating for a new job, or you’re getting divorced).

•   You don’t have another way to obtain the property without the USDA loan.

•   You can only keep one other house besides the new second home.

If, say, you’re moving from to a new region for a job opportunity, and USDA loans are available in the area you’re moving to, it’s possible to keep your first home and buy a second if you meet the above conditions.

Worth noting: An obstacle for borrowers can be that lenders need a way to verify rental income. A signed lease and bank statements may not be enough. Your lender may want to see the rental income reported on your taxes for two years.

•   VA Loans may also offer zero down payment options. Available to qualifying veterans, service members, and surviving spouses, these government-backed loans can only be used to purchase property that will be a primary residence. So, if you’re moving from one place to another and qualify, you can use a VA loan to purchase the next property with no money down.

Buying the Second Home as a Vacation Home or Rental

Is there a way to buy a second home with no down payment if you plan to use it as a vacation home or rental? Options are few and far between if you’re not planning to use the property as your principal residence. When you’re looking at non-owner-occupied financing, lenders usually want a bigger down payment, not a smaller one.

That said, here are a couple of options that could answer the question of how to buy a second home with no down payment:

•   Private loans: If you finance through a relative or other private source, it’s possible to obtain a no-money-down mortgage. Terms are agreed upon by both parties.

•   Seller financing: Much like a private loan, the conditions of seller financing (aka owner financing) a loan are whatever the two parties agree on. If the seller is willing to let you buy the property with no money down, you might be able to make this work. However, seller financing usually comes with a bigger down payment, not a smaller one.

Do You Need a Down Payment on a Second Home?

Down payment requirements for a second home are usually higher. Lenders also look for a higher credit score. The loftier down payment requirement and credit score reflect the fact that the lender is taking on elevated risk since borrowers are more likely to default on a second home than a first home. A lender may expect your down payment to be right around the average down payment on a house, which is currently 13%.

Yet, your mortgage lender is also looking for a loan that accommodates your unique situation to help you to buy a second home. Though no down payment options are rare, your lender may have access to financial products that allow for a smaller down payment.

Can You Buy Another Home When You Have a Current Mortgage?

If you financially qualify, buying another house when you have a mortgage is possible. Generally speaking, lenders look for a strong credit history and enough income to cover your debts (including the cost of the new mortgage) to determine if you qualify for an additional mortgage.

Recommended: What Is a Second Mortgage?

Using Home Equity as a Down Payment Source

If you don’t have enough cash for a down payment on a second home, you may be able to tap your home equity. A home equity loan or a home equity line of credit (HELOC) can help you access money to use for a down payment on a second home.

Though not all lenders will permit this, using home equity may be possible if you want to keep your first home and have no other way of obtaining enough money for a down payment on your second.

It may be advisable to get a home equity loan or HELOC while you are still living in your first house. This allows you to qualify for owner-occupant rates, which are typically much lower than non-owner-occupied rates.

Recommended: HELOC vs. Home Equity Loan: How They Compare

The Takeaway

While there aren’t many options for financing a second home with no down payment, you may be in luck. There are some no down payment loans available to qualified buyers, and these loans can help you preserve cash for renovations, improvements, and other expenses. Even if you can’t find a no down payment mortgage for a second home, you will likely have a number of financing options you can tap into that may allow you to snag another property.

SoFi now partners with Spring EQ to offer flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively lower rates. And the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit from SoFi, brokered through Spring EQ.

FAQ

What is the minimum down payment for a second home?

For a second home that is not going to be your primary residence, most lenders look for at least a 10% down payment.

How do I buy a second home without 20% down?

With a higher credit score and other financial qualifications, you may be able to find a lender or a program with a required down payment less than 20%.

Can I buy another house if I already have a mortgage?

If you’re a qualified buyer with good debt and income levels with a strong credit history, a lender may be able to approve you for a second mortgage.

Can I use my equity to buy another house?

It may be possible to use home equity to buy another home. Contact a lender to go over your unique situation.

