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 HELOC is a loan secured by the borrower's home equity. A HELOC works much like a credit card, providing the borrower with a credit limit rather than a lump sum. The borrower only has to pay back the amount borrowed and funds can be used for almost any purpose, including making a down payment on a second home. HELOCs usually have variable interest rates so the payment amount can change.
HELOCs generally are set up with two periods. During the draw period lasting five to 15 years, the borrower can get funds up to the credit limit and only has to make payments equal to the interest on the loan. During the payback period, which starts when the draw period ends and may last five to 15 years, no more funds can be withdrawn and the borrower has to make payments of both interest and principal.
Lenders set the size of the HELOC credit limit based on the amount of home equity and the amount of the original mortgage. The combination of the original mortgage balance and the HELOC credit limit typically will be no more than 85% of the home's value.
Federal law gives a borrower who signs a loan agreement secured by a primary residence three days to back out. The cancellation period starts when the borrower has signed the agreement, received a Truth in Lending form describing the interest rate and other key facts and gotten two copies of a Truth in Lending notice explaining the right to cancel. It includes Saturdays but not Sundays and lasts until midnight of the third business day. If a lender doesn't supply the required notices, the borrower may have three years to cancel.
HELOC Down Payment Example
How to Use a HELOC for a Down Payment
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.