Should you take out a line of credit for your down payment?

Taking out a line of credit may appear to be a tempting option to finance your down payment, but we wouldn’t recommend it as your first choice. First of all, a line of credit will almost certainly be a higher rate than your mortgage and as a general rule it’s a good idea to access the cheapest form of debt possible. More importantly, lenders will factor in the source of your down payment as well as your current debts into your mortgage eligibility, meaning a line of credit could hurt your approval chances. Using a line of credit is “not ideal” according to our mortgage expert Robert Malcolm, who suggests that home buyers explore other options if they want to qualify for the best rates.

Should you borrow money from family for your down payment?

With home prices as they are in major cities, borrowing from “the bank of mom and dad” is becoming increasingly common, and ultimately can be a viable way to afford your first home. If you’re lucky enough to have the financial support of family when buying your home, it’s important to establish clear terms, expectations, and maintain open communication with your generous lender. When large sums of money are involved, things can get ugly if there aren’t clear expectations set out ahead of time. Many first time buyers add a parent or spouse to their mortgage as a co-signer to help them qualify for their home.

Some examples of topics you should discuss with your family member or co-signer prior to a financial agreement include:

• Is the money a loan or a gift?
• Who will the owner of the property be?
• When is the loan expected to be repaid?
• Are there other expectations that come with the loan?
• What happens if you can’t afford the mortgage and need to sell the property?

It’s also not unheard of for a family member with existing equity in a property to take out a Home Equity Line of Credit (HELOC) and loan it to a child, in order to qualify for a more favourable rate on the loan. If you were considering going with a line of credit for example, and instead your parents offered to take out a HELOC and loan it to you, with you paying the interest, that would leave you with a much better rate. For example, our best 5-year fixed rate for a HELOC is 4.74% as of posting. If you were considering taking out a line of credit instead, the prime rate for most banks is currently at 6.70%. You would be saving at least 1.96% on your loan if you were able to take out a HELOC instead which on a $500,000 mortgage is nearly $10,000 per year in interest.

Should you take out a HELOC for your down payment?

Another option to consider is leveraging a Home Equity Line of Credit for your down payment. Real estate backed debt is often the cheapest form of leverage that’s available for most people, and a HELOC is a great way to leverage existing real estate equity. When borrowing against an existing property to fund a down payment, lenders will take into account your existing property and mortgage to determine your mortgage eligibility.

Here’s a breakdown of the usual cost of borrowing for some common loans:

In recent years it’s become more common to invest in real estate using leverage, especially by borrowing equity from an existing property. There’s even a term for it: the “BRRR method”. Ambitious real estate investors borrow equity from an existing property to fund the purchase of another rental property, which in turn will be paid off and fund the down payment on another property, and so on. The downside of this strategy is it is almost guaranteed to leave you overleveraged, which is a huge risk and could leave you in a disastrous situation if things don’t go as planned. If the market goes down for example and you can’t afford to pay for the debt you’ve taken on in order to fund your investments, you could be forced to sell at a loss. By using leverage you increase the potential risk of losses by much more than you would have otherwise.

Recommended reading: What is the BRRR method?

Alternative ways to make homeownership more affordable

If you’ve determined that borrowing money for your down payment isn’t the best option for you, that doesn’t mean you need to delay your dreams of homeownership. We’ve put together a number of tips to help first time buyers afford their down payment. One way you can make homeownership more affordable is by house hacking. Renting out a room or a basement apartment in your home can help make your monthly mortgage payments more affordable in the short term, and leave you with options later on. In one potential scenario you could work with an alternative lender to qualify for your mortgage, and then once you’ve got proof of rental income coming in, use that to help you qualify for a traditional mortgage lender with a more favourable rate.

Recommended reading: What is house hacking?

When it comes to borrowing money for your down payment, you’re going to want to carefully evaluate each option and consider your own circumstances. Taking out a line of credit, leveraging real estate with a HELOC, or borrowing from family can provide temporary financial assistance, but they also come with potential drawbacks. It is recommended to consult with a mortgage expert who can provide personalized advice based on your financial goals and situation.