If you’re in the market for a new home, and you’re like most homebuyers, you’re more than likely planning on selling your current home and using that money to help you buy a new one. But if you’d like to hold on to your previous home, or if you’re buying a vacation home, you may consider using your home equity to help you buy a new property.
If you fit more into the latter scenario, that process generally entails taking out a home equity loan or home equity line of credit (HELOC) and using money from the new loan as your down payment on the second home.
Using home equity to purchase a new home can help you expand your real estate portfolio without dipping into your own pocket quite so much. But it also carries considerable risks. We’ll go over both the benefits and the drawbacks in this article.
Buying a new house is an exciting milestone in life. However, coming up with the down payment can be challenging, especially in today’s competitive housing market. If you’re wondering how to get the funds together for your dream home, you may be considering using a home equity line of credit (HELOC) loan
In this comprehensive guide we’ll explain what a HELOC is the pros and cons of using it to buy a house, alternatives to consider, and tips for getting the best terms if you decide it’s the right option for you.
What is a HELOC Loan?
A HELOC stands for home equity line of credit, It allows homeowners to borrow against the equity they have built up in their current home
Equity is the difference between what your home is worth and what you still owe on your mortgage. As you make payments on your loan over the years, you build equity. A HELOC converts this equity into usable funds in the form of a revolving line of credit.
With a HELOC, you are approved for a set limit, similar to a credit card. You can draw from this limit as needed up to the total amount approved. HELOCs have variable interest rates, so your monthly payments will fluctuate based on current rates.
Pros of Using a HELOC to Purchase a Home
There are some potential benefits that make a HELOC an attractive option for financing a home purchase:
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Access to funds: HELOCs provide a lump sum of cash that can be used for the down payment and closing costs on a new home. This allows you to buy sooner than if you had to save up the amount needed.
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Potentially lower rates: In many cases, HELOC rates are lower than other financing options, including personal loans or credit cards. The interest is usually comparable to rates for home equity loans.
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Interest may be tax deductible: If you use the HELOC solely to purchase and improve your new home, the interest is usually tax deductible. Consult a tax professional to understand how this potential benefit applies to your situation.
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Pay it back on your timeline: As long as you make the minimum payments, you can take your time paying the HELOC back depending on what your budget allows.
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Keeps your investments intact: Using a HELOC avoids having to liquidate investments like your 401(k) or stocks to free up cash for the home purchase. This prevents you from losing out on future growth or paying penalties.
Cons of Using a HELOC to Buy a House
While they can certainly help you achieve the goal of homeownership sooner, there are also some potential downsides with using a HELOC to purchase property:
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Closing costs: You will have to pay closing costs on the HELOC, including origination fees, appraisal fees, and other charges assessed by the lender. These can range from 2-5% of the amount borrowed.
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Variable rates: HELOC rates adjust periodically based on changes to the prime rate. Your monthly payments can go up over time, making the overall cost less predictable.
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Collateral requirements: Your home is used as collateral for the HELOC. This means if you default, you could lose your original home.
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Shorter repayment term: Most HELOCs have repayment periods of 10-15 years. This is a relatively short term compared to a traditional 30-year mortgage. Higher monthly payments may be required to pay it off in time.
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Line availability: The lender can freeze or lower your available HELOC limit for a variety of reasons, limiting access to additional funds.
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Difficulty getting another HELOC: If you already have a HELOC, lenders usually will not approve you for a second one. Your only option to tap equity again later would be to refinance.
HELOC Alternatives for Buying a House
Beyond just saving up for the down payment the old fashioned way, here are a few other options to consider rather than taking out a HELOC:
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Cash-out refinance: This converts your home equity into cash by replacing your current mortgage with a larger one. The funds received can be used for a home purchase.
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Home equity loan: These second mortgages provide a lump sum upfront rather than a revolving credit line. They have fixed rates and terms of 7-15 years.
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Bridge loan: Designed to be short-term financing until you sell your current house or secure a more permanent source of funds. Often used to buy before listing a home.
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Relocation loan: Some employers provide loans or grants to cover costs when they require you to relocate. Check if this is an option with your company.
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Personal loan: Unsecured loans from banks or online lenders can provide funds for a down payment. However, interest rates are usually higher than home equity financing.
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Retirement savings: As a last resort, you may withdraw from 401(k) accounts or IRAs. Know the rules, restrictions, and tax penalties before going this route.
7 Tips for Getting the Best HELOC Terms
If you’ve weighed the pros and cons and decided a HELOC is the right choice to fund your home purchase, here are some tips for getting the best rates and terms:
1. Shop around
Compare offers from multiple lenders. Online lenders sometimes have lower rates than brick-and-mortar banks.
2. Check your credit
Good credit means better chances for approval and lower interest rates. Review your credit reports and improve your score if needed before applying.
3. Pay down existing debts
Lower credit utilization and monthly obligations improve your debt-to-income ratio and loan eligibility. Pay off cards and other debts if possible.
4. Know your home value
The amount you can borrow depends on your equity. Get an up-to-date appraisal or estimate to determine how much you qualify for.
