Home Equity Loan Strange Scenario

Personal Finances Buying or Selling a Home
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Hi guys, I think I am looking for Home Equity Loan advice, for a little bit of a strange scenario. Our current house is paid for. We are hoping to buy a better house and have started looking. We would like to buy the next house with cash. There is about a $250,000 difference in upgrading to the new house (probably). The current house needs some upgrading, which we would prefer to do, after we have moved into the new house, and then take a few months to do the upgrading, before selling it. Current house is worth perhaps $500K. Next house may be worth $750K. We are retired and most of our annual income comes from selling our stocks. We were wondering if we could get a home equity loan on our current house for perhaps $400Kā€¦(80% I have seenā€¦??) then sell only perhaps $350K of our stocks, and buy the next house with that as a cash sale. THEN, after moving out of our current house, we can upgrade and remodel it for a few months, before selling it, and getting the cash back out of it. What I am trying to do is take the least amount out of the stock market as I canā€¦ Maybe you guys know of another way of doing it, but I was thinking of a home equity loanā€¦ I could just get a mortgage on the next houseā€¦ .but getting approved might be problematic, because our income is a combination of social security and the sale of stocks, and I am not sure how that would be looked upon. We coluld also try to get the seller of our next house, to take a second for a few months or somethingā€¦ not sure if that is a crazy request or what. And I guess we could get a private signature loan or something. Just wondering if you guys have some creative suggestions for how to do this. Thanks in advance.

ā€“Footsox

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Some brokers will offer you a loan, a margin loan, against your equity holdings. Usually at better rates than the various home equity loan options. Though it definitely adds some risk if those stocks drop in the interim (if they drop below the margin requirements for those particular holdings). Ask your broker for more info.

I know you didnā€™t ask about this part, so you can ignore this comment if you want. It isnā€™t usually recommended for a ā€œregularā€ homeowner to do this. Most upgrades will not result in a net profit to you. The project will take longer than expected, will cost more than expected, and will result in less money than you expected. There are many reasons for this, but one of the main ones is that buyers of homes prefer their own renovations/remodeling rather than someone elseā€™s. If you are a contractor or a home flipper, maybe you have an edge of sorts, but otherwise it is highly not recommended.

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Is your only rationale to pay cash on new home is because you believe you may have a hard time getting approved? Iā€™m a mortgage lender and can tell you typically much easier to get approved for a purchase. And if you obtain a mortgage, will that avoid the need to sell stocks and get hit with capital gains? Or IRA withdrawals that boosts your tax bracket?

Every retiree is a bit different when I am preapproving for a mortgage but here are some information:

  1. We can gross up Social Security Income for a mortgage approval.
  2. ā€œsale of stocksā€ is that from non-qualified or qualified account? If from non-qualified - If you have a two year history of capital gains (Schedule D of 1040 tax return), that can be used as income. So can dividend income.
  3. On a purchase - we can use hypothetical income from your IRAs to qualify for the mortgage. Every lender has slightly different guidelines as there can be overlays from the standard FannieMae guidelines.
  4. It may benefit you just to have options to obtain a HELOC now even if you still plan on obtaining a mortgage. Just do not inform your HELOC lender you are planning on selling that home as that will be an automatic decline. Some lenders donā€™t like the HELOC being used as a bridge loan as they incur costs to approve you and therefore want to recoup those costs by you carrying a balance long term.

#1 rule I tell a retiree on the fence about a mortgage vs cash: donā€™t have the ā€œpaying cashā€ option put you in position where you to pay the IRS more in taxes. I have some retirees where we do a mortgage with a plan with the financial advisor and/or CPA to have it paid off with in X number of years based on systematic withdrawals or RMDs from retirement accounts. And keeping these distributions within reasonable tax brackets.

Feel free to DM or post further questions and Iā€™d be happy to provide more specific advise, but I recommend you start with speaking with a qualified mortgage officer and get preapproved so you know exactly what your options are. I encounter it numerous times per year where one will listen to the realtor or jump the gun on a home as cash and it screws the buyer because they didnā€™t know their options beforehand. Lastly, purchase loans have better rates than Home Equity and cashout refinances.

