A home equity line of credit (HELOC) enables you to access the funds you’ve built up in your home through appreciation and paying off your mortgage. You can use a HELOC for nearly anything, which leads some people to ask if can you use a HELOC for a down payment. If you’re looking to purchase another home, you can use the equity in your current home as a down payment, but you’ll want to consider several factors and evaluate whether you have enough equity to draw from to fund your down payment. Here’s what you need to know.
Understanding How a HELOC Works
A HELOC allows you to borrow against the equity in your home. As your home appreciates and you pay down the balance on your mortgage, the available credit in your home increases, allowing you to borrow against it.
Once you open a HELOC, you can borrow as much money as you need up to the credit limit you set at closing throughout the draw period, which commonly is 10 years. During those 10 years, you’ll only pay interest on the loan. However, most HELOCs have a variable interest rate, which means it will shift each month.
Most lenders won’t allow you to take out more than 80% of the home’s total value less the mortgage. So if you have a $400,000 home and an outstanding mortgage of $100,000, you can have access to a loan of up to $220,000.
You can use the line of credit for a variety of use cases, including purchasing a second home or paying off your mortgage.
How to Use a HELOC for a Mortgage Down Payment
If you’re ready to purchase an investment property or a vacation home, you might be looking to pull the equity from your existing home to fund the down payment. Here’s how to make that happen.
1. Evaluate How Much You Can Borrow
To do this, you’ll look at how much your home is worth and how much you still owe on your mortgage to determine the maximum HELOC you might qualify for.
For example, if you own a $400,000 home with a $100,000 mortgage, you’d start by calculating 80% of your home’s value, which is $320,000. Then, you’ll deduct your $100,000 mortgage, which leaves you with $220,000 of equity that you can access. That’s your maximum allowable HELOC.
2. Determine What You Can Pay Monthly
Next, you’ll need to determine how much you can pay monthly in loan payments. Even if you can afford the second home’s down payment with a HELOC, you need to know you can then make the monthly payments for your primary home’s mortgage, the HELOC interest payments, and your new home’s mortgage payments.
This will help you develop a budget for your second home that realistically fits into your budget. You’ll need to put no less than 10% down for a second home to qualify for a conventional loan.
3. Apply for a HELOC
Before you start shopping for a second home, you should apply for a HELOC to start putting the process in motion and ensure you qualify. The lender will help you determine the loan you are eligible for. Once you close on the loan, you can draw the funds you need for the new home’s down payment.
4. Apply for a Mortgage for the Second Home
Unless you can pay all cash thanks to the HELOC, you’ll need to also apply for a second mortgage and get preapproval before shopping for your home. This will help you prove that you have the funds when putting offers in on a home and provide confidence for the sellers that you are a worthy buyer.
5. Start Shopping for Your Second Home
Now you’re ready to shop for your second home. Reach out to a good real estate agent that is licensed in the area you’ll be buying. They can help you determine the best parameters for your search and recommend ideal neighborhoods based on what interests you.
6. Purchase Your Second Home
This process will feel reminiscent of your first home purchase. From the day the sellers accept your offer on the home to the date of closing will likely be 30-45 days as that’s how long it takes to close a mortgage. At the date of closing, you’ll need to be ready to make payments on the mortgage on your primary home, your HELOC, and the mortgage for your new home.
Pros and Cons of HELOC Down Payment
Before using a HELOC for a down payment on your new home, consider these pros and cons.
Pros
- Protects emergency fund: you don’t have to drain all your accounts to purchase a second home, which can help protect you in case of unforeseen circumstances.
- Potentially lower interest rates: the more you put down on your second home, the lower your interest rates can potentially be. That means you pay less throughout the loan.
- Lower closing costs compared to a traditional mortgage: HELOCs often have lower closing costs than a traditional mortgage.
- Improved cash flow during the draw period: the draw period — which is often 10 years — allows you to make interest payments only, improving your cash flow during the early years of owning the home to fix it up or adjust to your new budget with additional payments.
Cons
- Risk to primary residence: if you fail to make payments on your new home or can’t make HELOC payments, you could lose your primary home.
- Multiple payments to make: keeping up with the various payments required will be complex to manage.
- Variable interest rates: HELOCs have variable interest rates, making them more challenging to budget for compared to a cash-out refinance.
Should You Use a HELOC for a Down Payment?
Learn ideal times to use a HELOC for a down payment.
- You don’t have the cash to put at least 20% down on a new home
- Your existing mortgage terms are far better than they would be were you to complete a cash-out refinance
- You have a large amount of equity in your primary residence
While this is a great option for purchasing a second home, there are also times when you should not use it. Here’s a look at when to avoid a HELOC for a down payment.
- Your budget is too tight to deal with adjusting interest rates on the HELOC
- Managing multiple payments is too complex for you
- You can’t meet the payment requirements for your primary home mortgage, the HELOC, and a second home mortgage
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Alternative Mortgage Down Payment Options
If a HELOC is not right for you, consider these alternative down payment options for your new home purchase.
Home Equity Loan
While a home-equity loan is quite similar to a HELOC, it offers greater consistency because the interest rate is fixed. You pay the same monthly payment whereas a HELOC allows you to pay back the balance as you can. Generally, these loans have lower interest rates when totaled up compared to a HELOC. You should know that it changes your primary home from an asset to a form of debt. You’ll also be making two mortgage payments on your primary residence which could leave you upside down on payments if the real estate market experiences a downturn.
Cash-Out Refinance
You can refinance your current home’s mortgage while cashing out some of the equity in it. This means restarting your mortgage, but that can be beneficial because you’ll stretch out the payments across 30 years instead of keeping your current mortgage payment alongside a HELOC.
Bridge Loan
These loans are designed to help you bridge the gap between selling your current home and buying a new one. That way, you can buy without the contingency of selling your current home. This can help make you more competitive when putting in offers on new homes while avoiding a HELOC.
Home Equity Investment
Transition your home’s equity into cash with a home equity investment. You won’t face payments when you use this option and you’ll get a lump-sum payment right away. However, you are selling a portion of your home to an investor. You can buy the investor out with cash later. Many people use this option when they don’t have the credit to qualify for a HELOC or home equity loan. However, depending on how much the home appreciates, you could owe far more at the end of the term.
For example, if the investor purchases 20% of your $400,000 home today, you’ll get a lump sum of $80,000. But assuming the home goes up in value by 2.5% over the 10-year term, you could owe the investor $102,406.76 because that will be the new value of 20% of your home’s value.
Funding a New Home with Your Existing Equity
You have many options for ways to fund a new home using your existing home’s equity. A HELOC is a good option in many circumstances, just spend some time learning the pros and cons you’ll face with this option before taking out the loan.
Frequently Asked Questions
Is it good to pay off HELOC early?
So long as you have adequate cash flow and an emergency fund, you should pay off your HELOC early to avoid accruing more debt over the loan term.
What happens if I open a HELOC and don't use it?
If you open a HELOC and don’t use it, you’ll still need to pay the lender fees, including the appraisal fee, title search fee, etc., alongside any required monthly fees for leaving the line of credit open with your lender. Make sure you know these fees before opening your account.
Is there anything you cannot use a HELOC for?
Lenders do not put restrictions on what you can use a HELOC for. However, it’s not wise to use it for frivolous things, like a vacation, or for items where you can get a lower interest rate using another loan type, such as when purchasing a car.
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About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.