Create Own Mortgage to Finance Property

QUESTION: My husband and I own our home and have about $50,000 equity in it. At our ages (40 and 46), we realize we should have started investing in real estate years ago. Our banker suggested we take out a $35,000 home-equity loan to use as our down payment on rental property. But the variable interest rate at 2.5% over the prime rate scares us. We don’t want to sell our home, but all the refinancing alternatives seem so expensive. Any ideas?

ANSWER: Forget those high cost home-equity loans. Create your own second mortgage on terms you can handle, such as a 9% interest rate.

When you find a property you want to buy, offer your created mortgage on your home as your down payment. Not every seller will accept such an offer, but a seller who doesn’t need much cash will accept it.

People often ask me how such a mortgage is physically created. The first step is to make a written purchase offer for the property you want to acquire. For example, just put in the offer that your down payment is to be a $35,000 second mortgage secured by your residence, payable at 9% interest only for 10 years with a $262.50 monthly payment.

Even if the property seller counteroffers at 10% interest, you will have saved yourself loan costs and the higher interest rate charged by most lenders.

Trade Mortgage as Part of Down Payment Q: About six years ago, we sold our home and took back a second mortgage. It has nine years left to go and the borrowers make their payments on time every month. The balance is now about $32,000 but the interest rate is only 8.75%. I tried to sell this mortgage but the best I can get for it is $26,000. As I would like to buy a rental house, how can I sell this mortgage for $32,000 so I can use the money for a down payment?

A: That’s easy. Don’t sell your mortgage at a discount. Instead, trade it as all or part of your down payment for the rental house you want to acquire. Many property sellers will gladly take a seasoned mortgage like yours at full face value without any discount. However, you may have to sweeten your down payment offer with a little cash to pay the realty agent’s sales commission.

No Tax Due When If Converted to a Rental Q: My tenant is vacating a home I have rented to her for several years. If I move into the house and make it my personal residence how will I figure my tax? A: A tax is not due when converting property from rental to personal use status, or vice versa. Since there is no sale, no tax is due. Please consult your tax adviser for further details.

Leverage Multiplies Real Estate Profits Q: I recently inherited about $80,000, which I want to invest in real estate. Do you think I should invest it in one rental house so I can make a large down payment, or should I buy two or three houses, each with lower down payments? A: Please understand how leverage can multiply your real estate profits. To illustrate, if you buy a $100,000 house with a $10,000 down payment and the house goes up in value $5,000 in the next 12 months you will have a 50% profit. However, if you invest $80,000 in the same house and it appreciates $5,000 in the next year, your profit is only 6%.

But the trade-off is that with high leverage your monthly mortgage payments will be higher. So you need to balance the payments you can afford with the down payment required to reduce your mortgage payments. If you can afford the negative cash flow and want to maximize your profit per dollar invested, go for maximum leverage.

Depreciate Building Without Land Costs Q: I recently bought a two-family duplex that is rented to two nice families on the Section 8 low-income housing program. Thank you for writing about that excellent program several months ago. I am very happy to receive the housing authority’s check on the first of each month and the tenants pay their share promptly too. However, I only paid a $20,000 cash down payment plus about $5,000 of closing costs for the purchase of the $225,000 building. Can I depreciate $20,000, $25,000 or $225,000 on my income tax returns?

A: None of the above. You can depreciate the value of the building but not the non-depreciable land value. One way to determine the building’s value is to use the tax assessor’s land-to-building ratio. However, if you find this ratio unfavorable, you may wish to have a professional appraisal made.