The Complete Guide To Using A HELOC For A Down Payment On A Second Home

A home equity line of credit (HELOC) is a type of second mortgage that allows homeowners to borrow money against the equity in their home. The cash freed up through a HELOC can be leveraged in many ways. You can even use it to make a down payment on a second home, such as a lake cottage or an investment property.

Looking to tap your primary home’s equity for a down payment on another home? It’s important to understand how HELOCs work when deciding whether they’re the right choice for you compared to other loan options.

What To Consider When Using A HELOC For A Down Payment

A HELOC is used like a revolving line of credit. Though not a credit card, a HELOC works very much like one, often at a far lower interest rate. You can borrow up to the established credit limit and make payments on the principal plus accrued interest on what you’ve borrowed.

You can use HELOC funds for almost any purpose, including as a down payment on a second home. Your bank will set the credit limit on your HELOC based on the amount of equity in your current home and the balance of your mortgage. The credit limit will typically be set at no more than 85% of the value of your home. 

It’s important to keep in mind that using a HELOC as a down payment on a second home will result in three monthly payments: your first mortgage payment, your used HELOC balance and your second home’s mortgage payment. And since your home is used to secure the loan, you risk losing your home (or homes) if you fail to make payments.

Rocket Mortgage^® doesn’t offer HELOCs at this time.

How To Use A HELOC For A Down Payment On A Second Home

You can borrow against a HELOC, pay off the balance, and borrow again up to the credit limit for as long as the draw period lasts. If your loan is large enough, you can technically use some of the funds for a down payment while having extra to make repairs and improvements to the property. Here are the steps to using a HELOC for this purpose.

1. Determine Your Loan-To-Value Ratio (LTV)

Your loan-to-value ratio measures the appraised value of a home that you want to buy against the loan amount that you’re seeking to borrow. The lower your LTV, the more likely you’ll be approved for a mortgage by prospective lenders. For instance, if you want to buy a house valued at $100,000 and you can make a $10,000 down payment, your loan is $90,000 or 90% LTV. Most lenders want to keep the LTV on a HELOC to 85% or less.

Here’s an example of the maximum amount of credit you can qualify for based on how the LTV is calculated for a HELOC:

If your home’s appraised value is $500,000 and the amount you still owe on your mortgage is $300,000, you have $200,000 in equity in your home.

Multiply the home’s current value by 85% (0.85). $500,000 x 0.85 = $425,000.

Now, from that amount, subtract how much you currently owe on your first mortgage. 

$425,000 - $300,000 = $125,000

$125,000 would be your maximum allowed HELOC.

2. Set Your Second Home Budget

Making a detailed budget is important when considering a second home loan. If you’re taking out a HELOC to make your down payment, you’re taking on two new monthly payments: one for the HELOC and one for the primary mortgage. Plus, you’ll have to pay the closing costs for both loans, which are typically 2% – 6% of the loan amount. 

Also remember there will be property taxes, homeowners insurance and maintenance costs on the second home.

3. Apply For A HELOC For The Down Payment

Much like when you apply for a mortgage, a lender will want to make an assessment of all your financial commitments. They’ll determine the maximum amount of credit they can offer by calculating the LTV of your current home. Once you’ve closed on your HELOC, you can apply any or all of those funds to a down payment on a second home.

To qualify for a loan on a second home, you’ll need a down payment of at least 10% on a conventional loan

4. Find A Second Home

Finding a second home is a very similar process to finding your first home. A good real estate agent or REALTOR^® can point you to the best neighborhoods for your lifestyle and budget. They can also be a helpful asset throughout the home buying process.

5. Apply For A Loan For Your Second Home

Much like buying a primary home, buying a second home requires a down payment and a mortgage (unless you’re paying cash). Typically, the down payment on a second home is higher, at least 10%, because second mortgages are riskier investments.

6. Close On Your Second Home

The closing process takes 30 – 45 days in most cases. Remember that you’ll now have two mortgage payments, plus your monthly minimum HELOC payment.

Pros And Cons Of Using A HELOC For A Down Payment On A Second Home

There are advantages and disadvantages to using a HELOC for a down payment on a second home. Consider all the relevant factors before making such a large financial decision. 

Pros Of Using A HELOC For A Second Home

• Provides instant funds for a large down payment
• Preserves your savings for other uses
• Likely allows for tax-deductible interest
• Allows withdrawals of funds as needed, up to the credit limit
• Requires payments only equal to the interest on the loan during the draw period
• Comes with lower closing costs than other refinancing options

Cons Of Using A HELOC For A Second Home

• Invites unstable repayment terms due to a variable interest rate
• Offers a revolving credit line that can make it easy to over-borrow
• Includes the possibility that home prices will fluctuate and drop, potentially leaving you underwater on the mortgage
• Carries the risk of losing your home to foreclosure if you default

Other Down Payment Options On A Second Home

There are other ways to fund a down payment on a second home. Let’s explore some of those additional options.

Home Equity Loan

Though similar to a HELOC, a home equity loan is different in that you receive a lump sum payment and make monthly payments set at a fixed interest rate. 

One of the best reasons to use a home equity loan to buy a second home is that, because it uses the fixed collateral of your home equity, it’s considered a less risky loan and therefore has a lower interest rate than, say, a credit card or personal loan.

However, taking a home equity loan is not without risk. It turns an asset (your home’s equity) into debt, adds another mortgage payment to your budget and makes you financially vulnerable to downturns in the real estate market.

Cash-Out Refinance

Another way to get funds for a down payment on a second house is by doing a cash-out refinance on your primary home’s mortgage. In a cash-out refinance of your mortgage, you take advantage of the equity you’ve built by taking on a larger mortgage, paying off your current mortgage and pocketing the difference. This difference is what you can use as a down payment.

Cash Payment

If you have enough savings to pay the down payment in cash, you avoid the trouble and time it takes to get a loan. You also save all the money you would pay in interest over the life of a loan. And it can be advantageous to your credit score if you don’t take on any more debt.

The downside to making your down payment in cash is that the funds are now sunk into the real estate investment. You don’t have access to them for other expenses, known and unknown. If you can pay cash without significantly draining your cash reserves, this might be a good option.

The Bottom Line: A HELOC Can Help With Down Payments

A HELOC on your primary home can be a great way to get funds for the down payment on a second home. Based on how much equity you have in your house and its current value, you can borrow up to the established credit limit and make payments on the principal plus accrued interest on what you’ve borrowed.