Home Equity

Using a HELOC for Down Payment: Is It Possible?

October 18, 2023

If a lakeside cabin is on your bucket list, or you stumble across a fantastic rental property for sale, you’ll need to figure out how to come up with the cash for a down payment. As a homeowner, a HELOC is one way to do so if your equity level and financial footprint meet the lender’s qualifications.

Yet while you can use a HELOC for a down payment on a second home or investment property, it comes with risks—including foreclosure on your current home if you can’t meet your repayment obligations.

Let’s break down the nuances behind the question: Can you use a HELOC for a down payment and when should you consider this financing option?

What Is a HELOC?

A HELOC is a revolving line of credit with a variable interest rate that uses your home equity as security for the lender.

It comes with a lower interest rate than an unsecured loan or credit card but a higher interest rate than a traditional primary mortgage. That’s because a HELOC lender can place a lien or foreclose on your property to recoup expenses if you default on the loan, but they’re second in line for foreclosure proceeds (after your primary mortgage lender).

So how does a HELOC work? There are two stages to consider:

The draw period – For the first 5 to 15 years, you’ll be able to use as much or as little as you choose of your credit line. You’ll need to make minimum interest-only monthly payments on what you use. You can borrow, repay, and re-borrow as often as you need during the draw period so long as the balance never exceeds your limit.

The repayment period – You no longer have access to take out money from your HELOC loan once the repayment period (usually 10 or 20 years) begins. You’ll have monthly payments—which may change as the prime interest rate changes—on the balance of what you owe at the end of the draw period plus interest.

Using a HELOC for a Down Payment

There are no limits on how you spend HELOC proceeds. So long as you have enough equity in your current home and meet other qualifications, you can apply for a HELOC to cover a new property down payment.

One of the benefits of a HELOC is the flexibility to limit the debt if you end up needing less than anticipated. As a best practice, apply for enough to cover unexpected costs, then restrict your draws to exactly what you need instead of over-borrowing.

This can be particularly helpful if you’re still in search mode for a vacation, rental, or investment property.

Qualifying for a HELOC

Each lender sets their own requirements, so shop around for the best terms available for your property and financial profile.

If you want to know how to qualify for a HELOC, it usually includes:

A credit score minimum between 620 and 700
Two or more years of stable, verifiable income history
A debt-to-income (DTI) ratio maximum between 36% and 43%
A reliable history of mortgage and other debt repayments

The maximum credit line amount is based on your home value and how much equity you own. Most lenders will require you to own a minimum of 15–20% home equity after calculating for both your primary mortgage and HELOC (or have a maximum combined loan-to-value ratio of 80–85%).

Lenders often have minimum amounts for HELOCs as well, ranging from $10,000 to $35,000.

Alternatives to Using a HELOC for Down Payment

Is a HELOC a good idea for you? Before choosing a HELOC as your best financing option, consider these alternatives to getting hands on cash for a down payment:

Home Equity Loan

A home equity loan has similar qualifications and risks as a HELOC. When comparing a home equity loan vs HELOC, it differs in that:

You receive a single lump sum right away instead of a revolving line of credit
They’re typically fixed interest rate loans
You begin principal-plus-interest repayments right away (no interest-only draw period)
Monthly payment amounts are fixed and predictable

Cash-Out Refinancing

With a cash-out refinance, you take out a new primary mortgage to pay off your current mortgage plus receive cash back. There are several differences between a HELOC vs cash-out refinance. For example, instead of adding another home loan to your debt load, you replace your current mortgage with a new one. This provides:

A lower interest rate than a home equity loan or HELOC
A single repayment instead of another monthly bill
One lender to communicate and negotiate with rather than two

Sale-Leaseback Program

If your goals include freeing up cash for a down payment without moving out of your current home, consider a sale-leaseback program. Rather than taking on new debt, a sale-leaseback wipes out your current mortgage plus converts your home equity to cash. It combines:

A sale of your home to an investor-landlord
A contract that guarantees your right to remain as a renter as long as you choose
A lease with an agreed-upon rate with a multi-year lock
A transparent formula on how future rent increases will be calculated

You’ll be able to convert all of your equity to cash rather than a limited amount, and significantly improve your DTI ratio at the same time by paying off your current mortgage.

Key Takeaways

The answer to “can you use a HELOC for a down payment” is yes, but you need to be aware of the risks—including foreclosure on your primary residence—and the limitations of doing so.

Lenders look for HELOC applicants with a 600 or higher credit score, a DTI ratio no higher than 43%, and stable income and debt repayment histories. You’ll be able to borrow up to 80 or 85% of the equity you own after calculating it against your current mortgage and new HELOC.

Alternatives to free up cash for a down payment include a traditional home equity loan, cash-out refinancing, and—for a debt-free option—a sale-leaseback.

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