Take cash out from refinancing to pay for separate construction loan?

February 3, 2021 8:49 AM

I have a lot of equity in my current house. I am refinancing to a lower rate. I am also building another house in the next year. I will carry a mortagage on both homes for at least the next 5 years. I have this harebrained idea that I should take a bunch of money out of my current house when I refinance to pay down the construction loan I'm going to need soon.

I'm sure my refinance will be at a much lower rate than the construction loan will be, so it seems like this will save me money in the long run. Being a biologist, I am assuming I am overlooking something and that this is a bad idea. Any advice or words of wisdom would be appreciated.

posted by Patapsco Mike to Work & Money (7 answers total)

You are proposing using some of your safety net to lower long term costs. So, it is adding to your risk for economic benefit. If it works for you it is an example of how access to money makes money. A few risks to consider:

1. Is your income stream stable and sure enough to handle both mortgage and loan? What if it decreases or goes away?
2. What if the construction ends up costing more than you expect? Much more?
3. What if the construction takes longer than you expect? Much longer?
4. Do you have other economic safety valves you could access if things go really wrong. I.e. is this in any way putting ownership of your current house at risk.

A professional financial planner could help you assess these scenarios and measure your comfort with this move.
posted by meinvt at 9:12 AM on February 3, 2021

Another thing to consider is the interest you pay on your primary home is likely a tax deduction, but may not be for the second home. So if you can put the debt of the second hone into the first, this will likely increase your deductions and decrease your tax liability. However, if the second property will be an income property, it may be better as an expense associated to it. This is something you need to verify for your situation.
posted by Short End Of A Wishbone at 9:37 AM on February 3, 2021

Most people I know that have built a home have found it cheaper to just get a secured mortgage against their primary residence and use that money to finance the new build. Then they sell off the old house to pay off the mortgage and own the new build outright (or keep the old house and rent it out to recoup the carrying costs of the mortgage). Construction loans tend to be more expensive in the long run and have limitations on when money can be released.
posted by saucysault at 9:55 AM on February 3, 2021 [1 favorite]

In broad strokes, this is a good idea, especially given rates right now. Considering contingencies is also a good idea.

Is the plan to keep the big loan only on the first house, long term? Thinking about the exit strategy after construction -- if you eventually want to transfer the debt to the second house, rates may be somewhat higher at that point. A mortgage on a second house is a different scenario for banks than a single primary mortgage.
posted by Dashy at 10:16 AM on February 3, 2021

Thought of something else I've read about: for construction loans, the contractor usually has to meet benchmarks in order to get money released to start the next stage. This effectively means the bank is helping you oversee the construction, so you have a big and putatively more experienced entity backing you up in case of conflict, which happens.

If you are paying out of pocket as far as the contractor is concerned, you might want to set up some stricter oversight or inspections along the way, and conflict resolution.

The worst case scenario here is that you spend out a bunch of money and have no collateral against it (or anything to sell to recoup the loss) other than your first house. This could happen by contractor fraud, incompetence, giant error, conflict, they sue you because they see you as deep pockets, etc., any number of ways.
posted by Dashy at 2:03 PM on February 3, 2021

Make sure that you can pay down your mortgage early if you think that is a consideration. All things being equal, I would use a mortgage to borrow money rather than a loan of another sort because, as you say, rates are low, but I would rethink that if it meant I was now paying PMI, or if I was stuck paying it off over 30 years whether or not I wanted to, and I would use a spreadsheet to factor in closing costs when I did the comparison.

Tax breaks on a primary house mortgage don't cover interest on the cash out part of a refi, I think. And I'm fairly sure they do cover the mortgage on a secondary property, but I suspect that's only if you get the mortgage at purchase time. For those points, I would talk taxes with someone a lot more qualified than me.
posted by How much is that froggie in the window at 3:31 PM on February 3, 2021

Response by poster: Thank you for the interesting and helpful replies. The second home is where I plan to retire to in 5 years or so. I have very stable income and a partner with the same sharing the costs with me. We can afford to carry both, we'll feel rich when we sell the first house (after we retire and kids leave).

I don't read any terrible downsides that affect me. I think I will take as much equity as I reasonably can without penalties or needing PMI. I can not get a lower rate than this, I will be needing the money and this is a fairly painless way to get it. If I go the traditional route of a constrution loan that then needs to be rolled into another conventional loan in say 2 years who knows where rates will be. They could be triple what they are now.
posted by Patapsco Mike at 5:22 PM on February 3, 2021