Using a HELOC for a down payment: Is it a wise move?

Let’s say you want to buy a $500,000 house with a 20% down payment but don’t have enough cash. You'll need to borrow some or all of the funds before closing day.

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As a current homeowner, you may wonder if you can use a HELOC for your down payment. We’ll explain whether a HELOC is a viable option and offer alternative ways to tap into your home equity. That way, you can select the best strategy for your unique situation.

Can you use a HELOC for a down payment?

Yes, using a HELOC for a down payment is possible. In fact, many consumers get a HELOC to help them buy a second residence or break into real estate investing.

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A HELOC, also known as a home equity line of credit, is a type of second mortgage. It’s one of several ways you can use your property’s equity to finance a major purchase. 

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A HELOC functions like a credit card. During the draw phase, you can borrow up to your credit limit, pay down the balance, and borrow again. Let’s take a closer look at the pros and cons of HELOCs.

Pros

The biggest pro to using a HELOC for a down payment is that you can put more down than you could if you didn’t borrow. That larger down payment may help you qualify for your mortgage since second homes typically require more upfront investment than primary residences due to the lender’s added risk. If you have any credit line available after making your down payment, you can also use your HELOC to upgrade or repair your new home, save for emergencies, or invest in other assets.

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Plus, a HELOC may be a more affordable way to borrow than other financing options. Your lender may be willing to give you a lower interest rate because you’re more invested in the property from the start. A HELOC also features lower closing costs than other home equity products.

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Your HELOC’s term will be much longer than a personal loan – up to 30 years. During the draw phase, which can last for up to the first ten years, you may only need to pay the interest on the debt. Once you start the repayment phase, which lasts for the remaining life of the debt, you must make principal and interest payments.

Cons

The risk of foreclosure is the most significant downside to using any home equity product. If you don’t repay your HELOC as agreed, your lender could take possession of your property and sell it to pay off your debt.

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Taking out a HELOC also means you’ll have more debt overall, which could strain your budget. Plus, until you repay your HELOC, you’ll have fewer funds to invest or put toward other financial goals.

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In addition, your HELOC will likely have a variable interest rate, so your monthly payments may change throughout the life of the debt. Even though your closing costs may be lower with a HELOC than with other lending options, you’ll still have to pay a price to borrow.

HELOC requirements

HELOC requirements vary from lender to lender. However, here are the general qualifications you’ll need to meet:

• 680+ credit score (720+ preferred by most lenders)
• A debt-to-income (DTI) ratio of 45% or less
• No recent bankruptcies, foreclosures, or short sales
• Sufficient income to repay your existing debts, plus your new HELOC (If you experience income volatility, you may want to pay off other debt and diversify your income streams before applying.)

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Additionally, you’ll need at least 20% equity in your residence to qualify for a HELOC. Your equity is your property’s value minus the debt you have on it.

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You may also see your equity discussed as your loan-to-value (LTV) ratio. Your LTV ratio expresses how much of your home’s worth is tied up in debt. Generally, your LTV ratio must be 80% or less to get approved for a HELOC. Check your likelihood of qualifying for a HELOC using this calculator.

Alternative home equity solutions for a down payment

Bridge loan

A bridge loan is a short-term loan (12 months or less) that’s sometimes referred to as a swing loan, gap financing, or interim financing. You can tap your home’s equity to cover your down payment only or pay off your existing mortgage and cover your down payment. 

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Borrowers generally opt for this loan when their current residence is up for sale and need to close on another property before they have a buyer. A bridge loan may also make sense if you want to buy a house to flip because bridge loans often close faster than other home equity-based products.

Home equity loan

A home equity loan functions like a traditional loan in that you borrow a lump sum and repay the debt in equal installments over a set term (up to 30 years). Home equity loans generally come with a fixed interest rate, which means your payment amount will never change. A home equity loan may be right for you if you want a second mortgage with stable monthly payments.

Cash-out refinance

With a cash-out refinance, you borrow enough to pay off your existing mortgage and have money left over for your down payment. Unlike a home equity loan or HELOC, your cash-out refinance replaces your first mortgage, which means you'll only have one housing bill to pay. 

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A cash-out refinance might work for you if you don’t want to juggle multiple home loans. However, it’s generally harder to qualify for because you need to borrow more than you would with the other options we’ve discussed. Plus, since interest rates are higher now than a few years ago, you may end up with a more expensive mortgage if you go this route.

Home equity investment

With a home equity investment (HEI), you can get money now in exchange for a percentage of your property’s future value. Unlike a traditional loan, you won’t have to make monthly payments. Instead, you can repay your investment partner at any point during the agreement term (usually 30 years).

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Plus, unlike other home equity products, HEIs generally don’t have strict eligibility requirements. That means you may still be able to get the cash you need even if you have blemished credit. An HEI could be your best bet if you are looking for flexibility or don’t want to keep track of a monthly payment. 

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Final thoughts

We’ve answered the question “Can you use a HELOC for a down payment?” in the affirmative. However, just because you can doesn’t mean you should.

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It’s wise to identify, assess, and compare all your options before borrowing. That way, you select the right financial product for your situation today and in the future.

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