Jim owns his house free and clear - no mortgage - but he recently found another house that he likes a lot better. It has been repossessed by a bank and is priced far under its appraised value.
Jim plans to make a quick bid on the house - $250,000 - with no contingencies. He knows it may take six months or more to sell his present home since the market in his city is slow, but he thinks he can get at least $230,000 for it.If Jim sells his house for as much as he anticipates, he'll be able to get the new house mortgage-free since he has $50,000 in savings and the equity in his house.
In the short term, however, Jim must borrow $200,000.
What's the best way to do it?
- He could apply for a mortgage on the new house. Since he probably won't have to hold the mortgage for more than a year, an adjustable rate mortgage would be the best bet. He probably can get one for a rate of 7. 7 percent for a year.
- He can get a home equity loan on his current house for up to 80 percent of its value since he has no first mortgage and could live in the house until he sells it. He should be able to borrow $200,000 this way at an interest rate of about 11.5 percent. Banks in his town are competing for home equity business, so he won't have to pay any closing costs.
One other factor complicates the decision further - taxes. If Jim takes out the home equity loan, he can deduct interest on only $100,000, or half of it. But if he takes out a new mortgage, he'll be able to deduct all the interest he pays on the $200,000 loan.
At any rate, Jim needs to look at all the financial ramifications of his decision. It isn't as simple as it first appears.