Can I Use a HELOC to Buy Another House?

A Home Equity Line of Credit (HELOC) offers homeowners a flexible way to access the equity built up in their primary residence. This financial tool can provide a significant source of funds. For those considering expanding their real estate portfolio or acquiring another property, understanding how a HELOC can facilitate such a purchase is important. This article explores all aspects of utilizing a HELOC for another property acquisition, from obtaining the line of credit to managing its financial implications.

Understanding a Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit (HELOC) functions as a revolving line of credit that is secured by the equity in a homeowner’s primary residence. Unlike a traditional home equity loan, which provides a lump sum upfront, a HELOC allows borrowers to draw funds as needed, up to a pre-approved credit limit. This structure provides flexibility, enabling individuals to access capital incrementally over time.

HELOCs generally consist of two distinct phases: the draw period and the repayment period. During the draw period, which commonly lasts between five and ten years, borrowers can access funds, make interest-only payments, or pay down principal. Following the draw period, the repayment period begins, typically extending for ten to twenty years, during which borrowers must make principal and interest payments. The interest rate on a HELOC is predominantly variable, meaning it can fluctuate based on a chosen financial index, such as the prime rate, plus an additional margin set by the lender.

The amount of credit available through a HELOC is directly tied to the borrower’s home equity and the lender’s loan-to-value (LTV) or combined loan-to-value (CLTV) requirements. Lenders usually permit borrowing up to a certain percentage of the home’s appraised value, often around 80% to 90% of the combined value of all loans against the property. For example, if a home is valued at $400,000 and the outstanding mortgage is $200,000, a lender might approve a HELOC that brings the total debt, including the HELOC, up to 85% of the home’s value.

HELOC Eligibility and Application

Obtaining a HELOC involves meeting specific eligibility criteria set by lenders, which primarily assess a borrower’s financial stability and the equity in their home. A strong credit score is typically required, with many lenders looking for a FICO score of at least 680, and often preferring 700 or higher for competitive rates.

Another significant factor is the debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. Lenders generally prefer a DTI ratio below 43% to 50%, ensuring the borrower can comfortably manage additional debt. Most lenders require homeowners to have at least 15% to 20% equity, meaning the combined loan-to-value (CLTV) ratio should not exceed 80% to 85%.

The application process for a HELOC requires comprehensive documentation to verify income, assets, and property details. Borrowers typically need to provide recent pay stubs, W-2 forms, or tax returns. Bank statements and information on existing debts are also necessary.

A home appraisal is almost always a part of the HELOC application, which determines the current market value of the property and, consequently, the available equity. Upon submission of all required documents and a successful appraisal, the lender’s underwriting department will review the application to approve the credit line and set the terms. Closing costs for a HELOC typically range from 2% to 5% of the credit limit.

Applying HELOC Funds to a New Property Purchase

Once a HELOC is approved, funds become accessible for various purposes, including the acquisition of another property. Borrowers can draw funds as needed up to their approved limit, via checks, debit cards, or electronic transfers.

One common application is using HELOC funds for a down payment on a new home. Using equity from an existing home can avoid depleting savings. The HELOC balance becomes part of the borrower’s overall debt, considered in subsequent mortgage applications for the new property.

For less expensive properties, a HELOC might even facilitate a full cash purchase. This can allow a buyer to close quickly without traditional mortgage financing. However, the HELOC still represents a debt that must be repaid, carrying its own interest rate and repayment terms.

Financial Implications and Management of a HELOC for Property Acquisition

Using a HELOC to acquire another property carries significant financial implications that require careful management. Borrowers will face the responsibility of repaying the HELOC in addition to any existing mortgage payments on their primary residence and, if applicable, a new mortgage on the acquired property. This creates a complex debt structure.

The variable interest rate characteristic of most HELOCs presents a notable risk. Fluctuations in the underlying index rate, such as the prime rate, can cause monthly payments to increase or decrease, making it challenging to predict exact future expenses. Borrowers must budget for potential payment increases to ensure they can meet their obligations, even if interest rates rise considerably. Failure to manage these payments can lead to financial strain and, in severe cases, could put the primary residence, which secures the HELOC, at risk of foreclosure.

Regarding tax treatment, the interest paid on a HELOC is generally tax-deductible only if the funds are used to buy, build, or substantially improve the home that secures the HELOC. If a HELOC secured by a primary residence is used to purchase a second, unrelated property, the interest on that HELOC debt is typically not tax-deductible. This rule applies for tax years 2018 through 2025. Taxpayers considering deducting HELOC interest should consult IRS Publication 936. Limitations also apply, generally up to $750,000 for combined home acquisition debt.

Effective management involves developing a clear repayment strategy for the HELOC, possibly including making principal payments during the interest-only draw period to reduce the total interest paid over time. Borrowers should consider the overall debt burden, their cash flow, and potential market changes when planning their financial future with a HELOC.