Dear Debt Adviser,
We are fixing to close on our house in April. We are receiving a U.S. Department of Agriculture 100-percent financing loan. We are paying $117,000 for a house that has an estimated value of $191,000 to $234,000. Are we able to get a home-equity loan soon after closing, or do we have to wait until we have paid into our loan?
— Natalie

Dear Natalie,
Congratulations on your new home … maybe! You definitely bought while the market is down and purchased at a great price, below the home’s estimated value. I hope, too, that you bought only as much house as you can afford. Maybe even well below what you can afford!

What I am concerned about is what my wife, Barbara, calls “house fever.” It is easy to get carried away with the passion of home buying and go overboard. That you are immediately considering a second mortgage — yes, call it what you will, but it is still a second mortgage — gives me pause.

With that said, the only reason you have instant equity is because you bought the home below its estimated value. In addition, to qualify for the USDA Rural Housing Direct Loan that you received, you must be considered a low-income family for your area. Because of that, I am not sure if you would qualify for a home-equity loan or not. You may not have enough income for a lender to be willing to take the risk to lend to you.

But that aside, the question is, why borrow at all? Just because a lender is willing to lend you the money doesn’t mean that it’s a good idea or that you can actually afford the loan, especially if your circumstances change, as in underemployment or unemployment. Lenders use ratios of debt to income when making loans that may not apply in your specific situation.

I would much rather you apply for a home equity line of credit rather than a home-equity loan. With a line of credit, you don’t have to borrow anything, but the money is there if you need it. Plus, repayment terms can be better with a line rather than a loan. Should you find a lender willing to offer you a home equity line at a reasonable interest rate, I would encourage you to make sure you do the following before you take the plunge:

  • Agree on short- and long-term financial goals. Write them down.
  • Create a workable spending plan or budget that funds all your living expenses.
  • Save on a regular basis for an emergency savings fund of six months to a year of living expenses.
  • Save on a regular basis for the goals you set above.
  • Understand and agree how you will handle expenses if you have an income interruption or shortfall.
  • Look at your pay stubs and make sure you are contributing up to the maximum in your IRA or other retirement plans.

Natalie, I don’t know if you are a new homeowner but if you are, please be aware that unexpected expenses come up with a home all the time. I live in the Northeast where it is cold in the winter. Truthfully, it can be cold in the spring and fall, too! What I tell homebuyers is that a furnace will never break in the summer. It always waits for a cold weekend in February at midnight. And usually when you have other expenses to deal with!

My bottom line is to be careful not to treat your newfound equity as permanent until the housing market and employment markets stabilize. Even then, never confuse home equity as a substitute for a retirement plan or savings.

Good luck!