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Regarding the ā€œhypothetical incomeā€ (#3) I posted about, depends on your age but two formulas that can apply to conventional loans:

  1. take your retirement account balances and divide by 360. That gives you one potential number that can be used for additional income to qualify.

  2. Take retirement balances and divide by 240. This can be used for qualifying income. This option one must be 62 years old.

Again this is used for Qualifying Income. One does not need to actually pull this amount from retirement accounts.

If these numbers are not enough to qualify, then one can set up a systematic distribution from a retirement account to qualify. This has gotten a bit more stringent as in years past we would set it up, take one distribution, close, and then after closing; borrower would cancel the automatic distributions. (I know all the loopholes).

And if you are at the age or RMDs, you can use that to qualify. Basically you have options so donā€™t be in the mindset that just because you are on social security, you canā€™t qualify for a mortgage. A home equity is actually harder to qualify because those policies are the bankā€™s polcies; whereas the mortgage guidelines are federal guidelines and much more leeway with regards to debt-to-income ratios.

Hope that helps.

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I try to keep things simple. How about this: Rather than taking an equity loan against the old place, take a mortgage against the new one. When the old house sells, put the proceeds against the mortgage.

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Thank you so much everyone for the suggestions. So much great stuff! MarkR, since you are in the mortgage business (I think) I will DM you more questions in a day or two when I can digest what you have said. I hope that is OK. and tlucio, thanks for the suggestions also. I understand your suggestion about not taking the time and money to remodelā€¦ Our current house has been completely remodeled downstairs and is beautifulā€¦ We then have a second floor, which has ugly carpeting, popcorn ceilings, horrible stuff. You would not even know this is the same house, so we have decided to remodel the upstairs to give ourselves a fighting chance to sell at a decent price. But yes, I understand your suggestion. (and thanks). We wil try not to pour too much money into it. And RHinCT, thanks also for your suggestion. I guess that all depends on if we can get a mortgageā€¦ but sure sounds logical. Thanks everyone! Please keep adding your thoughts and suggestions. You open my eyes to all sorts of things.

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Hi @footsox,

If all this stock is in a taxable account, what impact will all the selling have on taxes?

As far as margin goes, what happens if the economy does go into a recession and your margin requirements increase while the value of the remaining stock drops? MARGIN CALLS!

I clicked RHā€™s suggestion: just get a mortgage. Why do you believe you canā€™t get one?

When we made the offer on this land in Dec 2020, I called an ag mortgage broker here, did everything via email/DocuSign and had the closing on Jan 15, in just 22 days through the Holidays to boot! We have been retired since 2005 and are new to this area.

Like I said, my first choice would be mortgage.

Absolute last would be a margin loan. Way too much risk!

Does that help you?

Gene
All holdings and some statistics on my Fool profile page
https://discussion.fool.com/u/gdett2/activity (Click Expand)

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If you plan to put the house on the market within 12 months, lenders are unlikely to approve you for a HELOC or a HELoan. Most lenders do ask, and it would be mortgage fraud to tell them you werenā€™t planning on putting it on the market.

There are a couple of other options that you could explore in addition to the margin loan that @MarkR suggested:

You could look into getting a reverse purchase mortgage on the new house, with a plan to pay off the reverse mortgage when you sell the current house. With a reverse mortgage, you wonā€™t have to make monthly P&I payments, although you may be required to pay into an escrow account for property taxes and insurance. The interest will just be added to the mortgage, so you will end up paying back more than you initially borrowed.

You could also look into getting a asset based forward (regular) mortgage for the new house, again with a plan to pay the mortgage off after you sell the old house. Unlike with a reverse mortgage, you will have to make P&I payments on the mortgage, but rather than basing the loan amount on your income, they will base it on your assets. Depending on the lender and their qualifying criteria, they will take the value of your total liquid assets (i.e. taxable brokerage accounts, retirement accounts, cash, etc.) and divide that by either 240 months (for a 20 year mortgage) or 360 months (for a 30 year mortgage).

For a $750k house with 20% ($150k) down, you would be borrowing $600k. At a rate of 7.25%, monthly P&I on a 30 year mortgage for $600k would be $4,350. To qualify for that payment, you would need to have $1.566MM in liquid assets.

