Q: We’ve decided to downsize and are building a new home. We put down a deposit of just over 10 percent and have a loan commitment for another 25 percent of the cost of the home. We have significant equity in our current home and plan to use that for the rest of the purchase price.
However, because the market is slow in our area, we have come to realize we may not sell our residence before we close on the new house. We can afford a large enough mortgage to buy the new home as well as our current home, but it won’t be fun paying for both.
Our lender is willing to consider a larger mortgage amount, but has suggested that we take out a home equity line of credit (HELOC) for the difference needed for the new house. The monthly payments would be interest-only (prime minus 0.5 percent) and it obviously would be paid off in full when we sell our current house.
Is there anything specific we should be concerned about with this approach?
A: I think your mortgage lender is offering you a pretty good option. Using a HELOC to finance the balance of your new house purchase is an easy move to get you out of a financial jam, especially since you’ll pay it off as soon as your home sells.
Your house will sell, especially if it is priced right and is in excellent condition. But you have to be realistic given where your neighborhood is today. You may have to face the fact that your home isn’t worth what it was two years ago, which also isn’t much fun. But if you’re realistic about where prices are in the neighborhood, and approach your sale as a seller and not a homeowner, you should be fine.
Remember that carrying two homes will be quite expensive, and that should give you an incentive to make a deal with a reasonable buyer who comes along.
In days past, when HELOCs weren’t as readily available, borrowers in your position would get a bridge loan. Essentially, the loan bridged the gap between when you’d have your cash from the sale and when you needed to buy your new home. Bridge loans were relatively inflexible in that they were good for maybe 6 months or a year, and then you’d have to renew it or refinance it. But they were designed as short-term vehicles only.
You can keep your HELOC open even after you pay it off. It will help build your credit history and score, and it will also give you a place to turn for cash, should you ever need it.
Although you’re prepared to pay the mortgages on both homes, keep in mind that the HELOC has a variable interest rate feature. While your lender quoted you a rate of prime minus 0.5 percent, that rate can go up or down as interest rates rise or fall.
If you end up selling your home quickly, the changes in interest rates might not affect you, but if you can’t sell the home and interest rates start to go up, you might feel quite a bit of pain.
Still, this sounds like the best, and easiest, path to take.