Buying your first home can be a major, life-changing event. Buying your second property can be even more exciting, particularly if you have plans to incorporate this additional home into your personal revenue stream or long-term family plans. For many individuals, the size of the down payment required to purchase a property can dissuade them from making a second property acquisition. That being said, it is entirely possible to use a home equity line of credit to either subsidize or completely pay the down payment on a second home. Understanding how to leverage a home equity line of credit, or HELOC, for a down payment on a second property is a powerful skill to have.
A home equity line of credit, or HELOC, allows homeowners to borrow funds that they have paid into their mortgage. These funds, commonly referred to as equity, can be used to fund a variety of other payments, including the down payment on a second property.
The Basics of a HELOC
A home equity line of credit is one of two forms of borrowing that uses the equity you have established in your property as the primary source of lending. When you make your monthly payments on your mortgage, the amount of money you have paid back into your loan is commonly referred to as your equity. The larger the sum of money you have paid into your home, the greater the amount of equity you have available.
Both a home equity loan and a HELOC allow you to essentially "borrow" the money you have already paid into your property for a designated period of time. This can be particularly beneficial if you have established a large amount of equity in your property already.
Withdrawing Funds from a HELOC
With a home equity loan, individuals can borrow these funds using an account specifically established for them by the facilitator of the credit line. Although the specific details of the HELOC may change, individuals generally have between five and 10 years to withdraw funds from their equity credit line. This window of time is commonly referred to as the "draw period." Throughout this duration of time, borrowers will still be required to pay back the interest on the funds they have borrowed. Repaying principal will not be required yet, however.
Following the closure of the draw period, borrowers will be required to begin paying back the principal of their loan. Repayment periods will typically last between 10 to 20 years. For many individuals, the terms of their HELOC are far more advantageous than their first mortgage, particularly when it comes to interest rates. Although monthly payments may, in some situations, be higher than their mortgage payment, this will be due to the truncated repayment period (mortgages typically allow for 30 years of repayment) rather than a higher interest rate.
Moving Forward With Your HELOC
Using a HELOC as part of a down payment is relatively straightforward. Given the fact that the funds accrued as part of your home equity will automatically be available to you once your credit line opens, making your down payment is as simple as transferring funds from the HELOC directly to the mortgage servicer.
It is important to remember, however, that just because the draw period does not require repayment of principal does not mean that payments are voided entirely. In a situation where you, the purchaser, use a HELOC to pay for a very large down payment, your interest payments that must be completed during the draw period could be quite substantial.
With that in mind, it is critical that you, the HELOC applicant, fully explore the current interest rates attached to home equity credit lines in order to ensure that using these funds for a second down payment is feasible. Interest rates for a home equity credit line can vary widely. In some more extreme circumstances, these rates can approach those commonly seen with credit cards. If this were the case with your HELOC, borrowing a large portion of your equity to make a down payment on a second mortgage could create huge interest payments in addition to regular payments on two mortgage. For most individuals, this scenario would stress their finances beyond a sustainable level.
Other Critical Considerations
Generally, a HELOC will allow homeowners to gain access to a portion of their home's total value, but not the entire sum. A common formula used to calculate the amount of funds a HELOC applicant may gain access to involves subtracting the remaining value of the mortgage from the total value of the house. The resulting figure will represent the total equity in the property currently available. From this amount, homeowners will most likely have access to roughly 70 percent or 80 percent of the total for their borrowing needs.
Although home equity loans almost always feature a fixed interest rate, a HELOC will usually have a variable interest rate. This means that it is entirely possible for the interest rate on a HELOC to skyrocket at some point in time during the duration of borrowing. With that in mind, you should always thoroughly research your options prior to borrowing these funds. Your finances and credit score could be hurt if you borrow funds that you are unable to pay back. In the worst case scenario, you could be forced to relinquish your home as part of a foreclosure.
Identifying HELOC Lenders
You do not need to stick with your original mortgage provider when it comes time to apply for a HELOC. If you find competitive borrowing terms through a different lender, you should pursue them. On a fundamental level, your HELOC is no different than a second mortgage on your property. With that in mind, you should plan on devoting the same amount of time and energy used to find your perfect first mortgage to your search for the right HELOC provider.
In the event that you are either unable or unwilling to research available HELOC lenders on your own, you can enlist the services of a mortgage broker. These individuals will scour the current borrowing offerings as well as the interest rates attached to them in order to help you locate a HELOC that matches your own financial profile rather than a generic industry benchmark.
As always, you should consider consulting a financial professional if you have any lingering questions about a HELOC or other potential options to finance your home purchase. If you do find that this particular method is not in your best financial interest, a financial advisor may help you come up with another efficient package for obtaining the funds you need to make your next purchase a huge success.
If your first mortgage is already presenting financial hurdles or challenges, it may be in your best interest to tackle these issues before embarking on the process of purchasing a second home.
- NOLO: Home Equity Loan and HELOC Basics
- NerdWallet: Best HELOC Lenders of June 2019
- Home Equity Loans and Credit Lines | FTC Consumer Information
- Discover.com. "Considering a HELOC? Know Your Draw Period." Accessed May 12, 2020.
- Internal Revenue Service. "Interest on Home Equity Loans Often Still Deductible Under New Law." Accessed May 12, 2020.
- Internal Revenue Service. "Be Tax Ready – understanding tax reform changes affecting individuals and families." Accessed May 12, 2020."
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community. Ryan's work has been featured at Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.