AJ

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Just to nip this in the bud, I am not in the mortgage business, and in fact am probably nearly as far removed from the mortgage business as possible. I am a retired engineer. I bought one house in my life, and it was done during a corporate relocation, so the company had people that dealt with, and paid for, most of the things related to buying that house. I only refinanced the mortgage once, in 2010, to 4%. I know I should have availed myself of the sub-3% rates in 2020/2021, and I seriously considered it, but in the end didnā€™t do it. One, because my mortgage balance was too low for anyone to be interested, so I would have had to create a new bigger mortgage (ā€œCash out refinanceā€). And two, as it was, I couldnā€™t think of good places to invest excess cash at the time, so why add an additional few 100k to that problem? In retrospect, it would have been a good move taking $300-500k out of the house and simply investing in treasuries or similar. And, of course, over a 30-year mortgage, simply investing in an S&P500 or similar index fund would be way better. Didnā€™t do it, and the current mortgage will be over in a year or two.

Nevertheless, you may ask any questions you have, and if I can answer I will try my best.

I just have to add my standard comment about pre-paying mortgages here. It is generally more risky to prepay a mortgage than to not prepay a mortgage. Thatā€™s because of how mortgages work. If you have a 30-year mortgage of $450k with a monthly payment of $3000, you have to pay $3000 every month or they will foreclose. If, after 6 months, you prepay $300k of the $450k, you STILL have to pay them $3000 a month. If a personal calamity occurs (loss of one income, medical issue, loss of a spouse, etc), and you canā€™t come up with the $3000 each month, they will eventually foreclose. But if instead you have a $450k mortgage, with its $3000 monthly payment, AND keep the $300k invested conservatively, then you have more than 100 months of mortgage payment available in case of a personal calamity happening. Much much less risky than the former option.

Now that I think about it some more. Owning two personal residences simultaneously is itself a form of ā€œbuying on marginā€. Thatā€™s because assuming more or less fixed capital (because thatā€™s the reality, you have as much money as you have, no more, no less), then owning two personal residences simultaneously (using leverage, i.e. loans) means that you are roughly multiplying by two any price changes during the period. If home prices go up by $25k, you gain $50k for the period. And if home prices drop by $25k, you lose $50k for the period. Obviously this doesnā€™t apply to rental real estate because those are investments that have all sorts of return on investment over time rather than ordinary personal expenses. But it does apply to owning two personal residences for a period of time.

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I think @footsox may be thinking of me. I was an engineer who helped run the servicing side of the mortgage business starting in 2006, until I retired in 2018. Talk about timing!

I mostly agree with this.** If you canā€™t pay the mortgage completely off, then just paying down large chunks without changing the monthly obligation leaves you in a much more difficult position financially. You still have the same monthly payment obligations, but less cash to fall back on if something happens. That said, with a mortgage, you generally have the opportunity to ā€˜recastā€™ the loan after you make a large principal payment. That is where they will keep the same interest rate and reset the term (length) of the loan back to the original payoff date. You need to check with your mortgage servicer before you make any pre-payment to see how large the payment would need to be (my employer used to require at least a $10k principal payment) and if they will charge any fees (my employer used to charge $300, although you could generally get them to waive it). By lowering your monthly obligation, that will allow you to gain some benefit from paying down principal.

**You will notice that in my reply, both times I suggested to ā€˜pay the mortgage offā€™ (not down) after selling the old house.

Yes, it is. But Iā€™m on my 9th owned personal residence and have done this successfully for 4 of the purchases. You just need to recognize the risks when you are making the decision to do so, and ensure that you can be approved for the mortgage(s) that you will need to take on.

Another way to structure this would be to take 2 different mortgages on the new house. Hereā€™s how you could do that with the circumstances described (Current house $500k debt-free, $750k new house):

Down payment on new house $150k
First mortgage on new house $400k
Equity loan (HELoan or HELOC) on new house $200k

You can vary the ratio between the first mortgage and the equity loan, depending on how much of a long-term obligation you want to end up with, vs. what you think youā€™ll be able to pay off after the current house is sold.

AJ

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Thank you AJ. Lots to think about. Our stocks are double that, so that seems doable. Thank you for laying it all out. I am definitely making notes and need to look at my options. We may also build a new houseā€¦ which would give us a few months to ā€œpay as we goā€ so to speak. I havenā€™t even started looking at the financial aspects of doing thatā€¦ Thank you again. I appreciate your insight on all the boards.

