Q. My wife and I plan to retire to Colorado, where we have made a down payment on some land. However, we cannot go ahead with building out there until we sell our present home, which we own outright. If we take out a "home equity" loan now, it will place an encumbrance on our present home that may make it more difficult to sell. If we wait until after the sale to build, it would mean several months of living in rental accommodations and paying furniture storage. Is there any alternative, given that the builder naturally needs a substantial amount "up front" before he starts work?
A. Believe it or not, your question has raised many complex issues. Although you are primarily concerned about raising enough money to build your home, you have to take into consideration such other matters as taxes, refinancing and selling.
First, let's correct one of your statements. If you take out a "home equity" loan -- or for that matter any mortgage on your property now -- it will not make it more difficult to sell. When you place a mortgage on your property, you pull out some equity. When you sell the property, your buyer's proceeds will pay off your existing mortgage, and any balance above that will be for you.
Indeed, this is a very good time to borrow money, secured by a mortgage (also known as a deed of trust) on the property. Interest rates are lower than they have been in years. No one can predict the future, but I suspect that rates probably will not go too much lower, and there is always the possibility that rates can go up again.
But more importantly, you need the money now. Because you still are living in the property, you also can obtain a better interest rate if you give thought to refinancing now. Lenders often charge a higher interest rate for loans on investment property, but because you probably do not know how long you will stay in the property, you can honestly tell the lender that the loan is to be based on an owner/occupancy basis.
When you refinance, you will have to pay points. You have to "do the numbers" to determine what interest rate to select compared with the number of points you will have to pay. Keep in mind that the lower the interest rate you obtain, the more points you will have to pay. If you intend to stay in the property for a year or two, it might make sense to pay fewer points up front and take a higher interest rate. Analyze all of the loans carefully with your calculator handy.
I can see no other solution to your immediate question than to refinance now and use these proceeds as a down payment on your new home. But have you carefully examined and investigated your Colorado purchase? Is the builder legitimate? Does he have a good track record? Will your deposit be placed in an interest-bearing escrow account, or does the builder intend to use your money for the purpose of building the property? Do you have a written contract with the builder that spells out exactly what will be built -- and when it will be completed? I have been involved in too many "horror stories" in which potential purchasers have been burned because they did not analyze the situation carefully before they gave a builder money.
Finally, there are the tax questions involved in the sale and the purchase of your new property. Because you plan to retire, I assume you are eligible for the once-in-a-lifetime $125,000 exemption. However, make sure that you have discussed all of the tax ramifications with your tax advisers before you sign a contract to sell your property. You may not now meet all of the once-in-a-lifetime guidelines. You may decide that it is better for you to roll over your profit into the new home rather than take the once-in-a-lifetime exemption now. Or you may want to take a combination of tax benefits.