When it comes to buying real estate, the home you purchase is always the collateral for that loan. Most banks will not allow you to use one home as collateral when buying another home. However, there are ways to use the equity you have built in a home you currently own to either make an outright purchase of another home (depending on the amount of equity and the purchase price of the second home) or to leverage the purchase of another home. But the disadvantage of using equity in one home to purchase another home is the possibility of losing one or both homes if, for some reason, you are unable to make the payments.
Collateral is some asset of value you pledge as a condition of receiving a loan. The collateral is the lender's guarantee that if you do not repay the loan as promised, the lender can sell the asset and recover losses. Lenders require collateral for significant loans such as real estate. In all cases when a borrower obtains a mortgage to purchase a home, the home itself is the collateral. That means if a borrower fails to make scheduled payments on a mortgage, a lender has the right to foreclose on the home and resell it to another buyer.
Home Equity Loans
A home equity loan is a second mortgage on a home you already own. The difference between what the house is worth and the amount that you owe on a mortgage is equity. Homeowners can borrow against the equity they have in their home as long as they are current on their mortgage payments and have a reliable source of income to repay the loan. If the borrowed money is used to purchase another home, it can be a way of using assets from one home to purchase another home. But the borrowed funds would not be considered collateral because you could potentially lose the second home without losing ownership of the first home. You would only lose the equity from the first home that was invested in the second home.
When you have enough equity in one home to make an outright purchase of a second home, the loan payments will be associated with the first home. This is about as close as it gets to using an existing home as collateral for buying another home. However, if the owner fails to make the home equity loan payments, he will lose the first home to foreclosure, but still have 100 percent ownership of the second home.
If you use your home as collateral to obtain an equity loan to purchase another home, interest rates, taxes and insurance can make the home purchase an expensive endeavor. You should make sure you will earn enough income to make the monthly loan payments. You also should be clear as to whether the monthly payments will remain the same throughout the life of the loan or will change over time based on fluctuating interest rates.