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Using equity to buy a second property

Dear Money Matters,
I own a condo that has appreciated in value. I'd like to purchase a townhouse to use as my primary residence and retain the condo as rental property. As part of the down payment for the townhouse, I wanted to draw against the some of the equity and appreciated value in my condo. What options would I have to acquire the funds I want?

Dear John,
On the surface, this may seem an attractive strategy for getting yourself into a new townhouse. The way this would work most effectively for you is if you happen to own the condo outright. Then, you could take out a home equity loan or line of credit and use those available funds as down payment on the new townhouse.

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Unfortunately, if I can read a bit into your comments, that doesn't seem to be the case, since you say you want to tap into the appreciated value of the condo (rather than saying that you own it and it's worth X amount). If that's the case, I would urge you to be cautious because you could structure a pattern of loans that may be prohibitively expensive.

Here's how I see things in a nutshell -- you have a mortgage on the condo and you take out a home equity loan or line of credit to put down toward the townhouse. From there, unless your equity in the condo is enough to cover the entire price of the townhouse, you're going to have to take out a mortgage to cover the remainder of the townhouse's purchase price.

With this scenario, you end up with three different loans instead of one. That can pose a number of problems.

First, of course, you have to make payments on all three, and that may be something you may not be comfortable with.

Secondly, paying the mortgage and the home equity loan or line of credit on the condo will depend on how easily you can rent it out and at what price. I would check on condo rental patterns where you live and see how quickly condos are generally rented and what their going rent might be. If you live in a city where it's hard to rent condos -- and there are areas where that's the case -- you may end up paying your condo expenses out of your own pocket. At the very least, you'll have to cover the condo's mortgage and home equity loan while you try to rent it or if it goes unoccupied for a while between tenants.

Another issue is whether you'll be able to get a mortgage for the townhouse you want to buy. I don't know the specifics of your finances, but carrying three separate -- and significant -- loans may be a higher debt ratio than many lenders will embrace. One thing you may wish to do is contact a bank or savings and loan and run your situation by them. That should give you a feel for how receptive they may be if you decide to move ahead with your plans.

I would urge you to assess the picture very carefully from your standpoint and that of a lender. It may work, but it also may be just too top-heavy from the obligation you'll be taking on.

Finally, ask yourself honestly if you want to be a landlord and the headaches that can entail. If you don't mind the notion of running over to the condo at 2 a.m. with a plumber's wrench in hand, that's fine. If not, you may want to back off for a while. You can always put management of the condo into someone else's hands, but that just adds another layer of financial burden to the picture.

-- Updated: April 1, 2002


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