2 mortgages haunt home dream

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Dear Dr. Don,
We currently own a home worth about $425,000 with an outstanding mortgage of about $290,000. We would like to start building a home on a parcel of land we own free and clear (valued at $85,000). We would like to build a $275,000 home on this property.

Can we use a construction loan to start building even though we have an as-yet-unsold primary residence? If so, then how? Our goal is to sell our current residence and have the new house be our retirement home. We could wait and sell, then build, but we were wondering if there’s a way to get started on one before selling the other.
— Dave Dilemma

Dear Dave,
It’s a common dilemma. You want to build your dream home but don’t want to give up the keys to your old home until after the new one is finished. Waiting to sell your current home until after you get a certificate of occupancy on the new house can mean you must have enough income to qualify for two mortgage payments.

The Bankrate feature, “Mortgage round-trip: Timing a home sale, home purchase,” provides a nice overview on the issues. However, don’t chase after the “no ratio” loan discussed in the piece. They’re not available in today’s mortgage market.

The construction loan itself shouldn’t be much of an issue. Construction loans are typically interest-only on the funds disbursed during construction. The loan typically has a maximum term of one year from signing. The construction loan has to be paid off when the home is completed. If you choose construction-to-permanent financing, you only have to close on one loan instead of two. But then you’re right back to the two-mortgage issue.

A bridge loan is a potential solution, but it’s going to be hard to find a lender willing to finance it. Bankrate’s glossary defines a bridge loan as follows:

A loan that “bridges” the gap between the purchase of a new home and the sale of the borrower’s current home. The borrower’s current home is used as collateral, and the money is used to close on the new home before the current home is sold. Some are structured, so they completely pay off the old home’s first mortgage at the bridge loan’s closing, while others pile the new debt on top of the old. They usually run for a term of six months.

It’s important to make sure the loan can be extended for another six months if the home hasn’t sold.

The good news is that the equity you have in the land will reduce the loan-to-value calculation when you look to finance the permanent mortgage on your retirement home.

Owning the land outright means you don’t need to come up with a down payment.

If the real issue is in not wanting to be forced out of your current home until your new home is finished, work with your builder to estimate the time spent in construction.

If the construction process is expected to take three to nine months, one way to finesse the issue is to put your current home on the market with a provision that you won’t close before the expected completion date on your new home. Then, counter any purchase offer with a requirement in the sales agreement that you are able to rent back from the buyer as a form of insurance against a delayed completion. (This is also called a “seller’s temporary residential lease.”)

Make sure your real estate agent knows this is non-negotiable so you don’t have to listen to him or her whining about a quick close.

Read more Dr. Don columns for additional personal finance advice.