What is a HELOC?
A home equity line of credit (HELOC) is a flexible way to borrow cash using the equity in your home. It offers a revolving line of credit—like a credit card—that lets you borrow as needed up to a set limit over a predetermined period. Your lender will set your terms and borrowing limit based on how much home equity you have and the strength of your financial profile.
HELOCs have two stages:
- Draw period: When you can take out funds as needed, usually paying only interest on what you borrow.
- Repayment period: When you pay back the principal and additional interest as a monthly payment.
Wondering how to pay for something using a HELOC balance? Homeowners often use HELOCs to fund big expenses when they aren’t sure how much they’ll need—think home renovations or large expenses. But keep in mind that HELOC interest rates are typically variable rather than fixed, so your repayments could increase if rates rise.
How a HELOC can be used to buy another property
Want to take on a residential investment property, snag a second home or buy rental property with a HELOC? If you are short on liquid cash but have a solid chunk of home equity, it’s possible to use a HELOC for a down payment. In rare cases, you may even have enough equity to buy a property outright! HELOCs typically let you borrow up to 85% of your home’s market value, minus what you owe on the mortgage. For instance, if your house is worth $400,000, your maximum borrowing potential would be $340,000. But if you still owe $100,000 on your mortgage, you could borrow the difference—up to $240,000 as a down payment financing option.
Lender rules and requirements
Every lender has different requirements, especially when it comes to funding second properties with HELOCs. In general, you need a stronger financial profile to prove you can juggle multiple properties and additional debt. Let’s check out common requirements.
- Loan-to-value (LTV) ratio: Your LTV compares your mortgage balance to your home’s current market value. Most banks require an LTV of 85% or less, so you should aim to have about 20% equity in your home.
- Minimum credit scores: For HELOCs in general, many lenders want to see a FICO® score of at least 680. When the loan is for another property, lenders may expect even higher scores.
- DTI/income requirements: A debt-to-income (DTI) ratio of 43% or less shows you can comfortably pay off your debts with your monthly income. Some lenders will allow a higher DTI of up to 50% with a strong FICO credit score. Your lender may have specific income criteria as well.
- Property restrictions: Not every lender will let you use home equity to buy another place, especially if you still need a mortgage to pay it off. Some lenders even reserve home equity loans for primary home expenses only, like renovations or repairs.
- Minimum loan: Some lenders have a minimum amount they are willing to loan. In certain states, the minimum amount of a HELOC loan is set by law.
Pros and cons of using a HELOC to buy another property
| Pros | Cons |
|---|---|
| Quick access to cash without draining savings or liquidating other investments | Payments can rise if interest rates increase |
| Flexible funding for unexpected expenses after closing | Not always allowed to finance a second property |
| Often lower rates than personal loans or credit cards | Adds more debt and reduces available home equity, which can be risky if property values fall |
| Long repayment period (up to 20 or sometimes 30 years) to help manage costs | Risk of foreclosing on your primary residence if you can’t keep up with payments |
Alternatives to a HELOC for buying another property
- Cash-out refinance: Replace your existing mortgage with a larger one and pocket the difference in cash. You’ll get a lump sum at a fixed rate, but you must accept new loan terms.
- Home equity loan: Borrow a lump sum loan against your home’s equity with predictable, fixed payments, though this option is less flexible than a HELOC.
- Personal loan: Access funds without using your home as collateral, though interest rates are typically higher than conventional mortgage rates.
- Retirement account loan: Tap into a 401(k) or similar plan, but keep in mind that this will chip away at your retirement savings.
- Savings or investment funds: Dip into your reserves or liquidate investments to cover costs and avoid new debt.
Steps to apply for a HELOC
- Check your fit: Use our HELOC calculator to estimate how much you could borrow and what your monthly payments might be. Is a HELOC right for your budget?
- Know your numbers: Double check your credit score, mortgage balance, home value and DTI ratio.
- Research & prequalify: Compare rates, fees and terms and see if you prequalify with a lender.
- Apply & wait for approval: Submit your documents and the lender will verify your information. If they approve your application, they’ll set your borrowing limits and terms.
- Close & use your funds: Sign the closing papers, access your funds and borrow only what you need to avoid unnecessary interest charges.
