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Financing an income property

Dr. Don TaylorDear Dr. Don,
I am thinking of buying some rental property. I plan on using the equity from our existing home to do this. I still have an existing first mortgage of approximately $35,000 and the home is worth around $175,000. Is it wise to take the equity and purchase another property or should I take out a fixed rate mortgage on the new rental property? The price of the rental property is $92,000, which would be paid in full. -- Pat Porter

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Dear Pat,
Don't expect any infomercials from Dr. Don any time soon on building a real estate empire. Not that there's anything wrong with building a real estate empire -- it's just the infomercial market is too saturated to have room for another player.

Step back and ask yourself what the goal is after you acquire this property. Are you looking to continue to acquire rental property, or is this a one-time purchase? If you're looking to buy multiple properties then you want to use the equity in your current home just to make a down payment on the current acquisition and take out a first mortgage on the rental property for the balance. That way you've kept funds in reserve to make a down payment on the next property.

If this is a one-shot deal, then you want to consider the costs between holding a first mortgage on the rental property and either a second mortgage or cash-out refinancing on your current home. Compare closing costs, interest rates and total interest expense with the three options. A Bankrate feature has more on financing real estate investments.

Before you purchase this property, put together a business plan to estimate the cash flows associated with the property, including management, maintenance and upkeep. Owners often underestimate the costs associated with rental property. Are you counting on appreciating real estate prices to earn a return on the investment or will the rental income generate a positive cash flow?

Finally, run all this by your accountant. He or she can help you structure the transaction and management of the rental property to maximize the tax benefits from this new venture.

-- Posted: March 18, 2005




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