If you’re looking to buy a second home or an investment property, you might be wondering whether it’s possible to use a home equity line of credit. The short answer is yes. However, going this route is not without any risks, so it’s wise to weigh the pros and cons before taking the plunge.
You’ll also learn in this guide the things you should consider when using HELOC to buy a house, when it makes sense to use HELOC for property purchase and when it doesn’t, and alternatives to HELOC.
Access Your Home Equity
What is a HELOC?
A HELOC is a revolving line of credit that lets you borrow money up to a certain limit, make payments, and borrow again. As you make payments to the borrowed amount, your available credit is replenished just like a credit card. However, this offers so much flexibility as you can draw as much or as little as you need over the draw period, which usually lasts for 10 years. Plus, you only pay for what you draw.
The credit is secured by the equity in your primary residence, meaning if you fail to make payments towards the credit balance, your lender can use your home as collateral. Unlike traditional mortgages with a fixed interest rate, HELOCs have a variable interest rate, meaning they can change from time to time. However, some lenders offer HELOCs with fixed rates.
To qualify for a HELOC, you must have equity in your home. Also, remember that the amount you owe on the house should be less than the property’s appraised value. Lenders will also look at your credit history, debt-to-income ratio, and other factors when evaluating your eligibility for a HELOC.
Is It Possible to Use a HELOC to Buy a House?
Yes, you can use a HELOC to purchase a house or an investment property. All you need is enough equity in your property, such that tapping into 75% to 80% of that equity will give you access to sufficient cash to purchase your next property. Once approved for a HELOC, you can use the credit line as a down payment or buy the property in cash.
Things You Should Consider When Using a HELOC to Buy a House
Before using a HELOC to purchase a property, you need to consider the following things:
The Current Equity You Have in Your Home
The amount of equity in your home is the first thing to know if you’re considering HELOC for property purchase. To find out the available equity in your home, subtract the amount you still owe on your mortgage from the home’s market value. Where your home’s equity stands currently determines how much line of credit you may qualify for. Generally, you need at least 15% to 20% equity in your home to be eligible for a HELOC.
If You Can Take Out Enough for a Down Payment
Lenders have varying requirements on the amount you can take out on the line of credit. For example, some are willing to increase your credit limit if you put down a specific percentage of cash. For this reason, it’s a good idea to find out from your lender if you can take out enough credit line for a down payment.
Access Your Home Equity
If You Are Eligible for a HELOC
Requirements for a HELOC vary depending on the lender. For most lenders, you need at least 15% to 20% equity in your home to qualify for a HELOC. You also need a good credit score, low debt-to-income (DTI) ratio, and reliable payment history. Looking at the lender’s eligibility requirements before sending in your application will shorten the process and increase your chances of approval.
HELOCs Interest Rates and Terms
HELOCs have repayment terms like any other loan and are typically paid back with interest. HELOC rates and terms are determined by your financial situation and credit score. Keep in mind that HELOCs interest rates are variable and usually operate on 30-year terms, with a 10-year draw period and a 20-year repayment period.
If You Can Afford the Monthly Payments
Finally, consider if you can afford your monthly payments if you take out a HELOC. Be honest with yourself. You don’t want to fall behind on payments, which can hurt your credit score. If you think managing your monthly payments can be a struggle, then using a HELOC to buy a house may not be a good idea.
When You Should Use a HELOC to Buy a House
Using a HELOC to purchase a house may make sense if you’ve built enough equity in your home. Plus, it can be an invaluable resource if you have short-term cash needs and will pay off the drawn amount quickly.
When You Should Consider Other Options
If you don’t have enough equity in your home, it may be challenging to get approved for a HELOC. Also, a line of credit may not be a good choice if you don’t intend to repay the borrowed amount faster. In such a situation, you may want to consider other financing options for your next home purchase.
Alternatives to HELOCs to Buy a House
If a home equity line of credit doesn’t sound appealing, here are two alternatives to consider:
A cash-out refinance is a mortgage financing option that allows you to pay off your current mortgage with a larger one based on your home’s equity. Simply put, it gives you access to a considerable amount of money to pay off your existing mortgage and remain with a lump sum of cash for your new home purchase.
Cash-out refinancing is an excellent option for homeowners who don’t want a second mortgage. However, while refinancing comes with several benefits, such as lower monthly payments, the ability to negotiate lower interest rates, and even change terms, you risk losing your home if your financial situation changes in the future.
Equity Sharing Agreement
Another option to consider is an equity sharing agreement which allows you to convert your home’s equity without using it as collateral. Unlike cash-out refinance and personal loans, you don’t have to worry about accumulating more debt, making monthly payments, or paying interest. Instead, the lender offers access to cash in exchange for a portion of your future change in value. And if it decreases, the lender shares the loss with you.
Equity sharing agreements are arguably one of the best financing options for homeowners who have built enough equity and want fast access to cash but don’t want more debt. If tapping into your home equity through co-investing sounds like a good option, you may want to work with Unison and get up to 17.5% of your home value.
To get started with the Unison equity sharing agreement, visit their website to see how much equity you can unlock by filling out a simple online form.