Can You Use a HELOC for a Down Payment?

When you’re exploring how to pay for a second home or investment property, it’s important to consider every option. And if you’ve built up a good amount of equity in your primary residence, one way to cover your down payment on a new property is to obtain a home equity line of credit (HELOC). A HELOC is one of the more popular types of home equity lending, and with good reason: It’s extremely versatile, allowing you to borrow funds for pretty much any purpose. Take a look at how a HELOC for down payment would work in your situation.

What Is a HELOC?

A HELOC is a line of credit with a limit that’s based on the equity you have in your home. Your home serves as collateral for a HELOC, so technically the HELOC is a mortgage. (If you are still making payments on your first mortgage, the HELOC is a second mortgage.) Because the HELOC is secured by the home, borrowers who fail to make payments on their HELOC risk foreclosure.

How a HELOC Works

If you have at least 15% equity in your home, you may qualify for a HELOC. What is equity? Put simply, it’s the value of your home minus whatever you owe on your mortgage. Divide that result by your home value and you’ll have your percentage of equity.

In addition to significant equity, you’ll need a credit score of at least 640 and a debt-to-income (DTI) ratio below 50%. (Your DTI ratio is the sum of your monthly debts — student loan, car loan, etc. — divided by your gross monthly income.) A higher credit score and lower DTI ratio are preferred and might help you qualify for a better initial interest rate.

Once you’re approved for a HELOC, you can borrow money in increments, as needed, up to the maximum on your credit line. The borrowing period, called the draw phase, lasts 5, 10, or even 20 years. During this time, most lenders won’t require you to repay what you borrow — they will, however, require you to pay interest on the borrowed amount. Once the draw phase ends, you enter the repayment phase. You’ll stop borrowing and begin to make monthly principal-plus-interest payments to pay off what you borrowed over a period of, say, 10 or 20 years. The payment due might increase significantly at this point, and it’s important to have a plan to cover it.

HELOCs typically have variable (also called adjustable) interest rates that will change, following market forces. The details about when and by how much rates can change will be disclosed before you sign a HELOC agreement. The variable rate introduces some uncertainty into your budget, as interest costs increase when rates go up.

How Much Can You Borrow with a HELOC?

Whether or not it makes sense to fund a down payment with a HELOC will depend on your credit limit and cash flow. The amount you can borrow will be based on your primary home’s appraised value and the amount you still owe on your home loan. Lenders crunch the numbers and may allow you to borrow up to 85% of your equity, up a maximum of $350,000. Your income, credit history, and monthly debts in addition to your first mortgage will be factored in, and the lender will allow a maximum credit line based on your overall financial picture.

How to Use a HELOC for a Down Payment

If you’re buying a second home with no down payment, turning to a HELOC to make a down payment possible is fairly simple. A HELOC can be used as a down payment on either a second home or an investment property. The details are somewhat different depending on what type of property you plan to purchase.

Using a HELOC for a Second Home Down Payment

If you’re approved for a HELOC and decide to use it for a down payment on a second home, you’ll write a check or execute a transfer from your HELOC to fund the down payment. You’ll have to disclose this financing method to the lender you’re working with to finance the mortgage on the second home.

It goes without saying but we’ll say it anyway: Before you write the check, you’ll want to make sure your budget can accommodate your first mortgage payment and your interest payment on the amount borrowed from a HELOC, plus property taxes, insurance payments, and maintenance costs on two homes. You’ll also want to have breathing room in your budget for potential HELOC interest cost increases, as well as the larger payment you’ll need to make when the draw phase ends.

Using a HELOC for an Investment Property Down Payment

If you hope to use a HELOC to build wealth by investing in a property that you’ll rent, it’s important to remember that if you fail to make your payments on the HELOC, you could lose your primary residence in foreclosure. Investments almost always involve risk, but they don’t always have the potential to cost you your home.

When using a HELOC on an investment property it’s even more important than usual to understand the ins and outs of budgeting for and managing a rental property. Make sure you have carefully studied the full monthly costs of maintaining the property, as well as market rates for rental units similar to the one you plan to purchase.

The actual process of drawing on the HELOC for the down payment is the same as it would be for a second home, and it’s important to disclose to a mortgage lender that you are using down payment funds from a HELOC.

Pros of Using a HELOC for a Down Payment

Using a HELOC to make a down payment has its advantages. For one thing, you won’t have to touch money you’ve saved in an investment or retirement account. Interest rates on a HELOC also tend to be lower than the rate on a personal loan or home improvement loan. And closing costs on a HELOC tend to be lower than those on a typical mortgage. Some homebuyers like the fact that the HELOC’s interest-only draw phase allows them to postpone making payments against the principal for a while.

