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Ask Dr. Don

Home-equity consolidation loan

Dr. Don,
I just purchased a home a few months ago for $217,000. The loan amount was $210,000. The approximate value of the house is $240,000. I want to take out a second mortgage to pay off all of my credit card debt, which is approximately $45,000. This amount is above the value of my home. It doesn't make sense to get a second mortgage unless I can pay off my entire credit card debt. What options do I have?
Wally Weal

Dear Wally,
You can get a second mortgage for $45,000, but you'll pay up to do it. It's a little unusual to see more than 10-percent appreciation on your home in just a few months, but not impossible. If the home appraises for $240,000 and you take out a second mortgage for $45,000, your mortgages will total 106.25 percent of the home's value.

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The lack of collateral backing the second mortgage will increase the interest rate on the loan. Besides being upside down in your house, you won't be able to use all of the interest expense as a deduction on your income taxes. Being upside down in your house can get pretty ugly if you have to sell -- especially coming up with the 6 percent to pay the real estate agent's commission.

I don't understand your all-or-none attitude on the credit consolidation. With less than 5 percent down on a first mortgage, you're in a position where you gained an additional $23,000 equity in just a few months of homeownership. That's a great investment. Don't grouse about not being able to consolidate all of your credit card debts into a home equity loan this soon into your first mortgage when you put so little down on the home.

A lot of people fall into a trap where they use the equity in their home to pay off their credit card debts, then don't change their spending habits and run up the credit card balances again.

My point is that paying down $23,000 with a second mortgage isn't too shabby, and the lower interest rate and payments spread over 10 years will help you free up the income to pay down the $22,000 that remains on the credit cards.

Timing real estate transactions

Dr. Don,
When living in one home and wanting to buy another, how do you make arrangements for making an offer on a home when the other has not even been listed? How do people move from home to home (financially) while still in their current home?
Lance Logistics

Dear Lance,
Contingent offers and bridge loans are the most common approaches:

  • A contingent offer is where you agree to buy the new home contingent upon the successful closing of your existing home. If your current home isn't even listed yet, you're going to have trouble convincing a seller to accept a contingent offer.
  • A bridge loan is a short-term loan that is secured by the equity in your current home and is used to cover the down payment and closing costs on your new home. Bridge loans are typically repaid within six months, but you should be able to extend the loan if your current home hasn't sold by then. The problem with a bridge loan is that you wind up with two mortgages and the bridge loan outstanding until you sell your current home. To take this approach you need to have a strong credit history and money available to cover both mortgage payments.

You're much better off listing and selling your existing home before contracting to buy a new home. You can stipulate in the real estate contract when closing will take place, and add an option to rent back for a period after the closing. Shop for your new home, but don't commit until your current home has sold, and even then you should write that the offer is contingent on the successful closing of your current home.

-- Posted: July 11, 2001

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