How-to Monday: Renting vs. selling, part II (financing)
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So you're buying a new house but thinking about renting out your current place rather than selling it. Naturally you've read last week's How-to post, so you have some food for thought about the joys and headaches of becoming a landlord. But how are you going to finance your move if all your equity is tied up in your old home?
You could always cover your down payment with the tens of thousands of dollars you squirreled away for just such an occasion. What? You haven't squirreled away tens of thousands of dollars? You average American, you.
That leaves you with mortgage options.
I posed the question to two people in the business -- Michael C. Parsons, president of Nationwide Home Mortgage in Rockville, and Laura Randall, principal of Baltimore-based World Capital Lending. Both suggested a home equity line of credit or a home equity loan.
Parsons notes that both require that you have enough equity in your current residence to borrow against and also that you have enough income to qualify. You can borrow up to 90 percent of the value of your current home, he said.
Parsons offers this example: Say your house, the one you're planning on renting out, is worth $200,000 and you owe $100,000 on the mortgage. You can borrow an additional $80,000 against that value -- a total of $180,000 in mortgage debt, or 90 percent of the house's value. That $80,000 is enough for a 20 percent down payment if you're moving up to a place worth twice as much as your current home.
Home equity lines of credit are generally variable-rate, which means the interest rate you pay can change whenever the rate your line of credit is indexed to -- usually the prime rate -- changes. You begin paying interest once you actually borrow against the line of credit, not when you sign the paperwork giving you access to it. Most banks will also eat the closing costs rather than passing them along to you as they would with a regular mortgage, Randall said. Bankrate.com's loan survey last week found that the average rate for lines-of-credit was about 7.6 percent.
Home equity loans are generally fixed-rate and look like a typical mortgage (in contrast to home equity lines of credit, which are often compared with credit cards). The average rate was about 8 percent last week, according to Bankrate.com.
What about a bridge loan, you say? This type of product typically lasts only six months and then comes due. "It's more or less a balloon note," Parsons said. It's a tool for someone buying a new home who wants to sell, not rent, their old one.
So: what to do? As always when lots of money is involved, you'll want to proceed with caution -- hence the yellow traffic light at the top of this post.
The thing to consider is this: Are you confident you can juggle three mortgages at once (two on your old home and one on your new)? Be especially wary if you're counting on good rental income to make the numbers work.
"You can't be reckless about decisions with real estate because there are predictions that there's not going to be another increase in equity for five to 10 years after the market bottoms out," said Randall, a real estate investor whose brokerage firm works primarily with other investors. "So real estate's not liquid, and you don't want to be stuck in a position where you're struggling to make ends meet."
If you go the landlord route, she warns, be sure to have money set aside for vacancies and unexpected expenses. "I just wouldn't suggest that people do this on a shoestring," she said.
One thing to remember about Maryland is that the homestead tax credit, that cap on property tax increases you get as a homeowner, does not apply when you're no longer an owner-occupier.
Holden Lewis, who follows mortgage issues for Bankrate.com, says this can all get so very complicated that a homeowner might want to sit down with a financial adviser to think through the implications -- income taxes, for a start.
If all this sounds headache-inducing rather than invigorating, there's another option: You could rent a new place while renting out your old one to someone else. Lewis recommends renting first in any case when you move to a new area.
"If you're leaving for a new job, you can't be sure if it's going to last forever," Lewis said. "You need to test it out. And also, you just want ... to live there for a while and find out where you want to buy."
There's nothing like being both a landlord and a tenant for a cocktail party conversation-starter.
Got other tips on this subject -- or questions you'd like to see answered here? You know the drill: Comment below or drop me a line.