Real Estate

Can You Use a HELOC to Buy a House?

July 21, 2023

Modern lenders offer many options for borrowing against your home—think mortgages, home equity loans, and Home Equity Lines of Credit (HELOC). HELOCs, in particular, are popular for homeowners due to their flexible borrowing structure and relatively low interest rates.

Borrowers seeking to move locations or buy a second home, however, may wonder: can you use a HELOC to buy a house?

The answer to which is yes, among other things.

HELOCs work similar to credit cards, and can be used to purchase whatever the borrower desires. If you want to know more about using HELOCs to purchase real estate, this guide covers their pros, cons, and potential alternatives.

What is a HELOC?

A HELOC is a means of borrowing against your property. They’re lines of credit taken out using the equity you have in your home as collateral. To understand how they work, it’s critical to familiarize yourself with the functions of:

Lines of credit – Unlike traditional loans, lines of credit aren’t a singular set sum lent with a fixed repayment plan. They’re agreements that allow borrowers to take out money as they need it, up to an established borrowing limit.³

Equity – Equity is the share of your home that you have paid off. Essentially, it’s the home’s value minus any outstanding debts you have against it.⁴

Collateral – If you fail to make payments on a loan, collateral is an asset that the borrower can take in order to recoup their lent money.⁵

So, a HELOC is essentially a monetary limit that a borrower can withdraw over a period of time. For instance, the ability to borrow up to $250,000 over ten years. Then, after that period of borrowing is up, there’s a repayment period in which any withdrawn funds must be paid back. Payments still must be made during the initial draw period, but only on the interest incurred on any borrowed sums.¹

Because there are no preset sums lent at the establishment of a HELOC, there are no fixed payment terms. Instead, payments are variable and pursuant to the amount the borrower actually takes out.

Using A HELOC to Buy a House

There are generally no rules dictating what you can and can’t buy with a home equity line of credit, and you could use one to purchase another home. Some limiting factors to think about include:

The amount you’re likely to get approved for
Your ability to pay the HELOC back, plus any other loans you may need to take out on the new property
How long it would take to get approved versus how quickly your desired home will sell

If you’re considering getting a HELOC to purchase a home, following these steps can help simplify the process.

How to Use a HELOC for Home Purchase

The first step to using a HELOC to buy a house is getting approved for one. There are usually a few financial prerequisites borrowers need to satisfy before being issued a HELOC. Lender requirements vary by institution, but often include:²

A minimum of 15% equity in your home
A decent salary with a verifiable income history
A credit score above 600
A debt-to-income (DTI) ratio below 40%

If you meet these qualifications, you’re likely to get approved for a HELOC. Then, your next concern is getting approved for a high enough sum to actually purchase a home. Generally, HELOCs will be granted for up to 85% of an owner’s equity in their home.²

Thus, if the price of your desired place exceeds your approval limit, a HELOC alone won’t be enough to purchase that new home. In such situations, you could use a HELOC in conjunction with a traditional mortgage to buy the home, or even use your HELOC to make payments on the mortgage. If you do, however, beware of borrowing beyond your repayment means.

Potential Benefits of Using a HELOC to Buy a House

Despite the risks of using a HELOC to buy a home, they do present some notable benefits versus other forms of loans, including:¹

Lower interest rates – Interest varies based on lender and loan agreement. In general, however, HELOCs tend to have a far lower interest rate than a personal loan, credit card, and other forms of debt not backed by an asset.
Being potentially easier to obtain – While it may not be as easy to get a HELOC as a credit card, their financial qualifications can be lower than other property-secured loan types, such as home equity loans. Learn how to get a HELOC with bad credit if you’re in this situation.

Variable payments – When you’re approved for a HELOC, you only pay back the amount you withdraw from it. That means no getting locked into payment plans if, in the end, you decide not to make the purchase.

Risks and Drawbacks of Using a HELOC to Buy a House

HELOCs aren’t all positives, unfortunately. In comparison to other methods of purchasing a home, they do present some drawbacks, including:¹

The potential to lose your home – HELOCs are backed by your existing property. That means—should payments become overwhelming and you begin to default—the lender has the right to claim your home in compensation for the loan.

You already need a home to qualify – Unlike mortgages, which are frequently issued to first-time homebuyers, HELOCs require you to already own property in order to be approved.

Variable interest rates – Not having fixed payments means interest rates are applied as money is borrowed. That means the potential to pay higher interest by borrowing in the future rather than setting a fixed interest rate in the present.

Comparing HELOC with Other Home Financing Options

While HELOCs can be a flexible, accessible tool for homeowners looking to buy another property, they’re not the only option for financing the purchase of a home. If you have a denied HELOC, mortgages, home equity loans, and cash-out refinance all offer options for quick cash to buy a home. They all likewise have their own associated pros and cons versus HELOCs.

