Can you use a HELOC for a down payment?

If you need to borrow money for a down payment on a second home, you can use a HELOC to finance it.  (Shutterstock)

A home equity line of credit — better known as a HELOC — is a form of revolving credit that makes it possible to borrow from the equity you’ve built in your home. With a HELOC, you can borrow up to a certain percentage of your home’s current assessed value once you subtract the amount you still owe on your mortgage. 

HELOCs are appealing because you only have to pay interest on the money borrowed during the loan’s draw period before the entire balance comes due. They’re also a good option if you want to fund a down payment for another property.

Here’s how HELOC down payments work, how to qualify for a HELOC and some advantages and disadvantages of this move.

While Credible doesn’t offer HELOCs, it’s easy to compare mortgage refinance rates from multiple lenders for a cash-out refinance.

• Can you use a HELOC for a down payment?
• How do you qualify for a HELOC?
• Pros and cons of using a HELOC for a down payment
• Should you use a HELOC for a down payment?
• Other down payment options

Can you use a HELOC for a down payment?

Yes, it’s possible to use a HELOC for a down payment on a home. 

Let’s say you already own a home, but you want to buy another property for investment or vacation purposes. It might be hard to save up enough money for that down payment while paying a mortgage on your existing home. In this case, assuming you have enough equity to fund it, you can use a HELOC to borrow the amount of money you need for the down payment.

Keep in mind that HELOCs are generally variable-rate loans, meaning the interest rate you initially pay may change in the future. A fixed-rate mortgage might prove to be a safer long-term option.  

How do you qualify for a HELOC?

To qualify for a HELOC, you have to meet certain requirements:

• Debt-to-income (DTI) ratio — Your DTI ratio looks at how much you spend on debt payments in comparison to your income. Lenders use it as a guideline when determining whether to qualify you for a HELOC to make sure you won’t be overextending your budget by taking on a new loan.
• Credit score — HELOC lenders generally want to see that you have a credit score of at least 680, but some lenders require even higher scores.
• Equity — Remember, you can only borrow up to a percentage of your home’s current assessed value — usually no more than 85% — after subtracting what you still owe on your mortgage. So if you haven’t had a chance to build up enough equity, you might not be eligible for a HELOC.

You can compare cash-out refinance rates all in one place with Credible.

Pros and cons of using a HELOC for a down payment 

Like any lending product, using a HELOC for a down payment has both advantages and disadvantages. 

Pros of using a HELOC for a down payment

• They have lower interest rates than other financial products. HELOCs generally have lower interest rates than unsecured loan products, like credit cards and personal loans, since your home acts as collateral and secures the loan.
• You can use a HELOC for more than just a down payment. When you take out a HELOC, you aren’t limited to what you can use the funds for like you would be with a mortgage loan or car loan. For example, if you buy an investment property, you could use a HELOC to cover the down payment and any renovations you need to help the house sell for a better price.
• You only pay for the money you use (plus interest). HELOCs are also flexible when it comes to how much you borrow, and you only pay interest on the amount you actually use, not the full amount of credit available to you.
• They can help increase your credit score. If you make consistent on-time payments and borrow a small amount of the funds available to you, having a HELOC can help improve your credit score.

IS THE INTEREST ON A HELOC TAX DEDUCTIBLE?

Cons of using a HELOC for a down payment

• HELOCs use your home as collateral. Because a HELOC uses your home as collateral, if you fail to make payments, you could end up losing your home.
• You’ll pay additional fees. HELOCs come with a few fees that add to your borrowing cost, including appraisal, application, and closing cost fees, alongside recurring annual, inactivity, cancellation, and draw fees.
• They reduce your home equity. When you borrow money from the equity in your home, you lower the amount of equity you have until you pay back the loan. This can be problematic if you need to sell your home and the market is down. 
• HELOCs can damage your credit if you miss payments. It’s important to budget for your monthly payments carefully because if you miss a payment, you can hurt your credit score.

Should you use a HELOC for a down payment?

Whether or not using a HELOC for a down payment is the right move for you depends on your situation as a borrower. Using a HELOC for a down payment may make sense in a few situations:

• You’ll generate income from the new home by renting it out.
• You plan to flip and sell the new home for a profit.
• You can afford to make your HELOC and mortgage payments comfortably at the same time.

It may not make sense to use a HELOC for a down payment if:

• You want to buy a vacation home, but you don’t plan to rent it out.
• You have a high DTI ratio or a tight budget and will struggle to balance HELOC payments alongside your first mortgage payments.
• Your first home isn’t currently worth as much as it was when you first bought it.

Other down payment options

If you don’t think a HELOC is right for you, consider these alternative options:

• Home equity loan — Similar to a HELOC, a home equity loan makes it possible to borrow against your home’s equity, but you receive the funds in a lump sum and make fixed payments for as long as 30 years — which can make this an easier loan to budget for.
• Cash-out refinance — With a cash-out refinance, you also get set monthly payments and a long loan term by replacing your existing mortgage with a new, bigger mortgage so you can pay off your original one. You can then use the remaining cash from the loan as a down payment on a second house.

WHAT IS A FIXED-RATE HELOC?

If you decide a cash-out refinance is a better fit for your financial goals, start by comparing mortgage refinance rates from multiple lenders with Credible.