The ability to borrow as needed means that you can open a HELOC before you know exactly how much you need to borrow. You might borrow some money for the down payment and then, a couple years later, use the same HELOC to finance renovations.

Finally, using a HELOC for a down payment could have tax benefits, provided you’re buying a second home and not an investment property. If a HELOC is used to buy, build, or substantially improve a first or second home, the interest costs may be tax deductible; consult a tax pro for advice on documenting and using this deduction.

Cons of Using a HELOC for a Down Payment

The most significant downside of using a HELOC for down payment purposes is that you are putting your primary residence at risk of foreclosure if you can’t keep up with the payments. It’s important to be aware of how large your payments could be when you reach the end of the draw phase and begin making those larger principal-plus-interest payments.

Some borrowers find the HELOC’s variable interest rate to be a deterrent. If you’re someone who likes predictability and consistency, having a rate that changes might not be for you.

Finally, it’s important to recognize that borrowing against your home equity depletes your equity in that property. If you sell the home that secures your HELOC, you will receive a smaller amount from the sale because a portion of the proceeds will go to settle the HELOC debt.

How to Use a HELOC for a Down Payment

Once you’ve carefully considered the pros and cons and ensured you meet the minimum threshold needed to qualify for a HELOC, applying for one is a straightforward process. You’ll be asked to provide documentation of your income and assets. The prospective lender will do a credit check. And an appraiser will likely need to come out to see your home and determine its market value. The typical HELOC approval process takes two to six weeks.

Other Down Payment Options to Consider

A HELOC isn’t the only way to come up with the cash for a down payment on a second home or investment property. Read up on your other options:

Home Equity Loan for a Down Payment

If a HELOC’s variable interest rate isn’t your style, you could also consider a home equity loan for down payment. The qualification process will be similar, but instead of a credit line you’ll obtain a lump-sum loan. A home equity loan is secured by your house, like a HELOC. But its interest rate is usually fixed. Another key difference: You begin making monthly principal-plus-interest payments on a home equity loan shortly after you receive the funds. There is no “draw” phase as there is with a HELOC.

Cash-Out Refinance

Another way you might use your home equity to obtain cash for a down payment is through a cash-out refinance. Picture this: You refinance your home loan for more than you currently owe on your house. The difference between your current loan balance and your newly financed amount is delivered to you in cash to use as you wish. Some borrowers prefer this route because a cash-out refi leaves them with one monthly mortgage payment instead of a mortgage payment plus a HELOC or home equity loan payment. One caution: Closing costs on a refi can be significantly higher than on a HELOC.

Cash Payment

Of course, if you have enough cash saved to cover a down payment (or to buy the home outright), you may prefer to take this route versus financing the down payment. However, if spending cash for the down payment means pulling money out of investments during a market low, or borrowing from your 401K, applying for a HELOC might feel like a better option.

The Takeaway

Using HELOC for a down payment could be a smart solution if you have built up equity in your primary home and have a good DTI ratio and strong credit score. It’s important to have a plan to begin making the larger principal-plus-interest payments when the HELOC’s draw phase ends. Keeping current with payments, even in the face of a variable interest rate, is key to utilizing your equity without risking your first home.

SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $350,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.

Unlock your home’s value with a home equity line of credit from SoFi.

FAQ

Can you use a HELOC for a down payment on a second home?

It is possible to use a home equity line of credit to obtain cash for a down payment on a second home. To do this, you’ll need a significant amount of equity in your first home, a strong credit score, and adequate income to continue paying your first mortgage while also making payments on the second loan.

What are the risks of using a HELOC for a down payment?

The primary risk of pulling money for your down payment on a second home or investment property from a HELOC is that you might overextend yourself. Because a HELOC is secured by your first home, you risk foreclosure if you are unable to make payments on the line of credit.

How much equity do I need to get a HELOC?

Lenders will require you to have at least 15% equity in your home in order to qualify for a home equity line of credit. To compute your equity, subtract your mortgage balance from your home’s estimated value. Then divide the result by the home value to arrive at a percentage.

Is a HELOC or home equity loan better for a down payment?

Whether you should use a HELOC or a home equity loan for down payment will depend in part on how you feel about a HELOC’s variable interest rate. Both types of borrowing use your primary home as collateral and thus have a risk of foreclosure. But a HELOC’s interest rate can go up or down with market forces, while home equity loans usually have fixed interest rates. Another important consideration: Do you know exactly how much you need to borrow, or would you prefer to have some flexibility? As a lump-sum loan, a home equity loan will require you to be specific about your needs, while a HELOC is a borrow-as-needed arrangement.

Does using a HELOC affect my debt-to-income ratio?

Because your debt-to-income ratio is computed based on your monthly debts, drawing funds from a HELOC will affect your DTI ratio — that is, unless you use the HELOC to pay off other debts, as in the case of a debt consolidation.

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