Q: I want to purchase the house next door for my son. The owner has passed away and the children want to sell. We offered them $25,000 and they accepted. We have 100 percent equity in the home I live in now. Would it be in my best interests to do a home equity loan to purchase the other house or should I look into other options?
A: Great question! A few years back, home values rose so much, so quickly and mortgage money flowed so freely that home equity lines of credit (HELOCs) and loans were the average homeowner’s go-to source — for better or for worse — for big bucks.
These funds were frequently parlayed into the purchase of another property. Now, though, mortgage markets and home equity have both dried up, as has the average American’s desire to even own a home — period, much less a second or third one.
So, cashing out equity from one’s personal residence to buy a second or third property has become much less common now than it once was.
Before I even discuss the pros and cons of either strategy (buying the house next door with a HELOC or home equity loan or getting a traditional mortgage to buy it), I’d like to strongly advise you to speak with your own personal mortgage professional and your own tax adviser.
Ask her to show you how the two different scenarios would play out. Get a quote of interest rates, mortgage payments, etc., for both possible courses of action, and take those to your tax pro. Then discuss. It’s not overkill to consult with a real estate attorney, as well, given the potential legal complexities of ownership, title and mortgage obligations for a property you buy for your son’s use.
OK. It used to be really easy to get a HELOC — you didn’t have to have any income, really. And that’s why it was a favored tool for parents to buy for kids; many retired parents couldn’t document the income to buy a place with a purchase loan, but could get a stated-income HELOC. Those days are gone. Now, you’ll have to document your income sufficient to pay the mortgage.
Equity lines and loans — or a refinance loan, since you own the home mortgage-free — generally have somewhat better rates than purchase loans — maybe two-tenths of a point. However, the rate you’d qualify for on an equity line depends largely on what percentage of equity you pull out of your home.
Assume that 80 percent is about the max any bank will lend you in cash. Now, that doesn’t sound too bad, but whether you would qualify for the payment on that may be an issue, depending on your income situation.
Also, whether 80 percent of the equity of your home will be enough to pay for your son’s home may be an issue — especially if your home is worth about the same as the one next door.
Pulling the money out of your house to buy his house has some major disadvantages, though. First off, the mortgage interest you would pay on an equity line or loan on your home might not be tax deductible, if you use the funds to buy his home vs. improving your own (check with your tax adviser on that).
More importantly, if you cashed out the equity in your home and used it to buy one for your son, you would very literally be securing his home with yours. That is, your home — which you currently own free and clear — would be subject to foreclosure if anything went wrong with the deal.
If there is any possibility you’ll have trouble making the payments on his, don’t take the cash to buy it out of your house. If you’re relying on him or anyone else to make the payments on the equity line or loan you use to buy his home, don’t.
If worse comes to worst and you end up defaulting on the loan, it’s far better to lose only his home and the security for the loan that went to purchase it — than to lose your home.
Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com.
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