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Dr. Don Taylor, CFA, Bankrate.com advice columnistFunding land investment with home equity

Dear Dr. Don,
My wife and I are looking at a piece of property to buy for investment purposes by refinancing our home. We owe $81,000 and have six years left to pay off the mortgage. Our current interest rate is 5.125 percent. Our house is valued at $300,000 and we would need to borrow an additional $100,000 to purchase the property we are interested in.

We are planning on retiring in two years and three months and will sell our house at that time and pay off the mortgage. We plan to build on the piece of property within a few years after that and resell. We already own our retirement home on a lake and this property is within a few miles of that home. Our current mortgage lender will refinance at 7.125 percent on a 15-year loan and our closing costs will be in the neighborhood of $1,800. Are we pursuing the right financial avenue or do you have other suggestions?
-- Don Domicile

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Dear Don,
A home equity loan or a home equity line of credit makes a lot more sense than refinancing your existing mortgage at 7.125 percent from 5.125 percent plus paying $1,800 in closing costs. A second mortgage (home equity) typically has much lower closing costs, and you'll only pay the higher interest rate on the $100,000, instead of $181,000. You'll want to make sure that there's no prepayment penalty on the second mortgage if it's paid off in two years when you sell your current home.

I'd lean toward the home equity loan with its fixed interest rate rather than a variable-rate home equity line of credit, but the Bankrate feature, "5 questions to help choose loan or line of credit," discusses the decision variables.

Currently the national average is 7.9 percent for a home equity line of credit and 7.63 percent for a home equity loan. I'm a little concerned that your credit history might not allow you to borrow at these levels. I got that concern from you saying your lender would offer a 15-year mortgage at 7.125 when Bankrate's national average for a 15-year fixed-rate mortgage is 6.29 percent. If your credit is in good shape, your lender's not doing you any favors at 7.125.

Bankrate has partnered with myFICO to offer a free credit score estimate or you can contact the credit bureau(s) and purchase your credit score. You can get a free copy of your credit report from a credit bureau once each year but that won't provide you with your credit score.

There are just too many unknowns in the mix for me to advise you whether it makes sense to buy the property and build a spec home on it. Bankrate's mortgage glossary defines a spec home as, "A house built before a buyer has been found, on the assumption that one will be found."

I don't recommend refinancing your first mortgage to buy the property if you can get a home equity mortgage that can do the job with lower closing costs and an interest rate currently below 8 percent.

We didn't talk about land loans to finance the property purchase. That's another possibility, but the home equity loan or line should be a less expensive way to finance the purchase if you plan to pay off the loan when you sell the house in two years. The Bankrate feature, "How to buy a vacant lot," has a good discussion about land loans and other considerations in buying land.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: May 8, 2006
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