Using a Home Equity Line of Credit or HELOC to purchase a house offers a unique financing strategy that provides flexibility and access to substantial funds. A HELOC allows homeowners to tap into the equity they’ve built in their primary residence and use the available credit as a down payment or to fund the purchase of an investment property. However, while this approach offers benefits, it requires careful consideration of the risks and responsibilities involved.

How to Buy a House with a HELOC

heloc to buy a home

In this article, we will explore the mechanics of using a HELOC for home purchases, analyze the pros and cons, and provide key insights to help homeowners make an informed decision.

As you may know, the HELOC works like a credit card with a revolving line of credit, but it is secured by the equity in the borrower’s house.

Homeowners are allowed to draw funds from the HELOC to buy a second home or investment property.

The borrower may not exceed the HELOC credit limit to buy a home unless the bank or lender agrees to increase the line of credit.

Pros and Cons of Using a HELOC to Buy a House

Using a HELOC to purchase a home offers distinct advantages, including quick access to cash and flexibility in borrowing. Here’s a closer look at the key benefits and drawbacks:

Advantages

  • Speed and Convenience: A HELOC offers fast access to funds, enabling buyers to act swiftly in competitive markets.
  • Lower Interest Rates: HELOCs and home equity loans generally have lower interest rates compared to personal loans, making them more affordable.
  • Flexible Use: The revolving nature of a HELOC allows borrowers to reuse the line of credit once repayments are made, providing continued financial flexibility for future needs. (CFPB, n.d.).

Drawbacks

  • Variable Interest Rates: Many HELOCs feature variable interest rates, meaning payments could increase over time, creating uncertainty for borrowers. The interest rate on a HELOC is tied to the prime rate index.
  • Risk to Primary Residence: Since a HELOC is secured by the borrower’s home, defaulting on payments could result in foreclosure.
  • Limited Tax Benefits: Unlike primary mortgages, interest on a HELOC or home equity loan used for non-home improvement purposes may not be tax-deductible.

HELOCs for Investment Properties Vs Primary Residence

Lenders treat HELOCs differently depending on the intended use of the funds. Borrowers seeking to purchase a second home or investment property may face stricter lending criteria, including higher interest rates and more stringent credit score requirements. Some lenders may even limit the available credit for investment property purchases due to increased risk (Investopedia, n.d.). Borrowers must also be mindful of their debt-to-income ratio (DTI), as home equity lenders will assess both the primary and new property’s liabilities during the application process.

Key Considerations to Qualify for a HELOC

Equity Requirement and Loan Limits

Home equity lenders typically require homeowners to have between 15% and 35% equity in their property to qualify for a HELOC. The amount of credit available will depend on the loan-to-value (LTV) ratio and the lender’s terms, meaning not all homeowners may be eligible to secure enough credit for a full home purchase. The loan to value requirements are very similar to a home equity loan program.

HELOC Repayment Strategy

Planning for repayment is crucial, especially since HELOCs often feature variable interest rates. Borrowers should devise a strategy to pay down the loan during the draw period to minimize financial strain during the repayment phase. It’s also essential to prepare for potential rate hikes that could increase monthly payments unexpectedly. (CFPB, n.d.)

Is a HELOC the Best Way to Fund the Down Payment on Another Home ?

For some, using a HELOC to buy a house can be a strategic move, particularly for those who have substantial home equity and a clear plan for repayment. However, it is not a one-size-fits-all solution. Consider the following scenarios:

  • For Investors: A HELOC can be a powerful tool for real estate investors seeking to finance fix-and-flip projects or rental properties. Real estate investors love the flexibility to draw funds as needed. It also aligns well with fluctuating home improvement project costs.
  • For Homebuyers Seeking a Second Property: Buyers looking to acquire a vacation home may find a HELOC convenient, but they should carefully evaluate the impact of variable rates on their long-term budget.
  • For Primary Residence Buyers: Homeowners looking to use a HELOC for down payment assistance must ensure their financial health remains stable to handle multiple mortgages.

