If you’re planning to build a new (second) home then your first step should be to look at your financial options. There is one main financial question to ask yourself, if you’re tight on cash: if you need a home equity line of credit on your current home or a construction-to-permanent loan?
Fox Business answers this : It’s a tough call. In arriving at your decision, the goal should be to minimize total interest expense arising from your financing. Fortunately, if you decide to obtain a home equity line of credit, you do have equity in your residence.
As far as establishing equity in the new home, a conventional mortgage requires 20% equity in the home to avoid private mortgage insurance, also known as PMI. The equity can be achieved through the difference between construction costs and appraised value, your investment in the land or bringing cash to closing.
Construction-to-permanent financing requires only one closing and one set of closing costs. The potential downside here involves how the interest rate is determined when you transition to permanent financing.
If construction takes longer than the rate lock (when and if available) on the construction-to-permanent financing, then you’re taking on the interest rate risk through construction. If taking this route, you become a captive consumer on financing costs.
A third option is to separate the construction loan from the permanent financing. This can give you more flexibility to find the least expensive construction loan and least expensive permanent financing.
You should be able to get the construction loan as an interest-only loan at the prime lending rate, which is currently 3.25%. That’s well below Bankrate’s national average for a home equity line of credit, or HELOC.
At issue is the trade-off between paying two sets of closing costs versus one, and the pricing of the permanent financing. The longer the construction process takes, the more likely you’d be better off doing two separate financings.
Source: Fox Business