- The Washington Times - Friday, November 14, 2008

Q. My wife and I have lived in Arlington for the last eight years. We have a 30-year fixed rate at 5.25 percent with a balance of $240,000. We have just had our second child, and we are starting to outgrow our house. We are looking at two scenarios and would like your opinion.

Our first option is to move. We have very good friends who live around the corner and will be relocating this spring. They have offered to sell us their house for $700,000. Looking at recent sales of houses that size, I think it’s a great deal. We would be able to sell our house, conservatively, for about $550,000 and use the proceeds as the down payment. The house is much bigger than ours and needs a little upgrading, but we really like it.

Our second option is to remain in our house and build an addition. We’ve had a couple of contractors come in and we are told that the two-story addition we are considering will cost between $200,000 and $225,000. Living in a house under construction doesn’t really appeal to us, but we like the idea of being able to design our addition the way we want it. We also hate the idea of giving up our 5.25 percent fixed rate.

On the other hand, buying our friends’ house is a great opportunity. They would give us up to six months to sell our house, although I don’t think it would take nearly that long. Both my wife and I have good jobs, salaries and credit.

Any comments?

My first comment is to suggest that you continue your due diligence and your decision will eventually become obvious. Let’s take a look at the pros and cons of each scenario, starting with remaining in your home and building an addition for $225,000.

Pros:

You are able to custom-build the addition to your specifications.

You won’t have to sell your house in a market that clearly favors buyers.

You can possibly keep your $240,000 fixed-rate mortgage at a below-market 5.25 percent rate.

Cons:

Building an addition, even with all the responsibilities in the hands of a general contractor, and living in a home that’s under construction can be stressful - especially with two small children.

You run the risk of cost and time overruns, compounding the stress level.

Financing options may be limited. While most home equity lines are tied to the prime rate, making them currently very inexpensive, the prime rate is likely to increase in the future. Fixed-rate second trusts will carry a higher rate and are harder to find, thanks to the credit crunch.

Let’s now consider purchasing your friend’s home for $700,000.

Pros:

I’ll take your word for it. The purchase is likely to be a bargain, especially if you plan on holding onto the property for a long time. At best, the price should be discounted to reflect the lack of real estate commissions paid.

The other pros in this scenario are the same as the cons in the first scenario. You don’t have to deal with construction and there are no risks associated with the cost.

Cons:

Likewise, the cons to purchasing your neighbor’s home are the same as pros in the first scenario. You have to sell your home in a disadvantageous market and you have to be satisfied with the current layout of the home, unless you are prepared to spend some money remodeling.

Let’s talk about financing for a minute. Selling your home for $550,000 would net you about $280,000 in cash, after sales commissions. Let’s back out $15,000 for closing costs and you have $265,000 left for a down payment, creating a new loan of $435,000 ($700,000 minus $265,000).

Unless Congress authorizes an extension of the so-called Fannie Mae and Federal Home Loan Mortgage Corp. (Freddie Mac) “Agency Jumbo” loans, you will be facing much higher interest rates unless the mortgage debacle has been largely solved when you’re ready to act. Otherwise, you may want to consider putting a little more money down or obtaining a second trust so you can limit your first trust balance to the current conforming level of $417,000.

Financing the addition could also pose a problem. If you need $225,000 for construction, your total debt on the property would be $465,000. If the property appraises for $550,000, the total mortgage debt would equal 84 percent of the property’s value. You may have trouble finding competitive financing with those numbers.

Although I don’t have enough detail to make a valid decision, my inclination would be to recommend that you buy your friends’ house if you think you can sell your current home without too much trouble. However, my real advice is this: Sit down with your wife, establish mutual objectives, prioritize your preferences and the answer will come.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at [email protected]

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