- The Washington Times - Wednesday, December 13, 2006

Q:We own a property in Arlington and have an opportunity to purchase a small, run-down home on a great lot. Our plan is to buy the home, renovate the existing structure and add an addition that will double the size. We think we can buy the house for $500,000. The renovation and addition will cost another $500,000.

Our current residence is worth about $950,000 and our loan balance is $300,000, so we have about $650,000 equity we can use, but we don’t have a lot of cash savings. My wife wants to keep our current residence to live in while the renovation is taking place, which will take about a year. What’s the best way to finance this project?

A: The best way to finance the property is not what your wife would prefer. She is suggesting that you purchase a $500,000 property, finance an additional $500,000 for the improvements, and retain your current residence for a year. Even if you could secure the financing, the question is whether you would want to. Let’s add up the numbers.

Retaining your current residence during the 12-month construction of the new house is a very expensive proposal. Here’s how you could do it:

First, take out a home equity line of credit (HELOC) on your current residence. To get the best rates, most lenders will limit the HELOC to 90 percent of the property’s value, less the existing liens. $950,000 times .90 minus $300,000 equals $555,000. This would be the maximum limit of the credit line.

Next, pull out $100,000 from the HELOC and use it as a down payment on the new property. Since the cost of the new property is $500,000, you would need to apply for a first-trust mortgage in the amount of $400,000.

Purchasing the property with this plan enables 100 percent financing because $400,000 is secured by a first trust and the remaining $100,000 is borrowed from the HELOC.

So, you now own two properties and your total mortgage debt has increased from $300,000 to $800,000.

The next step is to make your renovations and build the addition. You indicate that the project will cost $500,000, but your HELOC has only $455,000 left in available funds. You may have to scale back a bit with the addition or secure a $45,000 loan elsewhere.

Now let me illustrate my assertion that you may not want to carry both homes for 12 months.

Let’s assume your existing mortgage carries an interest rate of 5.75 percent over 30 years.

Your principal and interest (P&I) payment would be about $1,750 per month.

Add estimated taxes and insurance of $500, and your current total mortgage payment is $2,250.

A HELOC maxed out at $555,000 with an interest-only payment at 8 percent will carry a payment of $3,700.

We can’t forget about the $400,000 first trust on the new property.

Even with an interest-only payment at today’s market rates of 6 percent, the payment would fall in the range of $2,000.

Add an estimated taxes and insurance of $350 and we have a total payment of $2,350.

Adding up the entire monthly payments that would need to be serviced for a year, we come up with $8,300 per month.

Here’s the million-dollar question: Can you afford to make mortgage payments totaling $8,300 per month for the next year? Most lenders will require an income in excess of $250,000 per year to qualify for these payments.

If you don’t think you would qualify, and if you are unsure of your ability to make these payments, there is a much better solution: Sell your current residence, purchase the fixer-upper and live in the house during construction.

Living in dust for a few months won’t kill your family, but servicing $1,300,000 in mortgage debt may, indeed, kill your wallet.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavagepmcmortgage.com).

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