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Use line of credit to create cash for down payment

Homeowners considering a purchase of a rental property or second home often face challenges gathering sufficient cash for the down payment and closing costs. An option that is often forgotten is tapping into the equity of the home they currently own. If you are fortunate enough to have sufficient equity in your home you may find that converting that equity into cash is neither expensive nor difficult by obtaining a Home Equity Line of Credit (HELOC).

The cash from a HELOC may be used towards the down payment of another property but also may be used for anything the homeowner would like such as remodeling, paying off credit cards or the down payment for another home. Since property values have increased substantially over the past eight years, most homeowners have the equity necessary to create cash with a Home Equity Line of Credit.

HELOCs have become a popular method of tapping the equity in your home without disturbing your existing first mortgage. When recorded, a HELOC becomes a second mortgage on your property and with it come the same obligations of payback as your first mortgage. Lenders have made HELOCs very easy to obtain by typically offering them with no closing costs and sometimes requiring only a very minimal drive-by appraisal. Even the Internal Revenue Service has given HELOCs (or any second mortgage) favorable treatment by allowing the occupying homeowner to deduct the mortgage interest on these loans on their tax return. There are exceptions and maximum loan amounts so be sure to consult with your accountant for details.

The downside is that the typical HELOC creates a scenario in that the borrower is subject to a typically volatile index (Prime Rate) with a virtual certainty of substantial rate increases over the life of the loan (the Federal Reserve Board has predicted three more 0.25 percent rate increases this year alone).  Some lenders allow the borrower to make interest-only payments for the first 10 years while no principal payments are required. After 10 years passes, the borrower will be required to amortize the payments over the remaining 15 years. Given an example of a borrower tapping his HELOC for $100,000, the minimum monthly interest payment would be $375 per month at an interest rate of 4.5 percent. When the amortization period kicks in, with just 15 years remaining on the term, the payments would have to increase to $765 per month or if the interest rate moves up as predicted to, say, 5.5 percent, the payments would have to go to $817/month.

An alternative way to create cash from a home is to replace the current mortgage, if there is one, with a larger mortgage and getting a check from the title company for the difference (after closing costs). Again, the cash may be used for whatever you wish. Ask your mortgage professional to weigh the pros and cons of these two options.

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