Homeowners

Maximize Your Home Equity: How to Use a HELOC to Buy a New Home

Owning a second home, as an investment property or vacation property, can seem like a bit of a pipe dream.

But homeowners have a unique advantage when searching for a place to generate income or spend their downtime because they may be able to tap into the equity of the property they already own.

Homeowners may be able to use their existing property to purchase a new one, taking advantage of the equity in their current home.

A Home Equity Line of Credit (HELOC) allows homeowners to borrow against the equity they have in their properties. That’s the value of a home minus the amount a homeowner owes on it.

”You’re using your own money that’s in your house and using it to invest,” said New American Funding Branch Manager Steve Gray. He’s based in Greenwood Village, Colo.

How to use a HELOC to buy a new home

HELOCs are frequently used by homeowners to consolidate debts and pay for renovations. But they can also be used to scrape together a down payment on a second home.

In some cases, homeowners with a lot of equity may be able to even use that money to buy another property.

Homeowners interested in using an HELOC to buy a new property will still need to gather documentation to prove their income, such as paystubs and W-2 forms, undergo a credit check, and get their home appraised.

Lender’s individual requirements will vary, but most ask that the loan amount not exceed 85% of the original home’s value.

They will also check a potential borrower’s debt-to-income ratio (which is a measure of how much debt they have compared to their monthly income), and credit score. Many lenders prefer applicants with a credit score of at least 620. Borrowers with higher scores may be offered lower interest rates. 

Advantages of using a HELOC to purchase a second home

There are many advantages to using a HELOC over other routes to purchasing a second home.

“You’re not going through the headaches of getting a traditional loan,” Gray explained.

Homeowners can typically take money out of HELOCs for five- to 10 years. They generally have between 10 and 20 years to pay the loans back, depending on the terms of their loan.

Crucially, HELOCs also allow the purchase of a home without the need to sell your current home. Avoiding the arduous and drawn-out process of selling a home makes using HELOCs an option for many would-be homebuyers.

Downsides of using a HELOC to buy another property

A Home Equity Line of Credit isn’t without its potential pitfalls. Prospective homebuyers should be aware of possible snags before seeking a line of credit.

An HELOC is borrowed against your current home. Using an HELOC exposes you to the risk of losing your home if you are unable to make payments on your line of credit.

Larger payments at the end of an HELOC’s term frequently catch homeowners, especially those who had been making minimum payments, by surprise.

“The balloon payment can be a shock,” Gray said. “A lot of people don’t realize that they aren’t paying the principal balance.”

HELOCs can also come with higher closing costs than more traditional loans. And like many lines of credit, their interest rates are variable. This means they can change over time, affecting the size of your payments.

Alternatives to HELOCs you may want to know

HELOCs are not the only options available to purchase a second home.

Homebuyers may want to consider taking out a traditional mortgage to fund the sale.

They may also look into using a cash-out refinance to help them cover the down payment and closing costs. A cash-out refinance replaces the homeowner’s existing mortgage with a new one that’s larger than what the homeowner currently owes. The homeowner can then pocket the difference.  

Ultimately, homebuyers should assess which loan or line of credit makes the most sense for them.

Steve Gray NMLS # 2097256