When you have a lot of equity in your current home and lack the cash-on-hand to buy a second home or investment property, a home equity line of credit may be the way to go. A HELOC allows you to borrow a portion of the equity you've already built and use it toward another asset. Whether it makes financial sense to use an equity line of credit as a down payment on another house depends on various factors; however, if you've decided it's the right move, you'll need to strategize to ensure the deal goes through.
Understand the Role of Equity
Mortgage lenders only allow you to borrow part of your home's equity with a HELOC. A loan-to-value ratio, or LTV, compares your outstanding mortgage debt to your home's market value. For example, a mortgage debt of $200,000 on a home valued at $250,000 equates to an LTV of 0.8, or 80 percent LTV. If you tried to get a HELOC as a second mortgage with a primary mortgage already at 80 percent LTV, you'd probably be denied. That's because most lenders set a maximum 80-percent LTV limit when qualifying you for a HELOC. You would need to owe less than $200,000 or your home's value would need to exceed $250,000 to borrow equity via a HELOC in this particular case.
Obtain Your HELOC In Advance
Arrange to obtain your HELOC in advance. A new mortgage lender won't allow you to draw directly from a new HELOC account and deposit the money into escrow for the down payment. Your money for a second home or investment property should be sufficiently seasoned -- sitting in your bank account -- for several months before the new home purchase. Lenders closely watch the paper trail of all large deposits and withdrawals from your bank account. Because your down payment funds must be certified by your bank, HELOC funds must be placed into that account first.
Be Prepared to Pay for It
Because you pay interest on the amounts you tap into, or "draw," from a HELOC, using equity for a down payment is like financing two loans for a new house. Each month, you'll have to pay the first mortgage on the new home, plus HELOC interest for the down payment you borrowed. However, you can pay down a HELOC as quickly as you'd like, thereby restoring your available credit and lowering monthly payments on the credit line. Calculate whether you can comfortably afford both the new mortgage and the HELOC payments each month before using a HELOC as a down payment.
Meet Lender Debt-Load Requirements
The new lender for your home purchase will want to know the source of your down payment. In addition to reviewing your most recent bank statements, lenders also check your credit report to determine if you've recently opened new accounts and will see the date you obtained a HELOC and its last monthly payment amount. When qualifying you for the new loan, the lender considers your entire debt load, including the monthly HELOC payment. Lenders typically want you to spend no more than 43 percent of your gross income for all monthly debt payments. Your total monthly debts, including your HELOC payment, should be within this 43-percent debt-to-income threshold.
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