HELOC to finance construction of 2nd residence

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Topic Author
Prov227
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Joined: Thu Apr 03, 2014 11:13 pm
Location: Milwaukee, WI

HELOC to finance construction of 2nd residence

Post by Prov227 »

Does using a HELOC for the following purpose and situation seem sound? We live in WI and about a year ago bought 20 acres in TN. We will soon begin construction on a small residence to serve as a snowbird retreat and a bridge to permanently relocating in 1-2 years. (We intend to build a larger "forever" home elsewhere on the property in 3-4 years.)

WI Home: $550K value, $0 owed
TN Land: $340K value, $265K owed

Cash: $30K
Taxable: $35K (all LTCG)

The residence we are building is a metal siding & roof "shouse" or "barndominium" style. Per initial quotes, we expect the exterior shell to cost $80K. This includes siding, roof, windows, exterior doors, and interior rough framing. We are estimating another $80K or so for interior build out. We might go slower in the interior build-out stage to lessen the borrowing.

Discussing borrowing options with the lender who handled our land mortgage, I balked a bit at the interest rate (6.25% -ish) and the overall process for a construction loan. Particularly this instituion's format, a single-closing type that requires principal+interest repayment on disbursed amounts from the very beginning. I know interest-only options are available out there, but we got to thinking that a HELOC could be a better alternative.

I think we can get a more favorable rate* with a HELOC and be more in control of when to use it, how much to borrow vs cashflow, and when to start paying back principal. (*Third Federal showed a rate of 4.74% APR when I entered in my information.) Probably with fewer hoops to jump through than a construction loan?

By dipping into our current cash + incoming cash flow, and the taxable account, to put towards the build, we'd intend to keep the HELOC balance < $100K. We'll likely sell our WI home within 12 months or so, paying off the HELOC at that time and clearing ~$450K to contribute to paying down the TN land mortgage and development of the "forever" home.
"...and the borrower is slave to the lender." -Proverbs 22:7
123
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Re: HELOC to finance construction of 2nd residence

Post by 123 »

Prov227 wrote: Sun Aug 07, 2022 5:49 pm ... We'll likely sell our WI home within 12 months or so...
The sale proceeds from the WI home seem to be the riskiest element of your plan since a sale is not imminent. Depending on the direction of the economy (particularly in the local area of the WI home) and mortgage rates available to borrowers the selling price of the WI home could decline considerably. If housing prices were to decline by 1/3 would you still sell the WI home on the same timetable (perhaps forced to sell)? While housing price recoveries in some areas have taken 3 to 10 years (if ever) in the past it's an unknown. How long could you handle a stale housing market for the WI home while covering the costs of the TN loan?
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Admiral
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Re: HELOC to finance construction of 2nd residence

Post by Admiral »

Did you look into a 401k loan? Depending on balances and when you will actually need the money (in terms of retirement) this could be another option. Only if you have stable job(s), however. And of course this won't provide you with all the money you need.
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beernutz
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Re: HELOC to finance construction of 2nd residence

Post by beernutz »

Have you considered buying an RV of some type and building a structure to park it under? You could do both for a lot less and a lot quicker than building a new home which you aren't going to live in after 3-4 years.

That said, we're planning on building a forever house on some riverfront land we own and in preparation I obtained a HELOC on our other house. We will probably start construction in 2023 and our plan is to use the HELOC and other assets to finance construction and then sell our other house to pay off the HELOC balance and, hopefully, not have a mortgage on the new house.

Of course a lot of things could go sideways causing that plan to change so we're flexible.
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Topic Author
Prov227
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Location: Milwaukee, WI

Re: HELOC to finance construction of 2nd residence

Post by Prov227 »

123 wrote: Sun Aug 07, 2022 10:47 pm
Prov227 wrote: Sun Aug 07, 2022 5:49 pm ... We'll likely sell our WI home within 12 months or so...
The sale proceeds from the WI home seem to be the riskiest element of your plan since a sale is not imminent. Depending on the direction of the economy (particularly in the local area of the WI home) and mortgage rates available to borrowers the selling price of the WI home could decline considerably. If housing prices were to decline by 1/3 would you still sell the WI home on the same timetable (perhaps forced to sell)? While housing price recoveries in some areas have taken 3 to 10 years (if ever) in the past it's an unknown. How long could you handle a stale housing market for the WI home while covering the costs of the TN loan?
Definitely agree with the above concerns. I do think we have a fair amount of tolerance for selling lower, but if the slide were 30% down from peak, it's hard to say.

That said, specific to evaluating potential methods of financing construction for this 2nd residence, wouldn't we be no worse off -- maybe even better off? -- having done the HELOC vs a separate construction loan? Seems like the HELOC would give us more freedom to be flexible.
"...and the borrower is slave to the lender." -Proverbs 22:7
Topic Author
Prov227
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Location: Milwaukee, WI

Re: HELOC to finance construction of 2nd residence

Post by Prov227 »

Admiral wrote: Mon Aug 08, 2022 6:12 am Did you look into a 401k loan? Depending on balances and when you will actually need the money (in terms of retirement) this could be another option. Only if you have stable job(s), however. And of course this won't provide you with all the money you need.
I did some light reading and research about 401(k) loans. My takeaway left me very reluctant to miss out on investment gains by taking funds out of the market at this time, while also having some nervousness about something happening to prompt immediate repayment.

