Yes, you can use home equity as a down payment, but the money has to come through a loan first

If you own a home with equity—the difference between what it's worth and what you owe on the mortgage—you can borrow against that equity and use the cash for a down payment on another property. The most common way is a home equity loan or a home equity line of credit (HELOC). You borrow money using your current home as collateral, receive the funds, and then use those funds as your down payment on the new purchase. The equity itself doesn't transfer directly; you're taking out a separate loan against it.

Lenders will look at how much equity you have, your credit score, and your debt-to-income ratio before approving the loan. The process adds time to your down payment timeline because you have to close the equity loan before you can close on the new property. Most lenders want to see that equity loan funded and recorded before they'll fund your new mortgage.

Key Takeaways

  • Home equity loans and HELOCs let you borrow against your home's equity, but you receive the money as a separate loan that you then use for a down payment.
  • Lenders typically require you to close the equity loan before closing on the new property, which means additional closing costs and a longer timeline.
  • Your current mortgage lender may have first lien position, meaning the new equity loan sits in second position and carries a higher interest rate.
  • Cash-out refinancing is an alternative that replaces your current mortgage with a larger one and gives you cash, but it resets your loan term and may cost more overall.
  • Gift funds from family members are often simpler than equity loans because they don't add to your debt load or require a separate closing.

How home equity loans work as down payment funds

A home equity loan is a fixed-rate, fixed-term loan. You borrow a lump sum against your home's equity, receive it as cash, and repay it in monthly installments over a set period—typically 5 to 15 years. The interest rate is usually higher than your primary mortgage because the lender is in second position: if you default, your first mortgage gets paid before this loan does.

A HELOC works differently. It's a line of credit, like a credit card, that you can draw from as needed. You pay interest only on what you actually borrow. HELOCs often have variable interest rates that change with market conditions, and the draw period (when you can borrow) is usually 5 to 10 years, followed by a repayment period of 10 to 20 years.

For a down payment, a home equity loan is often simpler because you get all the money at once and know your exact monthly payment. A HELOC requires you to draw the funds before closing on the new property, and lenders want to see the money in your account for a certain period (usually 2 to 3 months) to verify it's not borrowed money.

Timeline and closing costs when using equity for a down payment

Using equity as a down payment adds steps to your purchase timeline. You typically need to close the equity loan 7 to 14 days before closing on the new property. This gives the lender time to record the loan and verify the funds are in your account. If you're under a tight deadline to purchase, this delay can be a problem.

Closing costs for the equity loan run 2 to 5 percent of the loan amount and include appraisal fees, title search, origination fees, and attorney fees. If you're borrowing $50,000 for a down payment, expect to pay $1,000 to $2,500 in closing costs on top of the down payment itself. These costs are separate from the closing costs on your new mortgage.

Some lenders offer no-closing-cost equity loans, but the interest rate is higher to compensate. Calculate whether the rate increase over the life of the loan costs more than paying closing costs upfront.

Cash-out refinancing as an alternative to a home equity loan

Instead of taking out a separate equity loan, you can do a cash-out refinance: you replace your current mortgage with a new, larger mortgage and receive the difference in cash. If your home is worth $400,000 and you owe $250,000, you could refinance for $300,000 and receive $50,000 in cash for your down payment.

The advantage is a single closing instead of two. The disadvantage is that you're extending your loan term and paying interest on the full new amount, not just the borrowed portion. If you had 20 years left on your original mortgage and refinance for 30 years, you're paying interest for 10 extra years. Run the numbers with a lender to see whether the total interest cost is worth the convenience.

Cash-out refinancing also requires a new appraisal and a full mortgage application, which takes 30 to 45 days. If you're in active negotiations on a new property, this timeline may not work.

Lender requirements and debt-to-income limits

Lenders have strict rules about how much you can borrow against your equity. Most allow you to borrow up to 80 to 90 percent of your home's value, minus what you still owe. If your home is worth $300,000 and you owe $200,000, you have $100,000 in equity. Most lenders will let you borrow $80,000 to $90,000 of that.

Your debt-to-income ratio (total monthly debt payments divided by gross monthly income) affects approval. When you add an equity loan payment to your existing mortgage, car loans, credit cards, and student loans, your ratio goes up. Most lenders want to see a ratio below 43 percent. If adding the equity loan payment pushes you over that threshold, you won't be approved, or you'll have to borrow less.

Your credit score matters too. Most lenders require a score of at least 620 for a home equity loan, but 680 or higher gets you better rates. If your score is below 620, you may not be approved at all, or the interest rate will be significantly higher.

When a gift from family is simpler than an equity loan

If a family member can give you money for a down payment without expecting repayment, this avoids the debt and closing costs of an equity loan. The lender on your new mortgage will ask for a gift letter stating that the money is a gift, not a loan, and that the giver has no claim to the property. Most lenders also want to see proof that the gift funds came from the giver's own account (bank statements showing the transfer).

Gift funds don't add to your debt-to-income ratio, so they don't affect your ability to borrow for the new mortgage. They also don't require a separate closing or additional closing costs. The tradeoff is that you're asking someone else for money, and family dynamics can complicate that conversation.

Some programs, like FHA loans, allow gift funds to cover the entire down payment. Conventional loans typically require you to have at least 3 to 5 percent of the down payment from your own funds, even if the rest is a gift.

Risks of using equity as a down payment

When you borrow against your home's equity, you're putting your current home at risk. If you can't pay back the equity loan and your new property purchase falls through or you face financial hardship, you could lose your original home to foreclosure. You now have two mortgages (or a mortgage and an equity loan) to pay each month.

Interest rates on equity loans are higher than primary mortgages because they're in second position. If rates have risen since you took out your original mortgage, the equity loan rate will be noticeably higher. Over 10 or 15 years, that higher rate adds up.

If your home's value drops after you borrow against the equity, you could end up underwater on both loans—owing more than the home is worth. This limits your options if you need to sell or refinance later.

Frequently Asked Questions

Can I use a HELOC for a down payment if I haven't drawn the money yet?

Yes, but most lenders want to see the funds in your bank account for 2 to 3 months before closing on the new property. They verify the money is yours and not borrowed. Draw the HELOC early enough to meet this requirement, or ask the lender whether they'll accept a HELOC commitment letter instead of actual funds.

What if I don't have enough equity to cover my down payment?

You can borrow the maximum your equity allows and combine it with savings, a gift, or a lower down payment percentage. Some loan programs allow down payments as low as 3 percent, so you may not need as much as you think. Talk to a lender about your options before deciding how much equity to borrow.

Do I have to tell my current mortgage lender I'm taking out an equity loan?

Yes. Your mortgage contract likely requires you to disclose any liens or loans against the property. The equity lender will run a title search and discover your current mortgage anyway. Failing to disclose can be grounds for the lender to call the loan due immediately.

Will taking out an equity loan hurt my credit score?

Yes, temporarily. A hard inquiry and a new account will lower your score by a few points. The bigger hit comes from the new monthly payment, which increases your debt-to-income ratio and may lower your score by 10 to 20 points. The score usually recovers within a few months as you make on-time payments.

What happens if I can't sell my current home and I'm stuck with two mortgages?

You'll have to pay both the original mortgage and the equity loan each month. This is why lenders look closely at your debt-to-income ratio—they want to make sure you can afford both payments. If you can't, you may face default on one or both loans. Plan for the possibility that you'll carry both payments for a period of time.