Photo credit: iStock/Nuttawan Jayawan

^²SoFi Bank, N.A. NMLS #696891 (Member FDIC), offers loans directly or we may assist you in obtaining a loan from SpringEQ, a state licensed lender, NMLS #1464945.
All loan terms, fees, and rates may vary based upon your individual financial and personal circumstances and state.
You should consider and discuss with your loan officer whether a Cash Out Refinance, Home Equity Loan or a Home Equity Line of Credit is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit not originated by SoFi Bank. Terms and conditions will apply. Before you apply, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and a minimum loan amount. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria. Information current as of 06/27/24.
In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOHL-Q225-002

Getting mortgage preapproval can give you an edge in the home-buying process, especially when the housing market is tight. A mortgage preapproval from a lender lets sellers know that you have tentatively been approved for a specific loan type and amount. Not only does this show them that you’re a serious home shopper, it also helps give you a good sense of your budget as you go house-hunting.

Here, you’ll learn the ins and outs of how to get preapproved for a home loan.

What Is Mortgage Preapproval?

Mortgage preapproval involves a thorough review of your credit and financial history. If you look like a good candidate for a mortgage, a lender will issue a letter stating that you qualify for a loan of a certain amount at a certain interest rate. The letter is an offer — but not a commitment — to lend you a specific amount. It’s good for up to 90 days, depending on the lender.

You’ll want to shop for homes within the price range of your preapproved mortgage. Armed with your preapproval for a home loan, you can show sellers that you are a serious buyer with the means to purchase a property. In the eyes of the seller, preapproval can often push you ahead of other potential buyers who have not yet been approved for a mortgage and make it easier to compete when there are multiple offers on a house.

Once you find a house that you want to buy, you can make an offer immediately based on the loan amount for which you are preapproved. And if the seller accepts, it will be time to finalize your mortgage application. At this point, a loan underwriter will review your application and conduct other due diligence measures, such as having the house appraised to make sure it is valued at the price it’s selling for. If all goes well, the lender will issue another letter called a commitment letter, which officially seals the deal on your loan, and you can schedule a closing date.

When Should I Get Preapproved for a Home Loan?

Preapproval typically lasts for 90 days, at most, so you want to seek it when you are actively in the market for a new home. Maybe you’ve done some initial online research into available properties. Ideally, you’ve also had a good look at your finances and thought about how much you have available to spend on a down payment as well as what monthly mortgage payments you can afford long-term. It takes around 10 days after you submit a request to be preapproved, so factor that timing into your house search as well.

Mortgage Preapproval vs. Prequalification

If you are house hunting, you will likely hear two different terms regarding early mortgage moves: prequalification vs. preapproval. Prequalification is a simple, less involved look at your financial qualifications for a mortgage. Preapproval for a home loan is a more in-depth review of your finances and an indicator that your loan application will likely move forward smoothly. Each has its advantages — and its moment.

Mortgage Prequalification

Getting prequalified for a home loan involves a review of a few financial details — usually self-reported — such as income, assets, and debt. The lender will then estimate what size mortgage you can afford.

Pros of Mortgage Prequalification

•   It’s fast. The process can often be done in minutes, by phone or online.

•   You’ll zero in on house prices. Prequalifying for a home loan quickly gives you an idea of what your monthly payment might be and how much house you can afford.

•   You can shop around. You can prequalify with multiple lenders to see what types of terms and interest rates they offer.

•   It’s easy on your credit score. Prequalification will not affect your credit score because it only requires a “soft inquiry” into your credit record.

Cons of Mortgage Prequalification

•   It’s no guarantee. Because it is an unverified, high-level look at your finances, prequalification doesn’t ensure that you will actually qualify for a mortgage.

•   It won’t help you bargain. Being prequalified won’t help you negotiate a lower price with a seller or compete against other bidders in a competitive market.

