Can You Use Equity as a Down Payment?

Homeowners often consider various financial avenues when planning a new property purchase, and leveraging existing home equity can be a viable strategy. Home equity represents the portion of a property’s value that the homeowner genuinely owns, calculated as the current market value of the home minus any outstanding mortgage debt. This accumulated value is not liquid cash, but it signifies a significant financial asset that can be converted into funds. It is possible to use this built-up home equity to fund a down payment for a subsequent property acquisition.

Understanding Home Equity Access Options

Accessing home equity for a down payment involves several financial instruments, each with its own structure. These options convert your property’s value into liquid funds.

A Home Equity Loan (HEL) functions as a second mortgage on your property. With a HEL, you receive a lump sum of money upfront, repaid over a fixed term, typically 5 to 30 years, at a fixed interest rate. This provides immediate access to a specific amount of cash without affecting your primary mortgage’s terms.

A Home Equity Line of Credit (HELOC) operates more like a revolving credit card. It allows you to draw funds as needed up to a predetermined credit limit during an initial “draw period,” often lasting around 10 years. During this period, you typically make interest-only payments, with the principal repayment phase following for another 10 to 20 years. HELOCs commonly feature variable interest rates, offering flexibility in borrowing amounts but with fluctuating monthly payments.

A cash-out refinance involves replacing your existing mortgage with a new, larger loan. The difference between your old mortgage balance and the new, higher loan amount is provided to you in a lump sum of cash. This option establishes new terms, including a new interest rate and loan duration, for your entire mortgage.

For those needing short-term capital to bridge the gap between selling one home and buying another, a bridge loan can be utilized. This temporary financing is secured by the equity in your current home and can provide funds for a down payment on a new property before your existing home sells. Bridge loans are short-term, often lasting six to twelve months, and may involve higher interest rates and fees compared to conventional loans.

Applying Equity Funds to a Down Payment

Once you have accessed your home equity through one of the available financial products, the next step involves applying these funds towards the down payment of a new home. The process centers on demonstrating the legitimate source of these funds to your new mortgage lender.

Mortgage lenders require documentation to verify the origin of your down payment funds. This may include recent bank statements showing the deposit of the HELOC draw, the lump sum from a cash-out refinance, or the disbursement from a home equity loan or bridge loan. Lenders ensure these funds are not undisclosed borrowed money, which could impact your debt-to-income ratio and overall loan eligibility.

The transfer of these funds occurs directly to the closing attorney or escrow agent handling the new home purchase. This happens via a wire transfer, ensuring a secure and traceable transaction. Alternatively, a cashier’s check may be required at the closing table for the new property.

Some mortgage lenders implement “seasoning” requirements for down payment funds. This means the funds must have been held in your bank account for a specific period, generally 60 to 90 days, before they can be used for a down payment. This requirement helps confirm that the funds are genuinely yours and not a short-term loan that hasn’t been fully disclosed in your mortgage application.

Key Financial Factors and Eligibility

Several financial factors determine both your ability to access home equity and your eligibility for a new mortgage. Understanding these criteria is important for a successful real estate transaction.

One primary consideration is the loan-to-value (LTV) ratio, which compares the amount of the loan to the appraised value of the property. For accessing equity, lenders allow borrowing up to 80% to 90% of your home’s value, including any existing mortgage. For instance, a conventional cash-out refinance has a maximum LTV of 80%, meaning you must retain at least 20% equity in your home. Similarly, the LTV of the new home purchased directly influences the required down payment amount.

Your debt-to-income (DTI) ratio is another metric. This ratio measures your total monthly debt payments against your gross monthly income. Taking on new debt through a home equity product will increase your DTI, which lenders evaluate to assess your capacity to manage additional mortgage payments. Lenders prefer a DTI ratio of 36% or less, though some may approve loans with a DTI up to 43% or even 50%.

Credit score requirements are important for securing favorable terms for both equity access products and new mortgages. A strong credit score, 620 or higher for conventional loans, indicates financial reliability and often leads to more competitive interest rates. Conversely, a lower score may result in higher interest rates or even loan denial.

Interest rates impact the overall cost of borrowing. Rates vary depending on the type of equity access product (fixed for home equity loans, variable for HELOCs) and current market conditions. Higher rates translate to larger monthly payments, affecting affordability for both the equity loan and the new mortgage.

Both accessing equity and obtaining a new mortgage involve closing costs and fees. These can include appraisal fees, origination fees, and title insurance, which can reduce the net cash available from an equity product or add to the overall transaction expense. For home equity loans and HELOCs, you will have two mortgage payments, while a cash-out refinance replaces your existing mortgage entirely. These factors collectively determine the feasibility and financial prudence of using home equity for a down payment.