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A home equity line of credit – better known as a HELOC – is a form of revolving credit that allows you to borrow against the equity you have accumulated in your home. With a HELOC, you can borrow up to a certain percentage of your home’s current assessed value after you subtract the amount you still owe on your mortgage.
HELOCs are attractive because you only have to pay interest on the borrowed money during the loan drawdown period before the balance is due. They are also a good option if you want to finance a down payment for another property.
Here’s how HELOC installments work, how to qualify for a HELOC, and some pros and cons of the move.
Although Credible does not offer HELOC, it is easy to compare mortgage refinance rates from several lenders.
Yes, it is possible to use a HELOC for a down payment on a home.
Let’s say you already own a house, but you want buy another property for investment or holiday purposes. It can be difficult to save enough money for that down payment while paying a mortgage on your existing home. In this case, assuming you have enough equity to finance 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, which means the interest rate you initially pay may change in the future. A fixed rate mortgage may be a safer option in the long run.
To qualify for a HELOC, you must meet certain requirements:
- Debt-to-income ratio (DTI) — Your DTI ratio looks at how much you’re spending on paying off debt compared to your income. Lenders use this as a guideline when determining whether you should qualify for a HELOC to ensure you don’t go over budget when taking out 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 that 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 been lucky enough to build up enough equity, you might not be eligible for a HELOC.
You can compare withdrawal refinance rates all in one place with Credible.
Like any loan product, there are both advantages and disadvantages to using a HELOC for a down payment.
Benefits of using a HELOC for a deposit
- They have lower interest rates than other financial products. HELOCs generally have lower interest rates than unsecured loan products, such as 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 are not limited to using the funds like you would with a mortgage or car loan. For example, if you’re buying an investment property, you can 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 in how much you borrow, and you only pay interest on the amount you actually use, not the total amount of credit you have.
- They can help boost your credit score. If you make regular payments on time and borrow a small portion of the funds you have, having a HELOC can help improve your credit score.
Disadvantages of using a HELOC for a deposit
- HELOCs use your home as collateral. Because a HELOC uses your home as collateral, if you don’t make payments, you could end up losing your home.
- You will pay additional fees. HELOCs come with a few fees that add to your cost of borrowing, including appraisal, application, and closing fees, as well as annual recurring, inactivity, cancellation, and drawdown fees. .
- They reduce the equity in your home. When you borrow money against your home equity, you reduce the amount of equity you have until you pay off 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 your monthly payments well because if you miss a payment, you can hurt your credit score.
Whether or not using a HELOC for a down payment is the right decision for you depends on your situation as a borrower. Using a HELOC for a deposit can make sense in a few situations:
- You will generate income from the new house by renting it out.
- You plan to flip and sell the new home for a profit.
- You can comfortably afford to make your HELOC and mortgage payments at the same time.
It may not make sense to use a HELOC for a deposit if:
- You want to buy a vacation home, but you don’t plan to rent it.
- You have a high DTI ratio or a tight budget and you’ll struggle to balance HELOC payments alongside your first mortgage payments.
- Your first home isn’t worth as much as when you first bought it.
If you think a HELOC isn’t right for you, consider these alternative options:
- Home equity loan — Similar to a HELOC, a home equity loan allows you to borrow against the equity in your home, but you receive the funds in a lump sum and make fixed payments for 30 years, which can make it an easier loan to budget for.
- Refinancing by collection — With a cash-in refinance, you also get fixed monthly payments and a long-term loan by replacing your existing mortgage with a new, larger mortgage so you can pay off your original loan. You can then use the remaining loan money as a down payment on a second home.
If you decide that a cash-out refinance is a better fit for your financial goals, start with compare mortgage refinance rates from multiple lenders with Credible.