Mortgage Preapproval

Requesting a mortgage preapproval is a more complicated process than getting prequalified. You’ll have to fill out an application with your chosen lender and agree to a credit check. The credit check will be a “hard pull” which will ding your credit score by a few points. You’ll also provide information about your income and assets. The evaluation process can take 10 days or more. Again, preapproval doesn’t mean it’s a done deal that you’ll get the loan, but it is a solid indication of your financial situation and ability to purchase a home.

There are a number of advantages to getting preapproval for a home loan, especially if you’re shopping in a fast-moving market.

Pros of Mortgage Preapproval:

•   It gives you an edge. Sellers will see that you are a serious buyer and have assurance that your financing won’t fall through and sink the deal.

•   It helps you get loan shopping done. When you’ve found your dream house, you don’t want to delay putting in an offer because you have to spend time getting your documents together and pursuing a loan. Going through the preapproval process helps you take care of these details before you’re in a fast-moving situation.

Cons of Mortgage Preapproval:

•   A mortgage preapproval expires. How long does a mortgage preapproval last? As noted above, the letter is only good for a certain period of time, usually 90 days, so you’ll want to make sure you’re seriously ready to start shopping once you have your mortgage preapproval in hand.

•   The application is time-consuming. You’ll need to provide a lot of documentation to get a mortgage preapproval and agree to a hard credit inquiry, which can drag down your credit score, though usually only by a bit.

•   Nothing is guaranteed. Even though your home loan preapproval letter likely has details on your loan amount and type, it is only a tentative approval — you still can’t be 100% sure that you will get the loan.

Here are the basic comparison points of prequalification vs. preapproval:

Steps to Get Preapproved for a Home Loan

Getting preapproved for a home loan will take some time, so it’s good to get the process started before you are ready to make an offer on a home. Here are some important steps along the way.

Check Your Credit Score

If you’ve established a credit history, a first step before applying for a mortgage is to check your credit reports, which are a history of your credit compiled from sources like banks, credit card companies, collection agencies, and the government.

The information is collected by the three main credit reporting bureaus: TransUnion®, Equifax®, and Experian®. You’ll want to make sure that the information on your credit reports is correct. Ordering the reports is free once a week through AnnualCreditReport.com.

If you find any mistakes in your credit reports, contact the credit reporting agencies immediately to let them know. You don’t want any incorrect information weighing down your credit score, putting your chances for preapproval at risk.

The free credit reports provided by the nationwide credit reporting agencies do not include your credit score, a number typically between 300 and 850. You can purchase your score directly from the credit reporting agencies, or from FICO®. Your credit card company also may provide your credit score for free, or you could try a money tracker app that updates your credit score weekly and tracks your spending at no cost.

Calculate Your Potential Mortgage

To help with the prequalification and preapproval process, use the mortgage calculator below to see what your estimated monthly mortgage would be based on down payment, interest rate, and loan terms.

Gather Documentation

Your credit score is only one of many factors a potential lender will consider when deciding on your mortgage qualification. So collect the many other documents you will need to paint a full picture of your financial life. Ask the lender what is needed, specifically. The list will likely include:

•   Recent pay stubs

•   Recent bank and investment account statements

•   Two years of tax returns and/or W2s, possibly more if you are self-employed

•   Verification of alimony or child support payments received and the court documents spelling out the terms of the payments

•   Social Security award letter, if you derive income from Social Security

•   Certificate of Eligibility from the VA, if you are applying for a VA loan

•   Gift letter documenting any money you are receiving from family or other sources toward a down payment

Receive Your Mortgage Preapproval Letter

Your first instinct when you receive preapproval will likely be to jump for joy. But next, take a moment to ask the lender if they made any assumptions about your finances in order to issue the letter, or if they flagged anything that could lead to you being denied a mortgage later on or that could increase your costs. Doing this could help you head off future problems that might scuttle a deal.

Upping Your Odds of Mortgage Preapproval

There are a number of steps you can take to improve your chances of preapproval or to increase the amount your lender may approve you for.

Build Your Credit

When you apply for any type of loan, lenders want to see that you have a history of properly managing your debt before they offer you credit themselves.

