Homeowners needing fast access to cash to buy another property can use a home equity line of credit. A HELOC can be the key to buying a second property or a vacation home. Some people even use a HELOC to keep their homes in the U.S. and buy properties overseas.
A HELOC can be a smart way to leverage your home equity, but not always. Read on to learn and understand how HELOC can help you own a new property.
Key Takeaways
- A Home Equity Line of Credit (HELOC) provides a flexible payment structure that can help you buy a house at lower interest rates.
- Homeowners should meet requirements such as having at least 15% home equity and a good credit score to obtain a HELOC.
- Shop for top lenders and compare other financing options such as home equity loans and cash-out refinancing, to find the most cost-effective way to purchase a new property.
How Does Using a HELOC to Buy a House Work?
HELOC stands for a home equity line of credit, secured by your equity or the portion of the property that you’ve already paid. HELOC is a revolving credit line that uses your home equity as collateral. Like credit cards, a HELOC allows you to draw up to a certain limit. However, credit card debt has no collateral, while a HELOC uses your home equity as a security against the loan.
With HELOC, there are no restrictions on what you can do with the money drawn against your credit limit. The challenge lies in getting approved for HELOC and having a credit limit high enough to cover the down payment for the property investment or second home.
Pros and Cons of Using a HELOC to Fund a Down Payment
Using HELOC to fund your next property purchase can be more convenient and easier. However, consider these factors before you move forward with this financing option.
Pros
- Quick access to cash
- Borrow a sizable sum if you have high equity
- Close faster on your second home purchase
- No prepayment penalties
Cons
- Monthly payments may increase due to variable interest rates
- Risk of foreclosure if you can’t make payments
- No tax breaks for interest paid on buying a new property
- Limited home equity decreases your purchasing power
What to Consider Before Getting a HELOC for a Down Payment
Aside from weighing the pros and cons above, consider the following before moving to the next phase.
Decide if It’s for a Second Home or an Investment Property
HELOC lenders will evaluate your application based on the purpose of your HELOC. Most banks, credit unions and lenders extend HELOC loans to acquire a second property. Your lender will likely consider both your primary and secondary homes to determine your credit limit.
On the other hand, if you are getting a HELOC for an investment property or a vacation home, you may have fewer financing options. Interest rates may also be higher because there’s a higher risk of default if you don’t live on the property.
Determine if You Have Enough Equity in Your Home
How much money you’ll get through HELOC depends on the amount of equity you have. Lenders often have a minimum equity requirement ranging from 15% to 35% for a HELOC.
Have a Clear Plan How You Will Repay the Loan
Although most HELOCs have a draw period of about 10 to 20 years, you should not wait until the deadline to think about repayments. You need a clear plan for paying back what you borrowed. Since most HELOCs have a variable interest rate, you should also consider paying back the loan quickly when interest rates increase.
How to Apply for a HELOC to Buy a House Home
If you think HELOC is the right option, here are the steps you need to follow to apply for a home equity line of credit.
- Step 1: Determine your eligibility. Most lenders have the following requirements:
- 15-35% Home equity
- A credit score of at least 660
- A steady source of income
- A debt-to-income ratio below 43%
- Step 2: Shop for lenders and get prequalified.
- Step 3: Pick a lender after comparing interest rates, repayment terms, and other offers.
- Step 4: Gather loan requirements and fill out the necessary forms. Once completed, submit your loan application.
- Step 5: Determine your home’s market value through an appraisal.
- Step 6: Wait for approval and prepare for closing.
- Step 7: Withdraw your funds and purchase a home.
Compare the Best HELOC Lenders from Benzinga’s Top Mortgage Providers
Before applying for HELOC do your research and perform the necessary due diligence. You can start by contacting these lenders to see their offers.
- Best For:Online MortgagesVIEW PROS & CONS:securely through Rocket Mortgage (formerly Quicken Loans)'s website
- Best For:Flexible Mortgage OptionsVIEW PROS & CONS:securely through Angel Oak Mortgage Solutions's website
- Best For:Self-employed BorrowersVIEW PROS & CONS:securely through CrossCountry Mortgage's website
Alternatives for Funding a Down Payment
HELOC provides many advantages in terms of speed, flexibility and convenience. However, homeowners who do not have enough equity or those denied HELOC can look to other options. Here are some HELOC alternatives and the associated benefits of using them.
Home Equity Loan
Applying for a home-equity loan against your property is another option. Like a HELOC, a home-equity loan uses your home as collateral but is structured as a second mortgage instead of a line of credit. A home-equity loan provides more predictable payments since you will have equal repayments over a set period.
For home equity loans, applicable interest rates for the loan depend on your credit history, income, and your home’s market value. Lenders typically allow borrowers to get a loan up to 80% of their home equity.
Cash-Out Refinancing
Homeowners who want to maintain only one mortgage can opt for cash-out refinancing. With this method, you have to get a larger loan to pay off your existing mortgage and get the cash you need for the down payment.
Cash-out refinancing allows you to consolidate your debt. You can also use the cash received from refinancing however you want. When done correctly, you can also get a lower interest rate on your mortgage.
Personal Loans
If you’re buying a tiny home, a mobile home or a cheaper property, getting a personal loan is also an option. Most personal loans range from $2,000 to $100,000. With this amount, you should have the required funds to pay the down payment for a small mortgage. Since you are not using the property as collateral, you won’t lose the house even if you default on the loan.
Retirement Funds
When buying a second home, tapping into your retirement savings is possible. However, it’s not recommended to use your retirement funds on a new property purchase. For one, there is an early-withdrawal penalty if you draw against your IRA and 401(k). You can use your self-directed IRA to buy an investment property without a penalty but there may be restrictions. While it’s possible to use retirement funds to buy a property, it is not recommended unless you are a sophisticated investor.
Personal Savings
Homeowners with enough money saved up can tap into their savings to buy a second property. If you have funds left over after funding your emergency funds, this is a low-cost option to fund your property purchase.
HELOCs to the Rescue
Can you use a HELOC to buy a house? Yes, you can. However, just because you can fund your second home purchase doesn’t mean you have to do it this way.
Consider the kind of property you want to purchase, how much you can get based on the amount of your home equity and if you can pay what you borrowed on time. If you are eligible for a HELOC, compare several lenders before making a choice.
If you don’t qualify for HELOC or getting a line of credit is too expensive, consider alternative options such as home equity loans, personal loans and cash-out financing.
Frequently Asked Questions
Can you use a HELOC to buy a rental property?
Yes, you can use HELOC for anything including the purchase of a rental property.
How long does it take to get a HELOC to buy a house?
HELOC approval can take from two to six weeks after lodging a complete application. Once approved, you can draw the funds you need to fund the purchase of your second home.
What happens if you can't repay a HELOC used to buy a house?
If you default on HELOC payments, your property may be foreclosed.