I’m retired, but want to build my dream home. Should I take out a mortgage to pay for it?

Sincerely,

Dreaming of Delaware

‘The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.

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Dear Delaware,

I don’t want to downplay how difficult of a decision this may be for you, but I do want to start by pointing out that you’re in quite an enviable position at the moment. Many people have no choice but to rely on mortgage financing — especially when building their own home, which can be quite a costly endeavor. It’s wonderful that the proceeds from the sale of your current home will cover almost all of the projected costs of building your new home.

Because of that flexibility, this decision between paying off the loan once your home is sold or paying down the mortgage over time will largely come down to personal preference. I presented your scenario to a couple of financial advisers, both of whom stressed that there are only a couple of potential pitfalls to consider. Otherwise, it comes down to the approach you like to take with your finances and budgeting.

“If retirees are not used to paying a mortgage any more, they may not be used to mentally budgeting for this payment,” said Marco Rimassa, president and founder of Texas-based investment advisory firm CFE Financial. “Overall, both approaches could work, and a lot depends on risk tolerance and willingness to adapt to the monthly budget needs either way.”

To build on Rimassa’s point, you need to figure out what your tolerance is for having a large monthly payment on your back. And, as I’m sure you’re aware, don’t forget that the mortgage isn’t your only home-related expense. There are taxes, utilities and maintenance to consider, too.

Furthermore, determine what the goal of investing the money and keeping the mortgage would be. Do you have kids to whom you’re hoping to leave a big inheritance? Are you hoping to go on a big trip in a few years and want to earn interest on the money you make from the home’s sale?

“If they don’t need the extra growth, and don’t care to take the risk, it’s best to pay off the mortgage and be done with it,” suggested Joshua Hargrove, a financial advisor with Insight Wealth Partners, an advisory firm based in Plano, Texas. “Psychologically, that feels much better to most people than investing the money does.”

A few things to keep in mind when determining your exact course of action. For starters, you should think twice before withdrawing money from your IRA during this process, and instead should rely on other savings at your disposal. Unless you have a Roth IRA, withdrawals will be taxable. “That may be more costly than the little bit of interest they’ll pay on the construction loan,” Hargrove warned.

If you anticipate only needing the construction loan for a short period of time, you might want to consider an interest-only loan. With this type of loan, you’re not paying down the principal when you make monthly payments. Instead, you’re just paying what would be the interest portion of a monthly mortgage payment. As a result, the monthly payment is lower usually.

“Many construction loans are structured this way,” Hargrove said. “Once finished, you refinance it into a conventional loan. The land value serves as the down payment so little to no cash is required at close. Once the old house gets sold, use the proceeds to pay off the new mortgage.”

Keep in mind though, interest-only loans typically carry adjustable-rates, and mortgage rates are on the up. So the rate you pay at the start may go up over time.

If you decide to go the mortgage route and invest the money you earn from your current home’s sale, you might want to consider a shorter term such as 15 years, rather than a 30-year loan. The monthly payments would be higher, but you would be debt-free more quickly. That could come in handy later into your retirement, particularly if your health worsens and you need to free up your monthly budget to account for increased medical costs.

Finally, be sure to consider the rising cost of home-building in the choices you make. Labor and building materials are in short supply, making building new homes a longer and more expensive process. I wouldn’t want you to be caught off-guard by higher costs along the way.

Whatever choice you make, I hope that you get plenty of enjoyment out of your new home and wish you the best of luck.

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