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Dr. Don Taylor, CFA, Bankrate.com advice columnist Buying new home before old home sells

Dear Dr. Don,
I am moving about 60 miles north of my present home. I need to sell my home but with the market in the county where I live, I am afraid it will not sell fast. I want to buy a home in the new area and get settled.

I am thinking about doing a 5/1 ARM on the new house while the other house is for sale. I have about $25,000 equity in the old house to put on the new house when it does sell. I could immediately refinance the new one when I get my equity out of the sale and go with a fixed-rate mortgage. Do you think this is a good or bad idea?
Thanks,
-- Kathy Coordinate

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Dear Kathy,
Closing on a new first mortgage is an expensive proposition.  According to Bankrate's 2006 national survey of closing costs, you could spend an additional $2,000 to $4,000 on that second closing, money much better spent elsewhere.

Your eagerness to refinance after the sale of your former home will depend on what interest rates you can currently qualify for in financing the second home and where rates are when you sell your former home, but I don't like the 5/1 ARM option you suggest. 

According to Bankrate's Bankrate.com's Feb. 7, 2007, weekly national survey of mortgage rates, the difference in interest expense between a 5/1 ARM and a 30-year fixed rate mortgage is just 0.14 percent. While you're not likely to get these rates when financing a second home, the example below shows you that there's not a huge difference in interest expense over the first year, and most of the difference in payments is going toward paying down principal.

You can use Bankrate's mortgage payment calculator to come up with a table that shows the specifics of your situation. If you can afford the extra payment associated with the fixed-rate mortgage, you've avoided the interest rate risk of the 5/1 ARM.

Difference in interest expense
 
30-year fixed
5/1 ARM
Difference
Loan amount:$ 165,000 $ 165,000  
Interest rate:6.31% 6.17% 0.14%
Monthly payment:$ 1,022 $ 1,007 $ 15
    
One year of payments:$ 12,269 $ 12,088 $ 181
Total interest expense:$ 10,357 $ 10,126 $ 231
Loan balance after 1 year:$ 163,088 $ 163,037 $ (51)

And while I'll be the first to tell you that I don't know where mortgage rates are headed, there's a lot more risk to the upside (higher rates) than potential for much lower fixed-rate mortgages after you sell your current home.

Depending on your credit history, the purchase price of the new house and the expected selling price of the old house, I think the first line of attack is to investigate a piggyback loan on the new property.

A piggyback loan has a first mortgage with a loan-to-value ratio of 80 percent or less, so there's no private mortgage insurance, or PMI, requirement on the property. The second mortgage can be for up to 20 percent of the home's value, depending on how much money you can put down prior to the sale of your home. This second mortgage can be a home equity loan or a home equity line of credit, also known as HELOC. You need to be aware of any prepayment penalties on these mortgages if you plan on paying down the mortgage balance with the proceeds from the sale of your former home.
  
A bridge loan is another alternative. The closing costs associated with a bridge loan can rival that of a first mortgage. The loan typically comes due in six months but may have an option to extend the loan for another six months. The Bankrate feature, "Pros and cons of a bridge loan," explains bridge financing in greater depth.

To state the obvious, the key in minimizing the interest and other expense is to minimize the time that you own two homes. Holding out for an extra $5,000 in the sales price of your old home can cost you $5,000 in interest, property taxes, insurance, etc. 

The condition and pricing of your old home, along with location, are key factors in how long the home will be on the market. While I'm not suggesting that you underprice your home to sell immediately, you are certainly a motivated seller and it's an expensive proposition to price the home at a level where it will sit and stagnate as a listing.

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: Feb. 13, 2007
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