Also, with rates as low as they are, time is of the essence when locking in a mortgage. The additional steps required to secure the project/renovation work may result in you missing out on today's attractive rates and may keep you "locked out" from a desired rate. Lastly, unless the value of your home immediately increases with the renovations, this mortgage option is not a good idea.
Mellody's Math: If you choose a fix-up mortgage, the $25,000 in home improvements, could cost you a lot more than the price of the repairs. Here is the math:
Traditional 30-year Mortgage Purchase price: $150,000 Down payment: 10 percent ($15,000) Mortgage: $135,000 Interest Rate: 5.37 percent
Your monthly payment would be $755.54 and you would pay a total of $136,994.55 in interest over the life of the loan.
Fixer-Upper Mortgage Purchase price: $150,000 "As completed" value of the property after repairs: $175,000 Down payment: 10% ($17,500) Mortgage: $157,500 Interest Rate: 5.62 percent (.25 percent higher due to fixer-upper mortgage) Your monthly payment would be $906.16 and you would pay a total of $168,718.21 in interest over the life of the loan, meaning the extra $25,000 for repairs would cost you an additional $31,723.66 in interest.
Piggyback Loans With Lines of Credit: If a buyer is unable to make a down payment of at least 20 percent, they are required to get private mortgage insurance which protects the lender if the borrower defaults on the loan. The downside for the borrower is not only an additional monthly fee, but unlike mortgage interest, no portion of the mortgage insurance payment is tax deductible. As a result, in order to avoid mortgage insurance, some consumers are turning to second or "piggyback" loans with home equity loans or lines of credit-to cover their costs. The first loan is for 80 percent of the purchase price, and the second loan covers the amount the borrower needs in order to fund the 20 percent down payment on their home. The danger with this scenario is it allows borrowers to push the limits by putting next to nothing down while taking on a higher burden of debt.
Mellody's Tip: The problem with this strategy is that as interest rates increase on the line of credit, the amount of your payments could increase beyond your means. The interest rate you pay on your loan is tied to the Prime rate and often has an additional margin added on by the lender (as high as 6 percent). Although the Prime rate is currently at 4 percent, unlike an ARM, there is no safety net which will protect you if it climbs to 12 percent.
Interest-Only: An interest-only mortgage allows a borrower to pay interest only for a set period of time at the beginning of a 30-year loan, lowering the monthly payment during this period. At the end of period (usually 3, 5, 7 or 10 years), the payments are adjusted to include principle and interest over the remaining life of the loan.
In addition to an initial lower monthly payment, the greatest advantage of this type of mortgage is that during the interest-only payment period, the entire monthly payment can be deducted on your tax bill as interest payments are tax-deductible (principle is not). Although there are benefits to this type of financing, especially if the money saved is invested wisely, the downsides can be far greater than the potential upsides.