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Thanks RHinCT. Lots of info there. I appreciate it. You are definitely right about owning 2 houses simultaniously. I would have to insure both of them, and we live in Florida, so thatā€™s a bit pricy. Then, there is the reality of having both houses hit by a hurricane. We are all too familiar with hurricanes here. So, something I need to seriously consider. Thanks for the great info on so many options. I had no idea! Time for me to study the many options. Thank you again.

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I think you meant someone else.

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Reverse Mortgages have very high costs, so would not recommend in this scenario.

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Yes, but it is an option. While @footsox stated that they want to purchase the new house with cash, they also said:

So, if the goal is to as much of their portfolio intact when upgrading to a new house, and in fact, they would prefer deploy the equity from their old house into the market instead into the new house, a reverse purchase mortgage, despite the costs, may fit the bill. If they donā€™t want to deal with monthly P&I payments, donā€™t really care about leaving the new house to heirs, and would rather leave a larger stock portfolio to heirs, a reverse purchase mortgage could actually be a good option, despite the costs.

One nice thing about FHA insured reverse mortgages (HECMs) is that if housing prices drop, and the heirs want to keep that particular house, the house can be sold to the heirs for 95% of its current appraised value to satisfy the mortgage. If the heirs donā€™t really care about keeping that particular house, they can just deed the house back to the lender. Thatā€™s part of the reason that reverse mortgages are more expensive. But it can be a great move for those who would rather leave a larger portfolio than a house that has little/no sentimental value, like a house that was purchased just a few years prior.

Since there seemed to be conflicting goals of paying cash for the house, but liquidating as little of the portfolio as possible, I thought I would mention a reverse purchase mortgage as one of the ā€˜creative suggestionsā€™ that @footsox was looking for.

AJ

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I suspect that the lowest cost solution could well be the standard margin loan at a broker. First step would be to contact your broker and ā€œnegotiateā€ a rate for a margin loan. One way to negotiate is to simply find out their margin loan rate, and then find out the lowest margin rate at a different brokerage (like IKBR) that typically has low rates. Then if they wonā€™t match the low rate just tell them that you will have to move your entire account to the place with the low margin rate. Almost every time they will offer you a lower margin rate. I donā€™t know what current margin rates are, and I havenā€™t used margin loans for many years, decades even.

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Yes, a margin loan could very well have lower expenses, but introduces the risk of a margin call, plus itā€™s a variable rate loan, while reverse mortgages can be fixed rate. And taking out a margin loan on your brokerage account still leaves you open to the risks of house prices dropping (which the reverse mortgage mitigates), and it leaves your heirs with an illiquid asset that they canā€™t just sign over to the margin loan lender to settle the loan. If they want to use the homeā€™s equity to pay the margin loan, they will have to sell the house, incurring time and expenses to do so. BTW, what does happen to a margin loan when the borrower dies? I presume that the loan would have to be paid prior to any transfer of assets to the heirs, so the heirs would have to deal with that in addition to dealing with the house.

Personally, Iā€™m considering taking a reverse mortgage despite the expenses (and yes, they are more expensive than forward mortgages) because:

  • Thereā€™s no sentimental value in my house - I bought it about 10 years ago, and any potential heirs (nieces/nephews) have only visited it a few times
  • It provides protection to a decrease in the price of the house, as my heirs, if they do want the house, would only have to pay either the current loan balance, or 95% of the current appraisal value, whichever is lower
  • Other than the possibility of having to escrow property taxes and insurance (which I need to pay anyway), thereā€™s no monthly outgo
  • It allows me to free up the equity in the house to either invest or spend

Itā€™s very dependent on individual circumstances, but reverse mortgages can provide advantages that are useful for some people.

AJ

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In this particular case, borrowing $600k on margin from an over $3M portfolio is reasonably safe. The stock market would have to go down over 60% to require a margin call, and heck, if the stock marker goes down 60% it would be very likely that everything else is also seeing value destruction, including any economics of this whole real estate transaction of two homes.

Hmmm, maybe a variable rate loan right now is better? The market is betting on interest rate reductions beginning in mid-2024, continuing through 2025, and ending in 2026. So it might be a perfect time to have a variable rate.