You can build your credit history by opening and using a credit card and paying your bills on time. Or you could consider having regular payments, such as your rent, tracked and added to your credit score.

Recommended: What Credit Score Is Needed to Buy a House?

Stay on Top of Debt

Your ability to pay your bills on time has a big impact on your credit score. If your budget allows, you should aim to make payments in full.

If you have any debts that are dragging down your credit score — for example, debts that are in collection — it’s smart to work on paying them off first, as this could help build your score.

“Really look at your budget and work your way backwards,” explains Brian Walsh, CFP® at SoFi, on planning for a home mortgage.

Recommended: Fixed-Rate vs. Adjustable-Rate Mortgages

Watch Your Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is your monthly debt payments divided by your monthly gross income. If you have $1,000 a month in debt payments and make $5,000 a month, your DTI ratio is $1,000 divided by $5,000, or 20%.

Mortgage lenders typically like to see a DTI ratio of 36% or less. Some may qualify borrowers with a higher DTI, up to 43%. Lenders may assume that borrowers with a high DTI ratio will have a harder time making their mortgage payments.

If you’re seeking preapproval for a mortgage, it may be beneficial to keep the ratio in check by avoiding large purchases. For example, you may want to hold off on buying a new car until you’ve been preapproved.

Prove Consistent Income

Your lender will want to know that you have enough money coming in each month to cover a potential mortgage payment, so the lender will likely want proof of consistent income for at least two years (that means pay stubs, W-2s, etc.).

For some potential borrowers, such as freelancers, this may be a tricky process since they may have income from various sources. Keep all pay stubs, tax returns, and other proof of income, and be prepared to show those to your lender.

What Happens If Your Mortgage Preapproval is Rejected?

Rejection hurts. But if you aren’t preapproved or you aren’t approved for a large enough mortgage to buy the house you want, you also aren’t powerless. You can ask the lender why it said “no.” This will give you an idea about what you might need to work on in order to secure the mortgage you want.

Then you may want to work on the factors that your lender saw as a sticking point to preapproval. You can continue to work to build your credit score, lower your DTI ratio, or save for a higher down payment.

If you’re able to pay more upfront, you will typically lower your monthly mortgage payments. Once you’ve worked to make yourself a better candidate for a mortgage, you can apply for preapproval again.

Dream Home Quiz

The Takeaway

In a competitive market, having a mortgage preapproval letter in hand may give a house hunter an edge. After all, the letter states that the would-be buyer tentatively qualifies for a home loan of a certain amount.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

FAQ

What happens during the preapproval process?

During the mortgage preapproval process, you’ll provide lots of background information on your finances. A potential lender will also check your credit score. If the lender feels you’re a suitable candidate for a loan, you’ll receive a letter that you can show a seller to potentially better your chances when making an offer on a home.

Do preapprovals hurt your credit score?

The lender will do a “hard pull” to obtain your credit score prior to a preapproval. This may cause your rating to drop by a few points, but it should rebound quickly if you pay your bills on time.

How far in advance should I get preapproved for a mortgage?

Get preapproved for a mortgage when you have a sense of the housing costs where you are shopping for a home, and you are ready to start looking in earnest.

Which is better: preapproval or prequalification?

Prequalification and preapproval each have a place in the homebuying process. Prequalification is helpful when you are trying to get a sense of what you can afford and which lender might offer the best terms. It’s time for preapproval when you are serious about searching for a home and have researched possible lenders.

Is it OK to get multiple preapprovals?

You only need one preapproval, but it is fine to get a few if you want to see what loan amounts and rates you might qualify for. Make all applications within a 45-day window — the time frame during which multiple lenders can check your credit without each check having an additional impact on your score.

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

^†Veterans, Service members, and members of the National Guard or Reserve may be eligible for a loan guaranteed by the U.S. Department of Veterans Affairs. VA loans are subject to unique terms and conditions established by VA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. VA loans typically require a one-time funding fee except as may be exempted by VA guidelines. The fee may be financed or paid at closing. The amount of the fee depends on the type of loan, the total amount of the loan, and, depending on loan type, prior use of VA eligibility and down payment amount. The VA funding fee is typically non-refundable. SoFi is not affiliated with any government agency.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.

