By Richard Montgomery
Reader Question: Soon we will begin a remodel on a house on our friend’s property. There are the main home and this second house on the lot. Our intention is to sell our existing home and have the second house become our permanent home in the coming months.
We are in unchartered waters about proceeding to obtain a personal loan to pay for the remodel. Other than our home mortgage, we are entirely debt free but with inadequate savings to pay for the remodel. The loan will be repaid straight away using the profit gleaned from the sale of our existing home. We anticipate about $75,000 upon the sale, and we will be requesting a remodeling loan of about $50,000. We live on the east coast and lenders are plentiful. In your opinion, what is the best and fastest way to get through this process?
Monty’s Answer: Your ability to finance the remodeling of your friends guest house will be dependent upon other assets you own that can be converted quickly to cash. You should be prepared to pledge such assets against any loan. Because you are inquiring about a personal loan, you are already aware a traditional real estate mortgage lender will have no property to secure a loan, and therefore, be unable to grant a loan. A commercial banker should be your first call. Preferably, someone who works at the institution you have banked with for years. It will help if you have a relationship there.
Also, there is a difference between “liquid savings” and “total assets.” If you own ample property such as a pension, IRA’s or other instruments, sometimes they can be borrowed against as collateral. Many people do not realize one can borrow money from some IRA’s for short periods of time without penalty, closing costs, and minimal interest. If you borrow from your IRA, your accountant can confirm the IRS guidelines.
I expect you will find a commercial bank as a source for the type of loan you are seeking, but the process does not change. Here is a link to an article on the Dear Monty website titled “How to find the right mortgage” you may find helpful. Be aware that a commercial lender making a personal loan may be subject to different requirements than a mortgage lender.
Will a lender throw a wrench in the deal?
In reviewing the plan you are contemplating, your message is silent on the arrangement with your friend. If you and your husband are investing $50,000 to improve your friend’s property in exchange for a “life estate” this method may raise other questions. For example, what will happen if the day after you move into your newly remodeled abode on your friend’s property, and your friend is stricken, and passes away? Is there a written agreement?
If a commercial lender believes providing the funds to you is not in your best interest, they will shy away from granting a loan. Without knowing the details of what has transpired, there are many ways your move could result in unintended consequences. The lender may require a copy of the document that describes the terms of the arrangement. If there is no document, they may need a record created and approved by your accountant or attorney.
Dear Monty receives many questions about issues that involve real estate where the parties were friends, neighbors or relatives and they did not feel a written agreement was necessary. The best way to stay on good terms with a friend when the subject is real estate is to put the arrangement in writing.
An alternate approach
Check out this article titled “Evaluating the risk of owning two homes” which is a discussion on buying before you sell, or selling before you buy. In your case it could be titled “Selling before you invest.” It may be less complicated to sell your current home to raise the money for the remodel, and rent the house back for a year, with a provision to cancel the lease after six months. You may also find a month-to-month rental if the buyer wants occupancy. This provision is to protect you in the event the remodel takes longer than expected, which is common. Another common occurrence with a remodel is the costs are often higher than projected. It is unclear if you have sufficient assets to withstand cost overruns, but it may be wise to consider a conservative scenario.
“Richard Montgomery gives no nonsense real estate advice to readers most pressing questions. He is a real estate industry veteran who has championed industry reform for over a quarter century. Send him questions at DearMonty.com.”