5. Ask about fees
Closing costs, application fees, and annual fees vary significantly. Ask lenders to explain all charges associated with their HELOCs.
6. See if you can get a fixed intro rate
Some lenders offer a fixed rate for the first 6-24 months. This gives payment stability before the variable rate kicks in.
7. Understand the fine print
Get details on repayment terms, rate caps, minimum payments, and conditions where the lender can change terms.
The Bottom Line
Taking out a HELOC to purchase a new home allows you to tap into your built-up home equity for the down payment. This can help you buy on your desired timeline instead of having to save for years. However, there are also risks involved when layering this type of financing.
Carefully consider both the pros and cons before deciding if using a HELOC to buy a house is the right move for your situation. Thoroughly evaluate the fees, rates, restrictions, and repayment terms before borrowing. With proper planning, a HELOC can be an affordable way to make your dream of homeownership a reality sooner.
Frequency of Entities:
HELOC: 28
home equity: 7
equity: 6
new house: 5
interest rates: 4
down payment: 4
home: 4
monthly payments: 3
variable rates: 3
closing costs: 3
lump sum: 2
revolving line of credit: 2
minimum payments: 2
home value: 2
credit card: 2
personal loan: 2
401(k): 2
current home: 2
Choosing Between a Home Equity Loan, Cash-Out Refinance or HELOC
These are the three most common ways people access their home equity, and each has its benefits and drawbacks. Here’s how they stack up.
| Cash-Out Refinance | Home Equity Loan | HELOC | |
|---|---|---|---|
| Loan Terms | Typically comes with a new mortgage term (e.g., 10, 15, 20 or 30 years) | Usually offers fixed interest rates and a term of 5 to 30 years | Typically has a variable interest rate and a draw period (5–10 years) followed by a repayment period (10–20 years) |
| Interest Rates | Usually fixed, potentially lower than HELOC rates | Typically fixed interest rates, providing stability in monthly payments | Generally comes with variable interest rates, which can change over time, affecting monthly payments |
| Costs | Involves closing costs such as appraisal fees, origination fees and other expenses associated with the new mortgage | Involves closing costs similar to those for a traditional mortgage such as appraisal and origination fees | May have fewer upfront costs, but might also include annual fees and transaction fees |
>> Related: Learn more the difference between home equity loans, cash-out refinance and HELOCs
Steps to Use Home Equity for a New Home
Here’s a step-by-step guide for using your existing home equity to purchase a new residence:
- Determine your current home equity amount: Start by calculating your current home equity. This can be done by subtracting your outstanding mortgage balance from your home’s current market value. You can get a rough estimate by checking your most recent mortgage statement and obtaining a current appraisal or real estate assessment.
- Research loan programs and prequalify: Research different loan programs for accessing home equity, such as cash-out refinancing, home equity loans or HELOCs. Prequalify to get an idea of the loan amount you may be eligible for based on your credit score, income and the value of your home.
- Compare costs of home equity loan vs. cash-out refinance: Compare the costs associated with both options. Cash-out refinancing may involve closing costs and potentially a higher interest rate due to the larger loan amount. Home equity loans typically have fewer closing costs, but you should compare the interest rates, terms and fees for both.
- Apply for a home equity loan or refinance: Once you’ve decided on the best option, complete the application process for either a home equity loan or a cash-out refinance. You will need to provide financial documentation, including income statements and credit reports.
- Get preapproved for a new mortgage with a down payment from your home equity: If you choose to use a home equity loan or cash-out refinance, you will receive a lump sum. Use this cash as the down payment on your new residence. You’ll need to get preapproved for a mortgage for the new property, and you can use your equity funds as the down payment.
- Make an offer and coordinate closings on both properties: Once you’re preapproved for the new mortgage and have secured the down payment from your home equity, you can start the process of finding your new home. Make an offer, and when it’s accepted, work with your real estate agent and mortgage lender to coordinate the closings of both properties. Ensure that the funds from your home equity loan or cash-out refinance are available for the down payment on the new home.
Remember to work closely with a qualified mortgage professional or financial advisor throughout this process to ensure you make informed decisions and successfully use your home equity to purchase your new residence.
>> Related: Learn more about things to consider before tapping into your home equity
How to use your EQUITY to buy another home (step-by-step)
FAQ
Can a HELOC be used to purchase a home?
Can I use a HELOC for a down payment on another home?
Can you use a HELOC to build a new home?
Can I use the equity in my house to buy another house?
Is a cash-out refinance better than a HELOC?
A cash-out refinance replaces your existing mortgage with a new one for a higher amount so you can pocket the difference. A cash-out refinance may be a better choice than a HELOC if you only want one loan on your property and one mortgage payment to make each month. And cash-out refinances typically have more attractive rates.
What is a HELOC mortgage?
A **Home Equity Line of Credit (HELOC)** is a **second mortgage** that allows homeowners to access cash based on the value of their home.Here’s how it works: 1.**Secured by Home Equity**: A HELOC is secured
How soon can you get a HELOC after buying a home?
However, some sources suggest that a HELOC can be obtained 30-45 days after the purchase of a home, assuming borrowers meet all of the necessary lender requirements, including having 15-20% equity in the