With rising home prices and interest rates staying above 5%, homeowners may seek to get creative on finding money to create a strong down payment on their next home. One source of funds that a homeowner might consider is the Home Equity Line of Credit, or HELOC.
A Home Equity Line of Credit (HELOC) is a financial product that enables you to access the equity in your home. Your equity is calculated as the current market value of your home minus the amount you still owe on it. For instance, if your home is valued at $450,000 and you still owe $350,000 on your mortgage, you have $100,000 in equity. Banks offer a line of credit that allows homeowners to borrow against a portion of this equity.
This loan product is secured, unlike credit cards. This means that your home is used as collateral in case you are unable to pay back the loan. If you can't make the required payments, it will result in foreclosure of the home and eviction.
Using a Home Equity Line of Credit (HELOC) as a down payment for your next house offers the advantage of accessing a larger pool of financial resources than what may be available in your savings. This means that you can borrow against your current home's equity and apply the funds to your next home purchase. Once you sell your current home, you can use the proceeds to pay off the mortgage and the HELOC, thus immediately settling the loan.
Using a HELOC as a down payment has several downsides. Firstly, the interest rate for a HELOC depends on market conditions. This means that the interest rate can change from month to month and could result in significant variations in the amount owed each month. The average rate for a HELOC for individuals with excellent credit is well over 5%, and depending on your circumstances, it can exceed 10%.
If you are using the HELOC as a short-term bridge loan, the fluctuating interest rate might have less impact, as you don't intend to make payments for the long term. However, using a HELOC for a down payment can create problems if your home's value decreases and you are unable to pay off both the mortgage and HELOC at closing. In this situation, you would need to fund the difference at closing or be in default.
The Bible does not prohibit the use of loans, but it strongly discourages their use. In the case of a bridge loan, one might argue that the consequences are limited to just a few weeks or months. However, Proverbs rightly warns us that any debt that uses our homes as collateral can lead to problems, especially if we are using a Home Equity Line of Credit (HELOC) because we have no other financial resources available. Proverbs 22:26-27 says,
“Be not one of those who give pledges, who put up security for debts. If you have nothing with which to pay, why should your bed be taken from under you?”
So if using a HELOC for a down payment is unwise, what are the alternatives? Consider these three alternatives to using a HELOC for a home down payment.
There are at least three other methods that you can use to extract the equity out of your home to help make a stronger down payment on your next home. These alternatives are much less risky than the HELOC.