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Can a HELOC be used for a down payment?
A second home or investment property is a dream for many homeowners. If you’ve been wondering, “can you use a HELOC for a down payment,” you’re not alone.
Although it's possible to use a HELOC as a down payment on a second home or investment property, there are some caveats to consider, including variable interest rates/payments, closing costs, and the financial risk of taking on a second mortgage.
Read on to learn more about using a HELOC for a down payment.
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What are HELOCs and how do they work?
A HELOC is a type of secured loan that lets you borrow money as a line of credit. A line of credit limit is determined by the lender based on several factors, including the equity in your home, your property’s fair market value, and your credit score. Generally, the more equity you have, the higher the line of credit you’ll be approved for.
A secured loan requires the borrower to pledge an asset as collateral to “secure” the loan. With a HELOC, your home is the collateral securing the loan. This means if you fail to repay the loan the lender can foreclose and take your home.
Getting a HELOC is a straightforward process, and many homeowners benefit greatly from their HELOC. HELOC funds can be used for anything, including making home renovations, paying off high-interest debt, paying for college tuition and even as a down payment on a second home or investment property.
How to use a HELOC for a down payment on a second home
A HELOC can be used for any purpose, whether paying-down high-interest debt, paying college tuition or making home renovations; the choice is yours. Some homeowners are particularly interested in using a HELOC for a down payment.
Here’s an outline of how to use a HELOC for a down payment:
Determine your loan-to-value (LTV) ratio. Loan-to-value ratio in real estate is calculated by the mortgage lender during the loan application process and is used to assess lending risk. If your LTV is too high, the loan is considered high risk and the offered interest rate will be higher, or the loan will be denied. The formular for calculating LTV is: LTV = (the amount of the loan ÷ Appraised value of the property) × 100.
For example: A loan amount of $200,000 ÷ an appraised home value of $400,000 x 100 = 50% LTV.
Most lenders will do a HELOC if you have an LTV up to 85%.
Set your budget. Look at your finances and determine how much you can afford to spend in monthly HELOC repayments. Although you may qualify for a large sum of money, you’ll eventually need to repay the entire amount you borrow with interest. HELOCs have a variable interest rate, so be prepared to pay the maximum amount.
Apply for a HELOC. Applying for a HELOC is easy, and starts with meeting your chosen lender’s HELOC eligibility requirements including your LTV, home equity, credit score, and debt-to-income ratio.
Find a second home. When applying for a HELOC, the lender will tell you how high a line of credit you qualify for. You can start shopping with confidence knowing how much money you will have available for a down payment and purchase.
Apply for a loan for your second home. If your HELOC covers the down payment on a second home but isn’t large enough to buy the property in full, you will need to apply for a mortgage to cover the remaining cost of the purchase.
Using a HELOC for a down payment. After the HELOC closing, the money will be deposited into your account on the fourth or fifth day after closing.
Close on your second home. All property closings generally follow the same process.
It’s important to keep in mind that you will have to make at least two mortgage payments each month, as you pay your first mortgage and HELOC, and a new mortgage for the second home (if the HELOC and cash don’t cover the full cost of buying the property.
Advantages to using a HELOC for your down payment
There are several HELOC pros and cons to be aware of, including the following:
Pay interest on the amount you spend. With a HELOC, you only pay interest on the amount you have used. (A home equity loan charges interest on the full loan amount, whether you use it or not.)
Low or no closing costs. Most lenders charge low or no closing costs.
Low interest rate. HELOCs typically start with a low variable interest rate.
Convert to a fixed-rate loan. When a HELOC’s draw period ends, the loan may be converted to a fixed rate loan.
Tax advantage. According to the IRS, interest on home equity loans and lines of credit are deductible if the borrowed funds are used to substantially improve the taxpayer’s home that secures the loan.
Disadvantages to using a HELOC for your down payment
Variable interest Rates May Rise. Depending on economic factors, a variable rate loan may be beneficial and result in paying less interest. Conversely, you could end up paying more interest if the index tied to the interest rate rises.
Overspending. Having easy access to money makes it tempting to overspend or spend the money on luxury purchases that aren’t necessary. Be sure to use your HELOC for your original intended purpose and make the most of your money by paying down debt or making improvements to increase your home’s value.
Hidden Fees. Some Lenders, particularly banks, may charge a pre-payment penalty if you pay off your loan before the specified term. Lenders may also charge an annual fee or an inactivity fee if you don’t draw money from your line of credit.
Risk of foreclosure and damaged credit. If you fail to repay the loan, make late payments or are unable to make your first mortgage payments, these events will be reported to the credit bureaus and your credit score will drop. Because a HELOC is secured by the equity in your home (i.e., uses your home as collateral), defaulting can result in the lender foreclosing on your home.
Other down payment options for a second home
Saving money for a second home or investment property takes time and dedication. If you do not qualify to use a HELOC as down payment, consider one of these down payment options:
Home equity loan. One of the most significant benefits of a home equity loan is the fixed interest rate, which makes it easy to budget your expenses each month and there are no surprises as with a variable interest rate HELOC.
Cash-out refinance. Cash-out refinancing is when a homeowner refinances their mortgage to a new mortgage (typically at a lower interest), and in the process, borrows more money than what is needed to pay off the current mortgage. The first mortgage is paid off and the homeowner gets a lump-sum payout of the extra cash amount at closing.
Cash. Saving up cash to purchase a second home takes time, but the advantage is you’ll save money by not paying loan interest.
Is using a HELOC for a down payment a good idea?
Using a HELOC for a down payment could be advantageous if you are committed to a real estate strategy that utilizes the HELOC to create cash-flow from owning and renting an investment property. Using a HELOC as a down payment for a second home or a vacation home could be risky because you’ll be adding to your overall debt burden without increasing your income to meet the higher payments required.
HELOC FAQs
Are HELOC rates fixed?
No, the majority of HELOCs come with a variable interest rate, which means that the interest charged is based on a financial index that varies. As the financial index moves up and down based on economic factors, the interest rate charged to the borrower will fluctuate.
Is it possible to increase my HELOC limit?
If the value of your home has increased and/or your equity in the home has increased, you could qualify for a larger loan amount and have more funds available to you. To increase a HELOC limit, most lenders require a HELOC refinance to a new limit, interest rate, and term.
Do I need an appraisal for a HELOC?
Some lenders may require an appraisal. CU SoCal does not charge appraisal fees for single unit loans.
How soon can I get a HELOC?
A HELOC can be obtained 30-45 days after the purchase of a home. However, borrowers will need to meet all the necessary lender requirements, including 15-20% equity in home, good repayment history, and more.
What are some HELOC pros and cons?
HELOCs can provide homeowners with access to cash. Among the cons, are a variable interest rate that can go up and make payments unaffordable. Consider these other HELOC pros and cons.
How much HELOC can I get?
The amount of HELOC you can get approved for will depend on the equity in your home, your home’s market value, and your credit score. There are additional HELOC eligibility requirements that lenders may look for, such as a good debt-to-income ratio.
What can I use a HELOC for?
You can use HELOC funds for any type of purchase or purpose. Many people use a HELOC for making home improvements, paying down high-interest credit card debt, paying for college tuition.
Why Savvy Consumers Choose CU SoCal
For over 60 years, CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!