I'm definitely open to hearing more pros/cons and considering this option as a supplement to the plan, though.

DW & I have a combined $350K in 401(k). (And another $200K in Roth IRA.) Jobs are stable, I've been with the same firm for 20 years. We are in early 40s, so lots of time before potential withdrawals at age 59 1/2.
"...and the borrower is slave to the lender." -Proverbs 22:7
Topic Author
Prov227
Posts: 77
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Location: Milwaukee, WI

Re: HELOC to finance construction of 2nd residence

Post by Prov227 »

beernutz wrote: Mon Aug 08, 2022 10:34 am Have you considered buying an RV of some type and building a structure to park it under? You could do both for a lot less and a lot quicker than building a new home which you aren't going to live in after 3-4 years.

That said, we're planning on building a forever house on some riverfront land we own and in preparation I obtained a HELOC on our other house. We will probably start construction in 2023 and our plan is to use the HELOC and other assets to finance construction and then sell our other house to pay off the HELOC balance and, hopefully, not have a mortgage on the new house.

Of course a lot of things could go sideways causing that plan to change so we're flexible.
We've definitely talked through alternative living arrangements, but have reached a pretty definitive conclusion that our preference is building this small place and then having it available for rent, for AirBnb, as a guest house, as a mother-in-law suite, etc, in addition to some other long-term business plans we have in mind.

Even just 1 year living in an RV would be really challenging for us. Let alone our plan for 3+ years, and the potential that it could turn into more, as things sometimes do.

Thanks for the additional data point RE: your similar plan to leverage a HELOC on your primary while building your riverfront house.
"...and the borrower is slave to the lender." -Proverbs 22:7
Admiral
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Re: HELOC to finance construction of 2nd residence

Post by Admiral »

Prov227 wrote: Mon Aug 08, 2022 6:01 pm
Admiral wrote: Mon Aug 08, 2022 6:12 am Did you look into a 401k loan? Depending on balances and when you will actually need the money (in terms of retirement) this could be another option. Only if you have stable job(s), however. And of course this won't provide you with all the money you need.
I did some light reading and research about 401(k) loans. My takeaway left me very reluctant to miss out on investment gains by taking funds out of the market at this time, while also having some nervousness about something happening to prompt immediate repayment.

I'm definitely open to hearing more pros/cons and considering this option as a supplement to the plan, though.

DW & I have a combined $350K in 401(k). (And another $200K in Roth IRA.) Jobs are stable, I've been with the same firm for 20 years. We are in early 40s, so lots of time before potential withdrawals at age 59 1/2.
If you can repay the loan w/i a year, I think the risk to your overall retirement plan is minimal at your age. Again, this is only 50k (less than 10% of your retirement account balance) and you're paying yourself the interest (albeit with after tax dollars). This is a pretty neutral explanation of the process:

https://www.investopedia.com/articles/r ... k-loan.asp

Would I do it? No. But I also would likely not build two homes on the same land parcel, and certainly not before selling my existing home. If it were me, I would continue to save until I had enough in taxable to take a very tiny loan, and/or wait until rates dropped. I think the HELOC rate is "OK" as long as you can pay it back quickly.
Topic Author
Prov227
Posts: 77
Joined: Thu Apr 03, 2014 11:13 pm
Location: Milwaukee, WI

Re: HELOC to finance construction of 2nd residence

Post by Prov227 »

Admiral wrote: Mon Aug 08, 2022 6:28 pm This is a pretty neutral explanation of the process:
https://www.investopedia.com/articles/r ... k-loan.asp
Thanks for the link. Helpful article.
Admiral wrote: Mon Aug 08, 2022 6:28 pm Would I do it? No. But I also would likely not build two homes on the same land parcel, and certainly not before selling my existing home.
Just to avoid any misunderstanding, the plan is only to the build small place while carrying the primary home, then sell the primary, then build the new primary.
"...and the borrower is slave to the lender." -Proverbs 22:7
Admiral
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Re: HELOC to finance construction of 2nd residence

Post by Admiral »

Prov227 wrote: Tue Aug 09, 2022 11:14 pm
Admiral wrote: Mon Aug 08, 2022 6:28 pm This is a pretty neutral explanation of the process:
https://www.investopedia.com/articles/r ... k-loan.asp
Thanks for the link. Helpful article.
Admiral wrote: Mon Aug 08, 2022 6:28 pm Would I do it? No. But I also would likely not build two homes on the same land parcel, and certainly not before selling my existing home.
Just to avoid any misunderstanding, the plan is only to the build small place while carrying the primary home, then sell the primary, then build the new primary.
Right. My point was that I would not pay $200k to build a "temp" house and then build another primary house. I would wait and build one. Then, maybe when the finances are better, build a second to rent out. You need to account for overage costs as well. At least 20%, from everyone I've spoken to (as well as my own recent experience) involved in renos and home building projects.

You could also sell your home first and then rent for a year as your new primary is built, which will be a lot cheaper than $200k.
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