Q. We own a home worth $120,000 and have about $20,000 left on the mortgage. We want to build a new home and estimate the costs at $45,000 for the land and $200,000 for construction. We have about $50,000 in savings that we plan to use toward this purchase. How do we finance the building of a new home while selling our current home?

You could potentially use four different loans in financing the home: a land loan, a construction loan, a bridge loan and a mortgage loan. If you pay cash for the land, your construction lender has to be willing to finance the building project with $0 to $5,000 down, plus hold the land as collateral. Alternately, you could choose to combine the two loans, land and construction, with $50,000 down. Either way, you end up borrowing $195,000, so choose the least-expensive option.

If you have your plans, land and contractor all lined up, you can bundle the loans by doing a construction-to-permanent financing loan. The main benefits from using a construction-to-permanent loan program are that it reduces the number of loan applications and closing costs. With a construction-to-permanent loan program, you should also have the ability to lock in a mortgage rate today, but you're likely to have to pay for that privilege. One problem with bundling the loans is that the mortgage is typically limited to the land and construction costs. Another problem is that it eliminates your flexibility to shop mortgage rates.

To avoid private mortgage insurance on the mortgage you need to have a loan-to-value of 80 percent or less. The appraised value of the property should ideally be more than the sum of the land costs and construction costs. If you've invested $50,000 on $245,000 in costs and the home appraises at $245,000 or more, then you've made the 80 percent loan-to-value target and won't have to pay mortgage insurance even with a construction-to-permanent loan program.

All this ignores applying the equity you have in your current home toward the new home. If you don't plan on selling your existing home until the new home is completed, you can still tap the equity by either taking out a home equity loan or a bridge loan. It comes down to closing costs and rates, but you need to make sure there's not a prepayment penalty on the home equity loan. But either type of loan would eventually be paid off from the proceeds on the sale of your current home. You won't be able to get 100 percent of your equity out with either loan, but it will give you a much larger down payment. Private mortgage insurance won't even be a consideration.

-- Posted: May 15, 2002