SOHL-Q225-048

There are many reasons to pursue homeownership, from obtaining a yard for your dog to painting the bathroom whatever darn color you want. But one of the biggest financial reasons to own your own home is to start building home equity.

Home equity is considered one of the most common and accessible ways to build wealth over time, thanks in large part to the appreciation of real estate over time. You can even leverage your home equity to take out loans and fund your retirement. But what, exactly, is home equity, and how does it work?

What Is Home Equity?

Home equity is the amount of your home value that you actually own. It’s calculated by subtracting your mortgage balance from the market value of your property. For example, if your home is worth $350,000, and you’ve paid enough toward your down payment and home loan that your mortgage balance is $250,000, you have $100,000 in home equity. (Keep in mind that the $350,000 value might not be what you initially purchase your home for — that figure may have increased over time, which is part of how equity is built!)

Once you have home equity, you can borrow against it. If you sell the home, your equity is the amount of cash you will walk away with (minus any costs associated with the sale).

In short, home equity is pretty great to have. But how is it built?

How to Build Home Equity

Home equity is primarily built in two ways: paying down your mortgage and seeing the value of your home appreciate over time. Both of these can be nudged a bit to help you build equity faster. Here’s how.

Making a Larger Down Payment

Many buyers, especially first-time homebuyers, take advantage of programs that allow small down payments — sometimes as little as 3% of the home purchase price. But when it comes to building equity, a higher down payment could help. The more you put down when you’re first purchasing your house, the more equity you have right out of the gate — and if you put down 20% or more, you’ll be able to avoid the additional cost of private mortgage insurance, commonly called PMI.

When calculating mortgages, you’ll also see that the higher the down payment you can afford, the lower your monthly mortgage bill. That said, substantial down payments can be prohibitive for many buyers, and it may make more sense to get in with a lower down payment and start building equity rather than waiting a long time to save up tens of thousands of dollars.

Paying Off Your Mortgage

If making a larger down payment isn’t possible, you might also be able to speed up your equity earnings — and save money on interest over time — by paying off a mortgage early. Of course, you’ll need to consult your mortgage documentation to ensure that your lender doesn’t charge a prepayment penalty, or if it does, that it would still be a cost-efficient decision to make. Only some lenders charge a prepayment penalty, and of those that do, typically only within the first few years (usually three to five).

Making Extra Mortgage Payments

If you can’t afford to pay off your mortgage early in its entirety all at once, you can chip away at the loan over time by making more than the minimum monthly payment. It’s a good idea to ensure that the additional funding is going directly toward your principal balance (the amount of money you borrowed in the first place). That way, you’re dialing down the amount of interest you’ll pay before it can even accrue.

Staying in Your Home for Five or More Years

Along with chipping away at the amount you owe, the other function that increases equity is allowing your home to appreciate. Although that rise in value isn’t guaranteed, if it’s going to happen, it takes time. Thus, staying in your home for a longer amount of time (at least five years) gives you a better chance at building enough equity for all the other costs of homeownership to be worth it.

Increasing Home Value Through Renovations

Allowing your home to naturally increase in value over time is one thing, but you can also take matters into your own hands and help drive up the value by renovating or remodeling. (Not sure about renovations vs. remodels? Essentially, remodels are more extensive — and expensive.)

While even lower-cost renovations, like painting, can increase the home value a little, major repairs may have major costs associated with them. Sometimes, though, the equity increase you’d gain makes it worth going to the expense in the short term. Home improvement loans can help make these efforts more accessible (but again, always look ahead to ensure that debt won’t eclipse the equity you’d stand to build).

That said, it’s important to think through the pros and cons of reverse mortgages, as borrowing against your home equity comes with risk. (For example, if the loan total ends up being more than the value of the home, heirs might lose the house, or need to refinance, if they can’t pay off the reverse mortgage in full.)