HELOC vs. Mortgage

A mortgage is a lending agreement that finances the purchase of property. Oftentimes, the property itself is used as collateral for the loan.⁶

Unlike HELOCs, you don’t already need a home to qualify for a mortgage—you may be approved for one based solely on your income history, minor assets, and ability to repay the loan.⁷

Mortgages are repaid over a fixed term, generally either 15 or 30 years. While HELOC interest rates are variable pursuant to when you borrow money, mortgage Annual Percentage Rates (APR) are usually set for the duration of the term. Currently, APR for fixed-rate mortgages stand at:⁸

6.28% for 30 years
5.64% for 15 years

HELOC vs. Home Equity Loan

On the surface, HELOCs and home equity loans have some striking similarities, including:

Using the equity you have in your home as collateral²
Generally being approved for the majority of an owner’s equity

However, the terms of the two can vary greatly. So, what are the differences between a home equity loan vs HELOC? Put simply, while HELOCs boast flexible borrowing, variable rates, and easier entry qualifications, home equity loans feature:⁹

Lump sums – Unlike HELOCs, which can be drawn in increments based on the borrower’s needs, home equity loans pay one lump sum at the beginning of the loan agreement.

Fixed terms – Because the sum borrowed is set from the start of home equity loan agreements, details such as repayment amounts and frequency are as well.

Stricter approval qualifications – While most HELOCs have comparatively relaxed borrowing prerequisites, home equity loans usually require a credit score of 620 and home equity of over 20%.

HELOC vs. Cash-Out Refinance

Planning on taking a cash out refinance to buy a second home? Cash-out refinancing refers to the process of taking out a mortgage larger than your current one and getting the difference between the two in cash. Like most other forms of loans in this guide, it also uses your home as collateral.

Whether you stick with your current lender or find a new one, cash-out refinances pay off your home’s existing mortgage before starting the new one. While they’re a quick way for homeowners to net large sums of cash, they have some notable downsides, including:¹⁰

Essentially restarting your mortgage’s payment term—meaning you’ll be paying for much longer
Potentially higher interest rates than other refinancing and mortgage options
Like all options with property as collateral, the possibility of losing your home

Consider a Residential Sale Leaseback as an Alternative to a Financing Option Like a HELOC

If you’re considering a HELOC as a means of obtaining a large lump sum with your house as collateral, there’s another way to leverage your property for quick cash.

A sale-leaseback agreement is a type of property sale contract in which a homeowner sells their house for cash and stays in it afterward. They work as follows:¹¹

A homeowner sells their house for a predetermined amount of money.
They rent the property back from the buyer according to the terms of a newly established lease.

The agreement persists as long as the owner and tenant agree to keep renting the property.

Sale-leaseback agreements offer flexibility to homeowners because they aren’t loans. So, after receiving the cash, there’s no expectation for repayment. Many sale-leaseback agreements do, however, allow the previous homeowners to purchase their home back within an agreed-upon period after the sale.

If you’re considering a HELOC or other type of loan secured by your home’s equity, consider a sale-leaseback or rent-back agreement instead. They can net you your property’s full value without tacking on any associated debt.

Key Takeaways

HELOCs can be used to buy a house, thanks to their flexible borrowing structure and relatively low interest rates.¹
To obtain a HELOC, borrowers must meet certain financial prerequisites such as having a minimum of 15% equity in their home, a verifiable income history, a credit score above 600, and a debt-to-income ratio below 40%.
Potential benefits of using a HELOC for a home purchase include lower interest rates, easier approval, and variable payments.
Drawbacks of using a HELOC to buy a house include the risk of losing your home, the need to already own a home to qualify, and variable interest rates.
Comparing HELOC with other financing options such as mortgages, home equity loans, and cash-out refinance can help borrowers determine the best choice for their situation.
A residential sale-leaseback agreement can be a viable alternative to a loan for homeowners looking to leverage their property for quick cash without incurring debt.

Sources:

Investopedia. Home Equity Loan vs. HELOC: What’s the Difference?. https://www.investopedia.com/
Investopedia. Home Equity Line of Credit (HELOC) Definition. https://www.investopedia.com/
Investopedia. Line of Credit (LOC) Definition, Types, and Examples. https://www.investopedia.com/
Investopedia. Home Equity: What It Is, How It Works, and How You Can Use It. https://www.investopedia.com/
Investopedia. Collateral Definition, Types, & Examples. https://www.investopedia.com/
Consumer Financial Protection Bureau. What is a mortgage?. https://www.consumerfinance.gov/
Investopedia. What Is a Mortgage? Types, How They Work, and Examples. https://www.investopedia.com/
Business Insider. Current Second Home Mortgage Rates. https://www.businessinsider.com/
Forbes. What Is A Home Equity Loan?. https://www.forbes.com/
Investopedia. Cash-Out Refinancing Explained: How It Works and When to Do It. https://www.investopedia.com/
EasyKnock. Sell & Stay. https://www.easyknock.com/