Can You Use a HELOC to Buy a House?

A Home Equity Line of Credit (HELOC) allows homeowners to access equity in their property. It functions as a revolving line of credit, letting borrowers draw funds as needed, up to a set limit. A common question is whether a HELOC can be used to purchase a new house. While secured by an existing home’s equity, its use in real estate transactions is nuanced.

Understanding the Home Equity Line of Credit

A Home Equity Line of Credit (HELOC) is a type of loan secured by the borrower’s home equity. Equity represents the difference between the current market value of a home and the outstanding balance of any mortgages or liens against it. This financial product operates as a revolving line of credit, similar to a credit card, where funds can be borrowed, repaid, and borrowed again up to an approved credit limit.

A HELOC typically consists of two distinct phases: the draw period and the repayment period. During the draw period, which often lasts for 10 years, borrowers can access funds as needed and are usually required to make interest-only payments on the amount borrowed. Once this period concludes, the HELOC transitions into the repayment period, which can extend for up to 20 years. In this second phase, borrowers can no longer draw funds and must begin making payments that include both principal and interest on the outstanding balance.

The interest rate on a HELOC is typically variable, meaning it can fluctuate over time. This rate is generally tied to an index, such as the U.S. Prime Rate, with a margin added by the lender. The amount a homeowner can borrow is based on their available home equity, often allowing access to up to 85% of the home’s value minus any existing mortgage balances.

Direct Use for Home Purchase

Using a Home Equity Line of Credit (HELOC) as the primary financing instrument to directly purchase a new home is generally not a common practice. A HELOC is typically structured as a second lien on a property, meaning it holds a subordinate position to any existing primary mortgage, which is the loan that financed the initial home purchase. Lenders prioritize repayment of the first mortgage in case of default or foreclosure.

The revolving nature of a HELOC also differs significantly from a traditional home purchase mortgage. A conventional mortgage provides a single, lump-sum disbursement for the home’s price. In contrast, a HELOC allows for flexible draws over time, which is unsuitable for the immediate, full funding required for a home acquisition. Furthermore, a HELOC is secured by the equity in an existing property, not the property being purchased.

Lending policies also limit HELOC use for primary home purchases. Lenders assess risk, and a HELOC’s subordinate lien and variable draw schedule have different risk profiles than a first mortgage. While some “first-lien HELOCs” exist, they are not widely available and differ from standard HELOCs.

Indirect Uses in Home Purchase Scenarios

While not primary financing for a new home, a HELOC can serve several indirect functions.

Down Payment

Funds from a HELOC secured by a current residence can cover a down payment for a new property. This allows homeowners to access equity without immediately selling their current home, though separate primary financing is still required for the new property.

Bridge Financing

A HELOC can act as a short-term bridge loan. It enables homeowners to access equity in their existing home to purchase a new property before their current home sells. This provides liquidity to cover the down payment and potentially closing costs on the new home, with the expectation that the HELOC balance will be repaid once the original home sells. This use offers flexibility compared to traditional bridge loans, often with lower interest rates.

Renovations

After purchasing a home with traditional financing and establishing equity, a homeowner can obtain a HELOC on the new property. These funds can finance renovation projects, offering flexible access to capital as improvements progress. This approach leverages the home’s value for upgrades, distinct from using the HELOC for the initial purchase itself.

Financial Implications of Using a HELOC

Using a HELOC has several financial implications.

Its variable interest rate means monthly payments can change. Borrowers should monitor market trends, as increases in the index rate will lead to higher interest charges and larger monthly payments.

The repayment structure also impacts finances. During the draw period, borrowers may make interest-only payments, resulting in lower initial outlays. Once the repayment period begins, borrowers must pay both principal and interest, which can substantially increase monthly payments.

A HELOC adds to a borrower’s debt load, influencing their debt-to-income (DTI) ratio. A higher DTI can affect qualification for other loans, including a new primary mortgage. Lenders typically prefer DTI ratios below 43%, though requirements can vary.

As a secured loan, a HELOC uses the borrower’s home as collateral. This places the home at risk of foreclosure if payments are not made. In a default and property sale, the primary mortgage lender is repaid first from the proceeds before the HELOC lender.