How to Use Home Equity

Once you’ve built up a significant amount of equity in your home, you may be able to use it as collateral to get a loan or line of credit. How much is significant? It varies by lender and situation, but typically at least 15% to 20%. But remember that while drawing on your equity can be tempting, you will have to pay back whatever money you take out as well as continue to make your original mortgage payments. That’s why it’s a good idea to consider tapping your home equity carefully in the context of your larger financial goals.

Buying a New Home

It may seem counterintuitive, but you can borrow against your home equity value to help purchase a new home. In fact, some people end up taking out home equity loans to purchase a second or investment home.

Borrowing Against Home Equity

There are several equity home loan types that can be used to liquify the cash wrapped up in your home and make it spendable. Just be aware that these loans come with costs and risks. For example, if the housing market suddenly shifts and your home’s value decreases substantially, you may find yourself in a hole. And if you can’t make the payments, you could even lose your home. Your home, after all, is the collateral for these loans.

Here are a few of the most common ways to borrow against your home equity:

•   A home equity loan offers a borrower a lump sum up front, based on their home equity. In return, they pay it back, typically through regular fixed payments throughout the term of the loan. There are generally closing costs.

•   A home equity line of credit (HELOC) works much like a credit card. A homeowner who takes out a HELOC has the opportunity to draw out cash as needed, up to a certain maximum limit. During the draw period (typically the first 10 years), they can often pay back only the interest on what they’ve withdrawn. After the draw period comes the repayment period, when they will have to pay back any principal, plus interest. Interest rates and payments are usually not fixed. Closing costs may be lower than those for a home equity loan and sometimes waived entirely if the borrower keeps the credit line open for a number of years.

•   With a cash-out refinance, a borrower takes out an entirely new mortgage while borrowing a portion of their existing home equity in cash. There are generally closing costs.

💡Quick Tip: If you refinance your mortgage and shorten your loan term, you could save a substantial amount in interest over the lifetime of the loan.

How to Calculate Your Home Equity

Phew! That’s a lot of information. To recap, here’s how to calculate your home equity:

Keep in mind, again, that “home value” isn’t the same as “purchase price.” To know for sure what your home value is in the current market, you’d need an up-to-date appraisal, but you can use estimates from your favorite real estate site or agent.

The Takeaway

While nothing is a surefire ticket to wealth, building home equity is one of the most historically reliable ways to grow your net worth. And down the line, home equity can be leveraged for a variety of loans.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

FAQ

What is a home equity loan?

A home equity loan provides the borrower with a lump sum of cash up front in return for fixed payments on a regular basis throughout the life of the loan. The borrower’s equity in the home serves as the collateral for the loan, so if the homeowner defaults, the lender may foreclose on the house.

How does a home equity loan work?

A home equity loan lets you use the equity you have in your home to secure a loan. You receive a lump sum. To pay it back, you make regular, fixed payments for the duration of the loan term. If you can’t or won’t make the payments, the lender may be able to foreclose on the house.

How does a home equity line of credit work?

A home equity line of credit (HELOC) lets you use the equity you have in your house to create a line of credit, much like a credit card. Once you’ve set it up, you can borrow (or “draw”) funds up to your HELOC’s maximum during the draw period. As you pay back what you’ve borrowed, the credit line replenishes and you can draw more again until the repayment period, when you are paying back principal and interest. Typically, HELOCs have adjustable interest rates, and your payments will depend on how much you choose to borrow.

Is it a good idea to take equity out of your house?

Whether or not taking equity out of your home is a good idea depends on your financial situation and motivations. Taking out a home equity loan for a month-long luxury cruise is not practical for most long-term financial goals. But taking out a home equity loan to pay for renovations or improvements to your home that will increase its value can potentially increase the worth of the equity you have in your home.

Do you pay back home equity?

When you take out a home equity loan, you start making payments, but technically you’re not paying back home equity, you are paying back the loan you took out. That said, you must pay back the loan or the lender may be able to claim your house.

