6 Steps to Effectively Use a HELOC for Your Down Payment

If you’re planning to get a second mortgage and struggling with arranging funds for downpayment, a HELOC can help you get out of the endless search for funds.

You can make use of the equity accumulated in your primary residence and get a HELOC to fund the downpayment on a second mortgage. Keep reading today’s blog to find out how this entire process works.

Example Of Using A HELOC As A Down Payment

Meet Henry who’s looking to purchase a second home which is valued at $300,000. He currently owns a home with a market value of $250,000 and has paid off $150,000 of his primary mortgage. This means he has $100,000 in equity in his primary residence.

• ➙ Using this as an opportunity, Henry decides to use a HELOC to fund the down payment for his new home.

• ➙ He applied for a HELOC with his current lender and got the approval for a HELOC of up to 85% of his home's appraised value, which is $250,000.

He gets a maximum HELOC amount of $212,500. He uses $50,000 from this limit as a down payment for his new home. Since he already has $100,000 in equity, he can comfortably access this amount without exceeding the 85% limit.

Now, if you want to use your HELOC for a down payment like Henry, follow the steps below.

6 Steps To Effectively Use A HELOC For Your Down Payment

Using a HELOC to buy a second home is like using a credit card to buy another pair of shoes!

As I mentioned earlier, you can borrow money up to a certain limit, pay it off, and borrow again during the draw period. Here's how to do it:

• 1. Calculate Your Loan-To-Value (Ltv) Ratio

  This is done to compare the appraised home's value you want to buy, to the loan amount you need. For example, if the home costs $300,000 and you can put $50,000 upfront as a downpayment, your loan is $250,000 or 83% LTV. Lenders prefer an LTV of 85% or less.

  Do numbers make you faint? Just go ahead and use a LTV calculator!

• 2. Plan Your Budget

  Consider the costs and implications of HELOC, its closing fees, new home property taxes, insurance, and maintenance. Make sure you can handle the new expenses, and seek advice from the best home equity loan companies to ensure you're prepared for any financial changes.

  Also keep in mind that you will be handling two new monthly mortgage payments, one is your HELOC and the other is your second mortgage.

• 3. Apply For A HELOC

  Just like every other mortgage, lenders will assess your finances to determine how much credit they can offer by calculating the loan-to-value ratio of your primary residence. Once approved, you can use the funds for the down payment.

• 4. Find Your Second Home

  Work with a licensed real estate agent to find the right property that fits your needs and budget. Of course, if you’re not a first time home buyer, you know the ins and outs of the whole process of buying a home.

• 5. Apply For A Mortgage

  You'll need a mortgage for the second home, right? This is where the funds approved on your HELOC application can be put to the best use. Usually, the borrower is required to pay a down payment of at least 10%.

• 6. Closing Process Of Your Second Home

  The closing process is similar to any mortgage. You need to review and sign all the documents if the terms are all clear to you.

  But again you'll have two payments to manage, one is your monthly mortgage payments plus your HELOC payment. So, read the terms accordingly without any confusion.

Now that you know the steps, aren’t you curious about how a HELOC could differ from a traditional mortgage? Read on to find out.

How Do HELOCs Differ From Traditional Mortgages?

Both these options are in high demand in the mortgage market right now and different people take out these loans for different reasons. Let’s see how they’re different from each other below.

HELOC	Traditional Mortgages
Homeowners can borrow in installments against the equity in their homes.	Usually borrowed by home buyers to purchase their primary residence.
Here, you get to withdraw funds whenever you require.	The funds can be used only once, for eg., a house purchase.
The draw period is for 10 years and you get to borrow money however you like.	The term options available for borrowers in traditional mortgages are 15, 20, or 30 years.
You need to own a house while taking out a HELOC.	You buy a new house with traditional mortgages.
Mostly, HELOCs are used for debt consolidation or home improvements.	There are a pool of options available and borrowers need to shop around to grab the best mortgage deal.

4 Tips To Maximize HELOC Down Payment Benefits

Maximizing the benefits requires strategic planning and careful consideration. Here are four tips straight from our expert’s table.

• Assess Your Financial Situation

  Before tapping into your HELOC for a down payment, evaluate your current financial standing. Consider factors such as your income stability, existing debts, and credit score. Ensure that you can comfortably manage additional debt and monthly payments associated with the HELOC.

• Know Your Loan-To-Value (LTV) Ratio

  Understanding your LTV ratio helps you figure out how much of your home's value you can use for a down payment.

• Plan Your Budget Wisely

  Create a budget that accounts for both your existing debts and the new expenses associated with using a HELOC for a down payment. It ensures that you can effectively manage and use the downpayment amount.

• Use The Funds Strategically

  Once you've accessed the funds from your HELOC, use them strategically for your down payment. Avoid unnecessary expenses and prioritize using the funds towards your home purchase.

Other Down Payment Options To HELOC

There are several down payment assistance options available for borrowers who either want to buy a primary or a second home. They are:

• Home Equity Loan

• Cash-Out Refinance

• Personal savings

• Retirement funds

• Gift funds

• Grants and assistance programs

Is A HELOC A Smart Choice For Your Down Payment?

It depends on how you utilize the funds.

You’re good to go if you’re considering this decision after weighing the pros and cons and other long term costs that are associated with borrowing against your home equity.

Also, if you’ve paid the most off your primary mortgage balance and have a substantial amount of equity in your first home, it is indeed a smart choice to fund a downpayment. Even if you think that you can make use of downpayment assistance programs, you can go ahead.

The ultimate choice is yours!