You can use a home equity line of credit to buy a new home by either securing the line against your existing home or taking out a home equity line of credit purchase loan on the new home. However, before deciding whether to use a HELOC rather than a mortgage you should carefully consider the closing costs and interest rates available with both types of financing.
Establishing A Line Of Credit
When you establish a line of credit on your existing home you do not have to make an immediate draw on the funds. Most lenders enable you to take out a HELOC with a line amount equal to up to 90 percent of your property value. If you have an existing mortgage on your home, the two loans combined cannot exceed 90 percent of the property value. If you take out a purchase HELOC you can normally borrow up to 80 percent of the property value and you make an immediate draw on the line in order to purchase the home.
Lenders typically do not sell HELOCs on the secondary market which means you do not have to buy private-mortgage insurance if your HELOC exceeds 80 percent of the property value. You do have to buy PMI if you have less than 20 percent equity in a home and financed it with a regular mortgage. Lenders often waive the closing costs on HELOCs which can save you several thousand dollars. However, if you close the HELOC within two years you normally have to reimburse the lender for those fees.
HELOCs have variable interest rates indexed against the United States prime rate. The prime rate changes up to eight times a year and has no cap although HELOC contracts normally include an interest rate cap of around 20 percent. This means your rate could rapidly rise once you have established the line of credit whereas if you buy a home with a standard mortgage you have a fixed payment for the life of the loan. However, on a HELOC you can opt to make interest-only payments which means you have flexibility.
Lenders do not allow you to borrow a HELOC against your current home to finance your new home purchase if you have your current home on the real estate market. Therefore most people only use their current home as collateral if they plan to buy an investment property rather than a new primary home.
If you do buy your new home with a purchase money HELOC, once you pay down the balance you can draw on funds again at any time without having to establish a new loan.
- Federal Reserve Board: What You Should Know About Home Equity Lines of Credit; August 2009
- Federal Trade Commission: Home Equity Credit Lines; February 2007
- Bankrate.com: "What is Home Equity Debt"; August 2009
- Comptroller of the Currency Administrator of Natioanl Banks: Answers about Home Equity Lines of Credit and Home Equity Loans