Can I Use Equity in Present Home As Down Payment for Second Home?
Homeowners buying a second property or new home can extract funds from equity in their current home for use as a down payment. People who have an existing home equity line of credit, or HELOC, have immediate access to funds. Some homeowners use HELOCs to buy foreclosed homes at auctions. People with sufficient equity can increase existing HELOC amounts if their credit and debit-to-income ratios satisfy underwriting guidelines.
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History
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In 1913, President Woodrow Wilson signed the Federal Reserve Act into law. The act included a provision sanctioning the creation of the Federal Open Market Committee. The committee, comprised of regional reserve chairmen, meets at least four times every year and sets the federal funds rate which is the benchmark for other interest rates, including the prime rate. Banks use the prime rate as the index for pricing home equity loans and lines.
Time Frame
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Most banks establish HELOCs that have a revolving term of 20 years. During the term, homeowners can use and pay down the line multiple times. A the end of the 20 years, most banks convert any remaining balance above $20,000 into a 15-year amortizing home equity loan and smaller balances into a 10-year home loan. Draws on a HELOC are billed on the next statement cycle. Home loans are not generally sold on the secondary market, so processing times are faster than mortgages and are typically less than four weeks.
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Types
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Most people who use equity to fund down payments use a HELOC because it enables them to have the money available ahead of time and only draw on it when needed. Home equity loans can also be used for down payments but they require the borrower to take a lump sum disbursement after the loan closes. If the down payment amount is less than anticipated, the only way to return the excess funds is through a principal reduction payment.
Warning
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HELOCs are effective short-term credit instruments but because they have variable interest rates, the monthly payments are subject to change. The Federal Reserve raises interest rates during inflationary cycles and most HELOCs have rate ceilings close to 20 percent. Credit cards with fixed rates might offer a better solution than HELOCs. Home equity loans have fixed rates but standard terms are 10 and 20 years. Despite higher closing costs, mortgages usually have lower rates than HELOCs and are more cost-effective in the long term.
Considerations
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Homeowners without an existing HELOC might have difficulty obtaining one if they plan to make a down payment on a new primary residence. Banks will not lend money against houses that are for sale. Most banks will not allow customers to take out a bridge loan on a house they currently live in but plan to sell. The reason banks do not permit such transactions is to prevent unscrupulous people loading debt onto a house they plan to abandon and then moving into a new home with no liens.
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