I financed a home for a couple a few years ago in an area near San Antonio, TX. Yesterday I received a call from them asking about a mortgage to buy some land near a lake where they would one day build a cabin. I told them they didn't want my money, and sent them on their way.

Why didn't I immediately take a loan application for a lot and construction loan? More money for me, right? Easy. They didn't need it. But let me explain.

When they bought their first home, they put about 40% down, so right out of the gate they had some really decent equity in their property. In addition, their home value has nearly doubled in four years time. That's a lot of equity. In this case, about $600,000 in equity, which I suggested they use instead of a loan to buy an undeveloped lot.

I've seen this on more than one occasion where clients simply look right past their biggest asset when exploring financing options and zoom right toward construction loans, lot loans or loans to buy a ski condo. Rates for properties other than a primary residence are not only higher, but they also require a minimum down payment. When you have some equity in your home, look there first for financing. And you usually have two distinct options.

A straight equity loan will typically be a second mortgage, assuming there's a first mortgage already in place. Second mortgages will have a slightly higher rate than a first, but not by much. And many times there are few, if any, closing fees associated with second mortgages. My client in San Antonio simply took out a 15-year fixed equity second with his Credit Union for around 7.00%, then bought the lakefront property outright. No mortgage, no closing costs, no worries.

Another option may be to refinance the primary mortgage to a lower rate while pulling equity out of the home in one single swoop, called a cash out refinance. It's fairly easy to decide which method works best. If the new monthly payment on a cash out refinance is lower than just adding the payment for a new second, then a cash out refinance may be your best bet.

Note that closing costs are usually much higher when refinancing a first mortgage when compared to obtaining an equity second. But just a few minutes running the numbers on both should point you into the right direction.

Published: February 22, 2002

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