Q: I’m a huge fan and really love your radio show. I have a question regarding my financial situation and really not sure on how to proceed.
I have a fixed 15 year mortgage at a rate of 5.75 percent from 2002. I have been able to accelerate my payments and have two years left on the mortgage, I only have a balance of $25,000 left.
Recently I put in an offer to buy an investment home for around $85,000. I talked to my lender about getting a new mortgage and home equity line of credit (HELOC) on my house. I would then use that money to buy the investment home.
My lender convinced me that I would be better off getting a new HELOC mortgage for $110,000 with an interest rate of prime plus 1.5 percent. I could draw on the loan over the next ten years but would have to repay the loan in full in twenty years. One advantage of the loan is that it would have no closing costs and would give me some flexibility on what I pay them back on a monthly basis.
Will I end up paying more interest on what is left on my current mortgage if I pay it off using the HELOC? Should I just continue paying my current mortgage as usual? Is a HELOC a good idea? And do these rates look good to you? I’m a little worried and don’t want to get myself in a financial bind.
A: This may be a good deal for the bank and it may be a terrible deal for you. Why?
First, you’re getting a loan that carries a variable interest rate. The payoff time is 20 years, which is longer than your first loan. The interest rate in that time can jump, and you didn’t mention a cap on the interest rate, which means you’re leaving yourself wide open to hyper-inflation. It’s a very risky scenario.
Next, today’s interest rates are still at near-historic lows. You’re far better off getting a new 15-year loan on your property. The interest rate will be in the low- to mid-4 percent range and it will be fixed, not variable.
If you need a home equity line of credit (HELOC) on your first home to get enough money to buy the investment property, fine. You should have plenty of equity in your current home to handle both loans. But focus on getting that loan paid off as quickly as possible.
Finally, I think you should shop around for another deal on the HELOC to make sure you understand what the rates are in your area. There was a time when lenders offered HELOCS at prime minus some amount or just at prime, but these days they want to get prime plus something.
Since you are considering buying an investment property, you should first determine your goals with that property. If you plan to rent it, make sure the property is located in an area where tenants are readily available. You also need to make sure you will get the rent you would expect to get for the investment property. You may find that rents are far lower in your area for a property like the one you are buying and the rent may not cover your monthly ownership expenses.
If you are buying the property to use as your principal residence, you may be in luck. Because your current loan balance is so low, you may be able to get a loan on the new home even if you haven’t sold your current home. You would close on the new home and you would then have to pay the expenses on both homes until your current home sells.
Depending on what you are planning on doing, you might want to check out some other lenders, including a credit union (if you belong to one or can join one), an online lender, like ING, and perhaps a local lender to see what they are offering. Many financial experts are predicting that interest rates will rise over time.
Some think that interest rates will rise quite high, others think that they will gradually rise but won’t get too high. I wish I knew when and how high interest rates will go – but my crystal ball cracked long ago.
But given the consensus by many that interest rates may be at a low point and are poised to increase – even a little over time – if you rely entirely on the HELOC loan, you need to feel comfortable that you could pay it off even if interest rates rise quickly and stay high for an extended period of time. If you are not comfortable with that scenario, you should lock in a fixed rate at today’s historically low rates.