Photo credit: iStock/PC Photography

SoFi Loan Products
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SoFi Mortgages
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SOHL-Q225-010

If you are planning on applying for a home loan or for a mortgage refinance, you are likely going to want to know your loan-to-value (LTV) ratio. This is calculated by dividing the loan principal by the value of the property. It’s an important metric when you’re getting a mortgage approved because it reflects how much of the property’s value you are borrowing. A higher number may be seen as a riskier proposition by prospective lenders.

Here, you’ll learn the ins and outs of calculating LTV, why it matters, and how it can have a financial impact over the life of a loan.

LTV, a Pertinent Percentage

The relationship between the loan amount and the value of the asset securing that loan constitutes LTV.

To find the loan-to-value ratio, divide the loan amount (aka the loan principal) by the value of the property.

LTV = (Loan Value / Property Value) x 100

Here’s an example: Say you want to buy a $200,000 home. You have $20,000 set aside as a down payment and need to take out a $180,000 mortgage. So here’s what your LTV calculation looks like:

180,000 / 200,000 = 0.9 or 90%

Here’s another example: You want to refinance your mortgage (which means getting a new home loan, hopefully at a lower interest rate). Your home is valued at $350,000, and your mortgage balance is $220,000.

220,000 / 350,000 = 0.628 or 63%

As the LTV percentage increases, the risk to the lender increases.

Why Does LTV Matter?

Two major components of a mortgage loan can be affected by LTV: the interest rate and private mortgage insurance (PMI).

Interest Rate

LTV, in conjunction with your income, financial history, and credit score, is a major factor in determining how much a loan will cost.

When a lender writes a loan that is close to the value of the property, the perceived risk of default is higher because the borrower has little equity built up and therefore little to lose.

Should the property go into foreclosure, the lender may be unable to recoup the money it lent. Because of this, lenders prefer borrowers with lower LTVs and will often reward them with better interest rates.

Though a 20% down payment is not essential for loan approval, someone with an 80% LTV or lower is likely to get a more competitive rate than a similar borrower with a 90% LTV.

The same goes for a refinance or home equity line of credit: If you have 20% equity in your home, or at least 80% LTV, you’re more likely to get a better rate.

If you’ve ever run the numbers on mortgage loans, you know that a rate difference of 1% could amount to thousands of dollars paid in interest over the life of the loan.

Let’s look at an example in which two people are applying for loans on identical $300,000 properties.

Barb:

•   Puts 20%, or $60,000, down, so their LTV is 80%. (240,000 / 300,000 = 80%)

•   Gets approved for a 6.50% interest rate on a 30-year fixed-rate mortgage

•   Will pay $306,107 in interest over the life of the loan

Bill:

•   Puts 10%, or $30,000, down, so their LTV is 90%. (270,000 / 300,000 = 90%)

•   Gets approved for a 7.50% interest rate on a 30-year fixed-rate mortgage

•  Will pay $281,891 in interest over the life of the loan

Bill will pay $103,530 more in interest than Barb, though it is true that Bill also has a larger loan and pays more in interest because of that.

So let’s compare apples to apples: Let’s assume that Bill is also putting $60,000 down and taking out a $240,000 loan, but that loan interest rate remains at 7.50%. Now, Bill pays $364,121 in interest;

The 1% difference in interest rates means Bill will pay nearly $58,014 more over the life of the loan than Barb will. (It’s worth noting that there are costs when you refinance a mortgage; it’s a new loan, with closing expenses.)

💡 Quick Tip: You deserve a more zen mortgage loan. When you buy a home, SoFi offers a guarantee that your loan will close on time. Backed by a $10,000 credit.‡

PMI or Private Mortgage Insurance

Your LTV ratio also determines whether you’ll be required to pay for private mortgage insurance, or PMI. PMI helps protect your lender in the event that your house is foreclosed on and the lender assumes a loss in the process.

Your lender will charge you for PMI until your LTV reaches 78% (by law, if payments are current) or 80% (by request).

