 Financing a new home plus improvements
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 Dear
Dr. Don,
I have recently sold my home for $175,000. Our current mortgage
payment on that home is $869 on a 30-year fixed rate mortgage at
4.9 percent. We have a payoff amount of $117,000 and will pay a
real estate agent fee of 3.9 percent. With all that said, we are
looking for houses and would like to know how to keep the mortgage
payment down while still moving up in home. We have seen a house
for $241,500. It will need about $17,500 in updates and improvements.
If we choose this house we plan to stay there (10-plus years), providing
nothing catastrophic happens. How would you finance this home?
There are so many options out there and some are risky and some aren't. We know this home will climb in value after the improvements are done so refinancing may be an option later. What do you think? Again we would like to keep the payment under $1,450 if we are going to stay there. We can go higher if it is for a short period of time. We want to eventually live on one income, but we know that cannot happen here just yet.
Thanks for your input and advice,
-- Dave Decision
 Dear
Dave,
You do have a lot of choices. The crux of the problem is that the
proceeds from the sale of your home represent about 21 percent of
the new home's purchase price, while the desired improvements are
about 7 percent of the purchase price. You can put 20 percent down
on a first mortgage, only to turn around and borrow against it for
the improvements; take out a piggyback mortgage and pay cash for
the improvements, or just take out a first mortgage and pay cash
for the improvements.
With a piggyback mortgage you take out a first mortgage
and a second mortgage at the same time. The advantage to this is
that there's no private mortgage insurance, or PMI, requirement
on the first mortgage. The downside is that the interest rate on
the second mortgage will be higher than the first mortgage. A Bankrate
feature, "Should
you jump on a piggyback mortgage?" talks about the problems
with a piggyback mortgage in today's interest rate environment.
Putting down the net proceeds from the sale of your home and then borrowing the $17,500 as a second mortgage isn't all that much different from the piggyback scenario. You may be able to get a better rate on the home equity mortgage -- especially if you get a home equity loan versus a home equity line of credit.
Financing with just a first mortgage will subject
you to paying PMI in the early years of the mortgage, but you'll
reduce the interest expense on the improvements and potentially
eliminate the need to refinance later on. I've put some numbers
together below. You can make your own table using Bankrate's mortgage
payment calculator
or this PMI calculator.
 |
Financing options: |
|
| Sales
price: |
$175,000 |
|
| Real estate
commission: |
$(6,825) |
|
| Mortgage payoff
balance: |
$(117,000) |
|
| Estimated
net proceeds: |
$51,175
|
|
| Needed improvements: |
$(17,500) |
|
| Available
for down payment: |
$33,675
|
|
| |
|
|
| New house: |
$241,500
|
|
| Down payment: |
$33,675
|
|
| First mortgage
amount: |
$207,825
|
Loan
to value: 86% |
| |
|
|
| Est. monthly
mortgage pmt. |
$1,314
|
(30-year
fixed at 6.50%) |
| Estimated
PMI payment: |
$90
|
|
| Total
monthly payment: |
$1,404
|
First
mortgage + PMI |
| |
|
|
| Purchase price: |
$241,500
|
|
| Down payment: |
$51,175
|
|
| First mortgage: |
$190,325
|
Loan
to value: 79% |
| Monthly mortgage
payment: |
$1,203
|
(30-year
fixed at 6.50%) |
| |
|
|
| Home equity
loan: |
$17,500
|
|
| Estimated
monthly payment: |
$117
|
(Interest-only
HELOC at 8%) |
| |
$128
|
(Principal
and interest home equity loan at 8%) |
| Total
monthly payment: |
$1,320
|
First
mortgage + HELOC |
| Total
monthly payment: |
$1,331
|
First
mortgage + home equity loan |
This analysis ignores any tax benefit from your being
able to use the mortgage interest deduction, but it should be close
among the three alternatives, at least in the early years. Ignoring
any appreciation argument for when PMI should drop off based solely
on the loan balance, PMI should drop off in six to seven years.
The second mortgage approach frees up some money in
your monthly budget that you could choose to use in making principal
payments or additional principal payments on the loan. Taking on
some interest-rate risk with the HELOC with its adjustable rate
and high HELOC payments would mean less money available to pay down
that loan. The HELOC is also interest-only in the early years of
the loan but may at some point become an amortizing loan with much
higher monthly payments. If you like the second mortgage approach,
the home equity loan has a fixed rate of interest.
With your plans to be in the house 10-plus years,
I'd lean toward the certainty of the larger first mortgage plus
PMI -- including the certainty that PMI will fall off in time --
but it's close enough among the alternatives that I don't see you
making a huge mistake by choosing one of the other approaches.
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."
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