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 (LTV) Ratio
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 ratio 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 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 line of credit 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 loan-to-value ratio 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.