Alternatives to Using a HELOC

Borrowers who are unsure about using a HELOC may explore other financing options, such as:

  • Cash Out Refinance: This option consolidates the existing mortgage and provides cash based on home equity but replaces the original mortgage with a new loan. Check the cash out refinance rates before investing a lot of time in the loan process.
  • Home Equity Loan: Unlike a HELOC, the home equity loan offers a lump sum with fixed payments, providing predictability. Compare home equity loan closing costs to a HELOC before committing to a lender. In many instances home equity loans may have higher closing costs because the interest rate is fixed.
  • Personal Loans: For those with limited home equity, personal loans offer unsecured financing, though typically at higher interest rates. The unsecured personal loan is very popular with renters and borrowers that only need to borrow a small amount. (Investopedia, n.d.).

Takeaway on Using a HELOC to Buy Another Home

Using a HELOC to buy a house offers both opportunities and risks. While this second mortgage provides quick access to funds and flexibility, the potential for variable interest rates and foreclosure risks should not be overlooked. Homeowners must weigh their financial situation carefully, ensuring they have a solid repayment strategy before proceeding. Whether purchasing a second home or buying an investment property, borrowers should also explore alternative financing options to determine the best fit for their needs. Consulting with a financial advisor can further help ensure a well-informed decision.

FAQ on Getting a HELOC to Buy a House

Can I use a HELOC to buy a second home?

Yes, we will show how to use a HELOC to buy a new home. Many homeowners leverage the equity in their primary residence to buy a second home with the HELOC financing the down-payment requirement. One of the primary advantages of using a HELOC for a down payment of a vacation home or rental property. This larger down payment not only reduces the loan amount but may also increase your chances of mortgage approval. Since most mortgage lenders consider a second homes and investment properties as higher-risk ventures, they typically require a more substantial down payment compared to primary residences. A higher initial investment can offset some of this risk, demonstrating financial stability to lenders and potentially securing better loan terms.

For many homeowners, leveraging home equity can be a strategic way to finance the purchase of an investment property. However, it’s crucial to understand the associated risks and have a well-thought-out repayment strategy in place. Using a HELOC or home equity loan means placing your primary residence as collateral, which increases the risk if repayment becomes challenging. A pragmatic financial plan ensures that borrowers can effectively manage additional debt and take full advantage of the benefits while minimizing financial stress.

Can I Get a HELOC on an Investment Property?

Yes, but you typically need more equity and higher credit scores to take out a HELOC on rental property or investment home. Make sure you shop for lenders that specialize in home equity loans and credit lines on investment properties.

How soon can you take HELOC after buying a home​?

A HELOC can typically be secured within 30 to 45 days after purchasing a home, but approval depends on meeting the lender’s criteria. Borrowers are generally required to have 15-20% equity in the property, a strong repayment history, and meet credit and income requirements. Lenders also assess the borrower’s debt-to-income ratio DTI to ensure they can manage additional debt responsibly. The exact timeline may vary depending on the HELOC lender’s internal processes and the borrower’s ability to provide the necessary documentation promptly.

Can I get a HELOC with bad credit?

Yes, if you meet the bank or lenders credit requirements for a HELOC you can take out a home equity line of credit with low credit scores. Typically the lenders will require more equity and a lower loan to value (LTV) to get an equity loan or HELOC with below average credit scores.

Can I write a check with a HELOC?

Yes. Most HELOC lenders offer a check book and HELOC credit card when you initially set up the HELOC account. You will be able to write a check for a down payment on home purchase or consolidate credit card debt if you so choose. If you take out a home equity loan, you will not be given a check as the money comes as a lump sum.

How is HELOC interest calculated​?

During the repayment period, HELOC interest is calculated similarly to a traditional mortgage. However, during the draw period, borrowers make interest only monthly payments that just cover  the interest on the portion of the HELOC used. These monthly payments may vary depending on the remaining balance and any changes in the interest rate, making it essential for borrowers to plan accordingly and manage their budget effectively.

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References

Consumer Financial Protection Bureau (CFPB). (n.d.). What is a HELOC? Retrieved from

Federal Trade Commission (FTC). (n.d.). Home Equity Loans and Credit Lines.

Zillow. (n.d.). Buying a Home Using a HELOC

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