- The Washington Times - Wednesday, April 19, 2006

Q:My husband and I are set to retire from the federal government in five years after 30

years of service. We have identified some land in North Carolina that we want to purchase and hold until our retirement. We will then build our retirement home.

The cost of the land is $230,000. My husband wants to pay cash by dipping into our investment accounts, which totals about $300,000. We both have about $250,000 in government thrift savings accounts, which we wouldn’t touch.

Here’s our disagreement: I think we should take out an equity line on our current residence to finance the land purchase. We have no mortgage on our house, which is worth about $800,000. We can easily afford the monthly payments, and we would just pay off the loan in five years.

My husband doesn’t like debt, so he’d rather pay cash. What’s your advice?

A: First, I applaud you and your husband’s prudent financial responsibility. There’s certainly nothing wrong with being debt-free. However, as I’ve mentioned many times in this column, I believe that each financial plan should be well-balanced.

Your current asset allocation can be described like this: $500,000 in illiquid retirement accounts, $800,000 in real estate equity and $300,000 in liquid investments, totaling $1,600,000.

If you pay cash for the land, your liquidity drops to $70,000 while your illiquid assets increase to $1,530,000 because the land was purchased with liquid assets. This means that only $70,000 of your $1,600,000 is liquid. That’s less than 5 percent. This, in my mind, illustrates an imbalance. I’d have to say that I’m with you on this.

Consider the advantages of taking out a mortgage loan to purchase the land. First, you don’t have to touch your investments. Liquidating $230,000 will probably result in negative tax consequences.

Also, adding a $230,000 mortgage should result in significant tax savings because the interest paid is probably deductible.

Considering the fact that you have $500,000 in tax-deferred retirement accounts and an additional $800,000 in real estate, I would certainly advise that you take out a mortgage rather than reduce the balance of your investments.

However, forget the notion of taking out a home equity line of credit (HELOC). Most HELOCs are tied to the prime rate, which is currently at 7.75 percent. Further interest rate hikes by the Federal Reserve Board are anticipated, which will push up the prime rate more.

Instead, take out a mortgage that carries a fixed rate for at least five years. In this unusual interest rate environment, you will probably discover that a 30-year fixed-rate loan is more favorable than a 5- or 7-year adjustable. Either way, you should be able to find a loan that carries a fixed rate for at least as long as you will own the home in the mid-6 percent range with little or no fees. This is a far better alternative to a HELOC that carries a rate in the mid-7 percent range and poised to move higher.

A good loan officer can give you plenty of alternatives that would make sense.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by email (henrysavage@pmcmortgage.com).

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