Split Loans & Home Equity Lines of Credit
July 13, 2009
Buying a home is a dream of many families, unfortunately, not everyone is in the position financially to buy the house of their dreams. A big hurdle to many families is coming up with money for a down payment. Yesterday we talked about how a low down payment on a home can effect how much private mortgage insurance you have to pay. Today we’ll take a look at two methods people use to buy “above their pay grade” and how they can be financially dangerous.
80/20 Split Loan
Some people get the housing itch after they get married, but they don’t have any money to use for a down payment. Others just don’t want to tie up cash in real estate, so they try to get a “no money down” loan. I will guess that there are no mortgage companies that will give someone a 100% single-mortgage loan, but instead, they will split the loan into two different mortgages.
The first mortgage will be your 80% of the purchase price, and the second mortgage will cover your 20% down payment for the remaining amount of the purchase price. These were very common in the early 2000’s and the housing boom, because so many people had housing buying fever. These loans are very hard to get right now, and I don’t recommend them to anyone. The second mortgage will be a horrible interest rate, and paying two mortgages isn’t fun.
If you have house fever and you don’t have much to put down, wait until you can save up 4 to 5% for a down payment, then apply for an FHA loan. They’ll loan up to 96% of the purchase price with a stellar credit history, low debt ratio, and high income. This is a great option for young professionals with high incomes that haven’t had much time to build up a pile of cash.
HELOC: (Home Equity Line of Credit)
Some people buy houses with the intent of fixing them up, adding on square footage, or just upgrading the kitchen and bathrooms. But very few new homeowners, have much extra cash after the down payment to put money towards home improvements or upgrades. Mortgage companies offer HELOCS to allow homeowners to borrow against their home’s equity.
So let’s say you bought a house for $200,000, and it appraises for $250,000. The mortgage company could allow you to borrow up to 50% of that “equity”, or $25,000. I don’t like these loans at all, because equity and home appraisals are so subjective. A house is only worth what someone is willing to pay for it, and HELOCS make it very easy to get upside down on your home loan.
For example, if you took the $25,000 HELOC, and you need to move two years later due to a job transfer, but now you can only sell the house for $215,000. Now you are $10,000 upside on the home. HELOCS are also considered as an additional lien against the home, so if the lender of that HELOC could technically foreclose on your home for non-payment.
These are a few things to consider when going through the home buying process. The bottom line is to be prepared when buying a home. Save up as much money as possible without jeopardizing your basic needs. The more you put down on a home and the more “equity” you start out with, the better shape you’ll be in. Don’t let your new home turn into a burden. Do everything you can to make sure it is a blessing.
Another thing that’s helpful in keeping you out of financial trouble is to buy only what you can actually afford “right now”… not what you think you can afford in a couple years. Make sure the monthly payment is affordable “right now”, and don’t be thinking you can skrimp and get by til that next raise and all will be ok. The raise might or might not come along.
If you have seasonal income, make sure the payment is affordable during the down season… base your payment on the worst case scenario for your monthly income, and that’s the payment you’ll be able to make no matter what. You can always double up on your payment or add extra principal to your payment in the ‘fat’ months… but the lenders are not happy if you have to deduct from your payment during the lean months.