Is it possible to refi reverse mortgages when rates drop? Is it a costly endeavor?

This would be a HUGE benefit of the reverse mortgage route. Does it protect you against price declines in all cases, or only if you hold the house until death of all the owners? Also, I really donā€™t understand how reverse mortgages work in the first place. If your house is worth $1M, would they give you a $1M reverse mortgage? If they only give you a $500k or $750k reverse mortgage, how does it protect you from price declines?

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Not sure why theyā€™d only borrow $600k when the house is going to be $750k, plus upgrades on the old house. That said, I do agree that, if their entire portfolio is marginable, itā€™s probably not a huge risk. But if half of their portfolio is taxable and the other half is in retirement accounts, that means that there is only a $1.5MM marginable portfolio, which makes a margin call on even a $600k loan more likely.

You can also get a variable rate reverse mortgages, which is why I said ā€œreverse mortgages can be fixed rateā€. So you have a choice.

It would be costly to do so, but it is possible.

Hereā€™s an Investopedia article that gives a pretty good summary of FHA HECMs (Home Equity Conversion Mortgages) Reverse Mortgage Guide With Types and Requirements (investopedia.com)

The percent of the homeā€™s value you can borrow is dependent on the age of the youngest borrower and the current interest rates. The older you are and the lower the current rates are, the higher the percentage that can be borrowed. In general, you the initial LTV canā€™t be more than 50% of the current value of the house, because each month, interest and fees will be added to the balance. With compounding, that can add up rather quickly, which is why the LTV that can be borrowed is pretty low. However, if, like many people, the value of your house has increased significantly since you purchased it, you may easily be able to borrow more than you originally paid for the house, plus any improvements - basically getting all of your money back out, and maybe even more.

The way that the downside protection works for HECMs is that the loan becomes due when:

  • You sell the home
  • You reside outside the home for more than 1 year
  • You fail to maintain the home
    or
  • You fail to pay property taxes and insurance

When the loan becomes due, even if the home is underwater, the lender can only require you to pay the lesser of the loan amount or 95% of the current appraised value. So if your home has gone down in value, you wonā€™t have to pay back the additional balance. But if you already got all of your money back out, and then lived in the house mostly for free (paying only property taxes and insurance) for several years, being able to walk away without owing anything may be a great deal - especially if the value of the house has gone down.

There are ā€œJumbo Reverse Mortgagesā€ that are not insured by the FHA, and allow you to borrow at a higher LTV and/or a higher dollar amount. The terms for those loans can vary greatly.

AJ

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Ah, so now we can run some numbers. If the LTV is exactly 50%, and the home price appreciates at an average of zero over the entire period, then, at 7% interest, the accrued loan value will exceed the home value in about 11 years. If 50% LTV, 7%, and home average appreciation is average 3.5%/yr, then itā€™ll take about 21 years until the loan value exceeds the home value.

I assume the banks have pretty good actuarial service so they determine the ages/LTV to work out well for them. Of course, they also add clauses to protect themselves, for example the ā€œresiding in house for a yearā€. That means that if you take the loan at age 67, and then enter assisted living, or just want/need to downsize, at age 82, you typically havenā€™t reached the breakeven point yet. You would have to live in that house until at least age 88 for the ā€œhome value decline protectionā€ to kick in with any meaningful result. They also have the ā€œmaintenanceā€ clause, so if you get older and begin to defer maintenance, they can ā€œcallā€ the loan before it becomes advantageous to you (or your heirs).

I bet they also have decent underwriting that will reduce the max LTV in areas where there is a higher possibility of price declines over the long-term.

It is definitely an interesting concept though. I wouldnā€™t mind a financial instrument that would allow me to ā€œshortā€ my house, especially now with the ā€œrent versus buyā€ so out of whack. Heck, if I could do it easily, Iā€™d just sell the house and rent something nearby. I think the house is overvalued right now, and the insurance is rising at a ridiculously rapid rate. Unfortunately I still have a few kids remaining at home, so itā€™s not easily done for the next few years. I guess thatā€™s one of the pitfalls of having kids in late 30s/40s rather than in oneā€™s 20s/early 30s. :smiley: