Can I Use a Line of Credit for a Down Payment?

Making the down payment on a home can be one of the biggest hurdles for aspiring homeowners. Coming up with enough cash for a 20% down payment is tough, especially for first-time buyers. And even a 5-10% down payment can be a stretch. This leaves many wondering – can I use a line of credit for a down payment?

The short answer is yes, you can use a line of credit for your down payment in most cases. However, there are some important factors to consider before taking this route. Let’s break it down.

What is a Line of Credit?

A line of credit acts like a credit card, providing you access to a set amount of funds that you can draw from as needed. The amount you can borrow is your credit limit.

With a line of credit:

• You only have to pay interest on the amount you actually borrow
• You can access more funds again as you pay down the balance
• The interest rate is variable, meaning it can fluctuate over time

Lines of credit are offered by banks and credit unions, Popular options include

• Personal lines of credit
• Home equity lines of credit (HELOCs)
• Secured lines of credit backed by an asset like a savings account

Can a Line of Credit Be Used for a Down Payment?

Yes, a line of credit can legally be used toward a down payment in most cases. However, there are a few things to keep in mind:

• Lenders may restrict it – Some mortgage lenders don’t allow lines of credit as a source of down payment funds. Shop around to find one that does

• The funds must be yours – Any borrowed down payment funds have to have been transferred to your accounts at least 90 days prior to the home purchase.

• Extra scrutiny is likely – Using a line of credit may raise red flags and prompt the lender to look more closely at your finances. Be prepared to document the source of funds.

As long as you can show a legitimate source for the down payment money and find a lender that allows lines of credit, this route is possible. But it also comes with some drawbacks.

Pros and Cons of Using a Line of Credit

A line of credit provides easy access to funds, but also comes with higher interest rates and risks. Consider the key pros and cons:

Pros

• Quick access to down payment funds
• Only pay interest on what you borrow
• Can re-borrow funds as you pay it down
• Often easier to qualify than a traditional loan

Cons

• Higher interest rate than traditional loans
• Risks your home if secured against your property
• Variable rate means payments may rise over time
• Need the discipline to pay off the balance

For buyers who don’t have much cash savings but have equity in their current home, a HELOC is often one of the more affordable line of credit options. But it does put your home at risk if you default.

HELOC vs Personal Line of Credit

The two most common types of lines of credit used for down payments are HELOCs and personal lines of credit. Here’s how they compare:

• HELOCs are secured by your home equity. This allows you to qualify for a higher limit, but failure to repay could result in foreclosure.

• Personal lines are unsecured, so there’s no collateral at risk. But you may only qualify for a lower limit based on your credit score and income.

• HELOC rates are often lower, while personal line rates are generally higher.

• HELOC limits max out at 85% of your home’s value, while personal lines have lower caps.

For homeowners with sufficient equity, a HELOC tends to offer the best terms. But personal lines provide more flexibility for buyers who rent or have minimal equity.

Tips for Using a Line of Credit Responsibly

If you opt to use a line of credit for your down payment, make sure you go in with a plan for paying it off quickly:

• Only borrow what you need for your down payment and closing costs
• Make payments above the minimum when possible
• Create a budget to aggressively pay off the balance
• Refinance into a lower rate/payment as soon as possible
• Be prepared for rate and payment fluctuations
• Have a back-up plan ready in case you can’t pay

A line of credit can be a helpful tool for accessing down payment funds, but use caution – it is still debt that must be repaid.

Alternatives to Using a Line of Credit

If you don’t feel comfortable using a line of credit or don’t qualify, here are a few other options for coming up with down payment funds:

• Save aggressively – Cut costs, take on side jobs, and stash every extra penny into your down payment savings.

• Explore down payment assistance – These programs provide grants or loans to qualifying buyers. Eligibility is based on factors like income, location, and more.

• Ask for gift funds – Friends or family may gift you money toward your down payment. Lenders generally allow this as long as you document the gift.

• Sell assets – Consider liquidating stocks, bonds, or other assets that have gained value. Just be sure to plan for tax implications.

The Bottom Line

At the end of the day, a line of credit can be a viable way to access funds for a down payment quickly. But make sure you go in with eyes wide open to the repayment responsibilities and risks involved. A line of credit shouldn’t be used lightly or as an easy fix for lack of savings. But with proper planning, discipline, and shopping around, it can be a reasonable option for some buyers.

Yes, a personal line of credit can generally be used for a wide variety of expenses. Unlike loans tied to a specific purchase, like a car or house, a line of credit provides flexible access to funds that can be used for nearly anything.

Yes, a business line of credit can potentially be used for a down payment on a house, especially if it’s for an investment property or if the business is actively using the property.