Can a first home's equity be used to bring down the interest rate on a second home mortgage?

Question

Supposing you have a home worth around $500k which you have completely paid off. Now you want to buy a second home, but don't want to sell the first because it brings good rental income. Can you put this first home down as equity when getting a mortgage for your second? And if so would that help to reduce the interest rate on the loan?

Lets assume you have solid income and good credit, and the second home is only valued at $200k and you are putting a down payment of 40%.

Would it be possible to get a near 0 rate given the equity and the high down?

Sorry if this is multiple questions, the gist of what I need to know is how to lower my rate with the cards I have (first home, savings for down).

Answer 1

Can you put this first home down as equity when getting a mortgage for your second?

(I think you mean "collateral", not "equity") Not with a traditional mortgage. The mortgage will be a lien on the subject property, so adding additional collateral does not help unless the mortgage is underwater.

Would it be possible to get a near 0 rate given the equity and the high down?

No. Your interest rate will be determined by long term (10-20 year) interest rates which are not near 0. If you have good credit you will not get a significantly better rate by putting down more than the 40% you plan on.

the gist of what I need to know is how to lower my rate with the cards I have (first home, savings for down).

Well, you mention having a home worth $500k, which you don't seem to be selling, so remember that mortgages for non-primary residences will be higher than a primary residence regardless of how much you put down. If this is your actual situation, the best move mathematically (other than saving up and paying cash) would be to take out a mortgage on the primary residence and use it to buy this "second" home. If you can put down $80k (40% of $200k) that would mean taking out a mortgage of $120k on your $500k house, which would get you about the lowest interest rate you could get.

In general, your credit score, length of the loan, and Loan-to-value (LTV) ratio are going to be the biggest factor in your interest rate. So given that you can't instantly change your credit score, the best you can do is put as much down as possible and get the shortest term mortgage you can afford, which gives you the added benefit of paying less interest and paying it of quickly.

Answer 2

Both other answers provided are quite good, but I'd like to address what I believe is the root of your misunderstanding:

A mortgage is just a loan, that has collateral attached to it. In the case of a mortgage on a house, that house is collateral, meaning the bank has some rights to that property if you fail to meet your mortgage payments. Many people tie their understanding of the mortgage, to the house sale in particular. In fact, you should consider it as two separate transactions: (1) You take out a loan from the bank, equal to the value of the mortgage; then (2) You pay the amount of the loan to the house seller [the bank will do that transfer to the seller's bank directly, because they do not want the risk of giving you so much money in cash].

Because a mortgage has collateral, it has lower interest rates than other types of credit - because it is less risk to the bank. If you have a mortgage on the home you live in, the bank feels you are less likely to just walk away from your obligations, because (1) you would be losing the value of the house; and (2) you are personally invested in living there. Because of #2, a mortgage on the house you live in, will be lower risk to the bank than the mortgage on a rental property (as pointed out by @NathanL).

So forget for a moment the second house you want to buy. If you want the bank to loan you $400k [80% of the value of your house], you could 'remortgage' your current home. The bank will regain the collateral of your house, meaning you are a low risk for them, and they will give you money at an interest rate generally similar to if you were just buying it new.

Now to your specific question: Will the bank decrease my interest rate, if I own another valuable property?

The answer is yes, if you give the bank collateral of that valuable property. It is the collateral they care about, not just the fact that you own it. It is true that having wealth will generally make you lower risk to the bank, but really what they want is the direct rights to something more valuable than your loan, should you default.

Will that lower interest rate be close to 0%?

No, because the bank still needs to make money. They just don't need to worry as much about you running away from your obligations, so they won't charge you as much of a 'risk premium'.

Answer 3

How close to zero? Would ~3% be close enough? Yes, you can take another mortgage on your first home, or you can open a home equity line of credit. Having a loan-to-value ratio below 50% would certainly get you a better rate, particularly if you chose a shorter term than 30 years on the note.

What other considerations are there? If you no longer occupy the $500k home, you might not get as good of a rate. Rentals are considered higher risk by mortgage companies.