How to Use a HELOC for a Down Payment

A homeowner who has equity in a primary residence may be able to use a home equity line of credit (HELOC) to make the down payment on a second home. The amount of equity limits the amount of money a HELOC can provide. Lenders generally want a larger down payment on a second home and will also check the borrower’s income and existing debts before approving the HELOC. A HELOC borrower who fails to make payments on the HELOC risks losing the borrower’s primary residence to foreclosure.

Consider working with a financial advisor as you explores ways to come up with down payment money.

HELOC Basics

A home equity line of credit (HELOC) is a revolving line of credit that allows homeowners to borrow against the equity they’ve built in their home. Equity is the difference between your home’s current market value and the amount you still owe on your mortgage. Unlike a traditional loan that provides a lump sum, a HELOC gives borrowers access to funds as needed, up to a lender-approved credit limit.

Most HELOCs have two phases: a draw period and a repayment period. During the draw period, which often lasts five to 10 years, borrowers can withdraw funds as needed and may only be required to make interest payments. Once the draw period ends, the repayment period begins, and borrowers typically repay both principal and interest over a set number of years.

HELOCs usually have variable interest rates that fluctuate based on broader market conditions, although some lenders offer fixed-rate options for all or part of the balance. Because the loan is secured by your home, HELOCs often carry lower interest rates than credit cards or personal loans. However, changing rates can increase monthly payments over time, making it important to understand how borrowing costs could affect your budget.

Lenders generally evaluate several factors when approving a HELOC, including your credit score, debt-to-income ratio and the amount of equity you have in your home. Many lenders require homeowners to maintain at least 15% to 20% equity after the HELOC is established, though exact requirements vary. Borrowers should also consider closing costs, annual fees or other lender charges that may apply when comparing HELOC options.

HELOC Down Payment Example

When it comes to using a HELOC as a down payment on a second home, much depends on individual circumstances. A borrower’s credit score, income, other debts and amount of home equity are all major factors affecting the likelihood of being able to qualify for a HELOC that can serve as a down payment on a second home.

However, in many cases a homeowner with a home valued at $300,000 and a mortgage with a remaining balance of $200,000 could qualify for a HELOC with a $55,000 credit limit. This figure is arrived at by multiplying the $300,0000 home value by 0.85, yielding a figure of $255,000, and subtracting the remaining primary mortgage balance of $200,000 from that result.

With that $55,000, the homeowner could make a 10% down payment on a second home valued at up to $550,000. If the second home will be used as an investment property, lenders may require a larger down payment of 15% or more. In that case, the value of the second home might be capped at approximately $367,000.

HELOC Down Payment Pros and Cons

Using a HELOC as a down payment lets a buyer hang on to any available cash, investing it elsewhere or keeping it as an emergency fund, rather than using it for the down payment. It can also let a second-home buyer get a lower interest rate and other advantages by making a larger down payment.

HELOCs generally have lower closing costs than other refinancing methods. And by making interest-only payments, a second-home buyer can improve cash flow during the draw period.

The major downside of using a HELOC for the down payment when buying a second home is that the borrower’s primary residence could be foreclosed on if the borrower fails to make the HELOC payments. And having a HELOC in addition to mortgages on the first and second home can make it difficult to keep up on the combined payments.

Other Second-Home Down Payment Options

Using cash savings is often the simplest way to fund a second-home down payment because it avoids taking on additional debt or paying interest. While this approach can strengthen your mortgage application and reduce your monthly housing costs, buyers should be careful not to deplete their emergency fund or other savings needed for unexpected expenses.

A cash-out refinance allows homeowners to replace their existing mortgage with a larger loan and receive the difference in cash. Those funds can then be used toward a down payment on a second home. This option may be attractive when mortgage rates are favorable, but refinancing also changes the terms of your primary mortgage and may increase your monthly payment.

A home equity loan lets homeowners borrow a lump sum against the equity in their primary residence and repay it in fixed monthly installments. Unlike a HELOC, which offers flexible access to funds, a home equity loan provides predictable payments and typically comes with a fixed interest rate. It may be a good fit for buyers who know exactly how much they need for a second-home down payment.

Some buyers fund a second-home purchase by selling investments or other valuable assets. While this can reduce the need to borrow, selling assets may trigger capital gains taxes or affect a long-term investment strategy. Before liquidating investments, it’s worth considering the tax implications and the potential impact on your overall financial plan.

Bottom Line

A HELOC can give a homeowner who has significant equity in the primary residence a source for funds to make a down payment on a second home. HELOCs feature low closing costs and the option to make interest-only payments during the draw period. However, a homebuyer who uses a HELOC for a down payment risks losing the primary resident to foreclosure. And the credit limit on a HELOC is limited by the amount of equity in the primary residence securing the loan.

Tips on Mortgages

You can get expert help evaluating options for financing a second-home purchase with the help of a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you would like to get more information about using a HELOC for a down payment, look at SmartAsset’s mortgage calculator.
The mortgage rate environment is more volatile now than ever. Check out SmartAsset’s mortgage rates table to get a better idea of what the market looks like right now.