Is It a Good Idea to Use a Credit Union HELOC to Buy Another Property

For homeowners who may be interested in expanding their financial portfolios, there’s the possibility of purchasing a second home without putting as much cash down upfront. How is this possible? With a credit union HELOC, you could have enough to put down on another home, either using it for a rental income or moving into it and turning your first home into a rental property. If you have a partial down payment and need to supplement it, a HELOC might be the right choice for you.

What Is a HELOC?

A HELOC is a home equity line of credit, or a loan based on the worth your home has accrued over time. The amount of money you could be approved for in a HELOC coincides with the overall amount you owe on your mortgage and how much your home is worth now. Let’s take a quick look at an example to understand the math behind the loan and the process.

Let’s say you’ve purchased your first home for $200,000 with a loan for $160,000. So far, the mortgage has been paid down to $120,000. The house has also appreciated to $240,000. You can now get a credit union HELOC for up to 85 to 95 percent of the first home’s value. For our example, we’ll use 90 percent.

Ninety percent of $240,000 is $216,000. Take away the existing outstanding loan amount ($120,000) from the home, and you’re left with $96,000 that can be applied as a down payment on the purchase of another property. It can’t all be taken out at once, but a portion of it could be used toward another property.

Investment Property or Second Home: How to Decide

When you’re deciding if you want the purchase of this other property to be used as an investment property or a second home, the lender who reviews your application is going to look very closely at your debt-to-income ratio in order to determine if you’re a good candidate for this type of loan. One of the main things they want to look at is your potential ability to manage two mortgage payments. A lower debt-to-income ratio is better for two reasons. First, a lower debt-to-income ratio means you can qualify for a better interest rate on the loan, and second, lenders like to see a debt-to-income ratio of less than 36 percent.

When looking at the lenders out there, start with the lender that you’re currently working with for your first mortgage. The fact is, you already have a working relationship and they may be able to work with you just based on knowing you and your financial history. That said, it doesn’t hurt to look around, as you might be able to find a better deal with another lender.

The down payment for the second loan may vary depending on whether you’re planning to use the property as an investment or as a second home. If it’s the latter, plan to put 10 to 20 percent down, or if it’s going to be used as an investment property, some lenders will require more at the outset.

Challenges with Second Home Purchases

One of the challenges you may come across when purchasing a second property is that they may be harder to finance, especially if it’s going to be used as a vacation rental. Due to the seasonal nature of the property type, there’s a risk that money won’t be coming in to cover the mortgage. Additionally, should the economy take a turn for the worse, lenders know that people will stop paying mortgages on their secondary properties to try to stay afloat with the first home.

Advantages of HELOCs

One of the primary benefits of a HELOC is that you don’t have to go through the whole procedure with a separate mortgage loan. Lenders can secure their loan with the existing equity of the first property and they can see the payment history of your first mortgage. Lenders predominantly care about your credit report, whether the primary property can support the loan, and what your income looks like.

By using a HELOC for this sort of purchase, it’s going to be important to have enough equity in your home and that your debt-to-income numbers are adequate. Just remember, a HELOC isn’t a lump sum disbursement but is meant to be drawn from over time, up to 10 years.

Using a Second Home as an Income Property

There are a couple of things to be aware of if you’ll be using the second property as an income-generating resource. If you only live in the house for 14 days per year (or 10 percent of its occupation timetable), you can utilize many of the tax benefits allotted to income properties, such as deducting maintenance costs, depreciation, and similar components. The rent can even be used to pay for the loan money you used to buy it. If you’re living in the property or using it for more than the 14 days per year, there are still relative amounts that can be deducted, per IRS guidelines.

During the application process, it’s worth it to note whether the previous owner used it as an income property. If so, you can generate a report for the lender to review in their consideration. Additionally, another smart choice is to hire a professional appraiser to look at the property and the neighborhood. Consider having them do a comparison analysis between the property you’re interested in and comparable property so as to project the property’s future worth.

If you can show the lender the property is likely to grow in value, they may be more apt to give you a HELOC. Again, the equity that you have built up in your first home is where lenders will start looking when they’re making a decision about lending money to you.

A Short List of Pros and Cons of a HELOC

Pros:

  1. This lending shortcut can “find” money for you to use for additional investment.
  2. If you sold your home, you would take the equity, or the difference in what you’d paid down, to put toward another loan. This way, you don’t have to sell the property.
  3. You won’t have to pay a series of extras, like closing costs, agent fees, and so forth, which you would normally have to do if you sold your home.
  4. It’s a reasonable financing option with regard to costs and interest rates.

Cons:

  1. Your equity in the first property gets tied into the second property, and you won’t have that to fall back on.
  2. The interest rate is adjustable and, therefore, not as predictable.

If a credit union HELOC is for you, the knowledgeable experts at Rivermark Community Credit Union can help look at options and answer any lingering questions.