Q: Twenty years ago, we built a two-family house so that we could live with my parents. They lived on one side, and we lived in the other.
Unfortunately, they both passed away last year. Our last child is going off to college, and it has occurred to us that we no longer need a two-family home. So, we are thinking about selling the property and buying or building something new.
Would it be prudent to get a home equity loan, pay off the $45,000 mortgage, our credit cards and car loan? We are thinking of getting a home equity loan for 20 years for $100,000 which would also give us cash to do some needed repairs before we sell.
After the repairs are done, our real estate agent says she thinks the house will sell for around $320,000. We would net out around $200,000 after paying the commission and paying off the home equity loan.
The home we buy or build would be smaller and cost about $250,000. Is this a good plan?
A: I really like the idea of using some of your home equity to pay off your cars and credit card debt and improve your home before you sell. However, depending on what interest rate your mortgage carries, and how long you’ve had it, you might not want to pay off that loan when you pay off all of your other debts.
Interest rates on home equity loans have risen quickly, thanks to the Federal Reserve Bank’s multiple increases in the short-term Federal Funds rate. Right now, home equity loans are anywhere from 7.5 to 8.25 percent.
You might instead want to simply do a cash-out refinance instead of taking out a home equity loan. If your credit history is good, the overall interest rate would be less than 7 percent, significantly lower than the current rates on a home equity loan or line of credit.
Since you intend to sell this home relatively quickly, another option is to make that loan an interest-only mortgage. These loans will allow you to pay just the interest owed each month, which will further reduce your out of pocket expenses. That will allow you to put more cash each month into fixing up your home, or even allow you to rebuild your emergency fund.
Once you sell, you will be able to pay off the interest only loan. Then, you can get whatever financing you need for your new purchase.
July 2, 2006.