PMI can be a substantial added cost, typically ranging anywhere from 0.1% to 2% of the value of the loan per year. Using our example from above, a $270,000 loan at 7.50% with a 1% PMI rate translates to $225 per month for PMI, or about $18,800 in PMI paid until 20% equity is reached.

Recommended: Understanding the Different Types of Mortgage Loans

How Does LTV Change?

LTV changes when either the value of the property or the value of the loan changes.

If you’re a homeowner, the value of your property fluctuates with evolving market pressures. If you thought the value of your property increased significantly since your last home appraisal, you could have another appraisal done to document this. You could also potentially increase your home value through remodels or additions.

The balance of your loan should decrease over time as you make monthly mortgage payments, and this will lower your LTV. If you made a large payment toward your mortgage, that would significantly lower your LTV.

Whether through an increase in your property value or by reducing the loan, decreasing your LTV provides you with at least two possible money-saving options: the removal of PMI and/or refinancing to a lower rate.

💡 Quick Tip: Generally, the lower your debt-to-income ratio, the better loan terms you’ll be offered. One way to improve your ratio is to increase your income (hello, side hustle!). Another way is to consolidate your debt and lower your monthly debt payments.

The Takeaway

The loan-to-value ratio affects two big components of a mortgage loan: the interest rate and private mortgage insurance. A lower LTV percentage typically translates into more borrower benefits and less money spent over the life of the loan.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

FAQ

Why is the loan-to-value ratio important?

Mortgage lenders use the loan-to-value ratio (LTV) to evaluate how much they are willing to lend you and what interest rate they will offer. A high LTV tends to translate into a high interest rate, which can increase the costs of your mortgage payments significantly.

How can I reduce my LTV?

A good way to lower your loan-to-value ratio is to make a larger down payment. That will reduce the amount of your loan. While it can be challenging to make a large down payment, doing so is likely to mean that you are offered better interest rates and will be charged smaller monthly payments.

How does LTV affect PMI?

For a conventional mortgage, most lenders prefer borrowers to have a loan-to-value (LTV) ratio of less than 80%. If you put less than 20% down on a house for such a loan, you will probably have to pay private mortgage insurance (PMI).

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

^‡SoFi On-Time Close Guarantee: If all conditions of the Guarantee are met, and your loan does not close on or before the closing date on your purchase contract accepted by SoFi, and the delay is due to SoFi, SoFi will give you a credit toward closing costs or additional expenses caused by the delay in closing of up to $10,000.^ The following terms and conditions apply. This Guarantee is available only for loan applications submitted after 04/01/2024. Please discuss terms of this Guarantee with your loan officer. The mortgage must be a purchase transaction that is approved and funded by SoFi. This Guarantee does not apply to loans to purchase bank-owned properties or short-sale transactions. To qualify for the Guarantee, you must: (1) Sign up for access to SoFi’s online portal and upload all requested documents, (2) Submit documents requested by SoFi within 5 business days of the initial request and all additional doc requests within 2 business days (3) Submit an executed purchase contract on an eligible property with the closing date at least 25 calendar days from the receipt of executed Intent to Proceed and receipt of credit card deposit for an appraisal (30 days for VA loans; 40 days for Jumbo loans), (4) Lock your loan rate and satisfy all loan requirements and conditions at least 5 business days prior to your closing date as confirmed with your loan officer, and (5) Pay for and schedule an appraisal within 48 hours of the appraiser first contacting you by phone or email. This Guarantee will not be paid if any delays to closing are attributable to: a) the borrower(s), a third party, the seller or any other factors outside of SoFi control; b) if the information provided by the borrower(s) on the loan application could not be verified or was inaccurate or insufficient; c) attempting to fulfill federal/state regulatory requirements and/or agency guidelines; d) or the closing date is missed due to acts of God outside the control of SoFi. SoFi may change or terminate this offer at any time without notice to you. *To redeem the Guarantee if conditions met, see documentation provided by loan officer.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.