When I have a chance, I listen to the Ray Lucia Show on Bloomberg AM radio, which is a call-in show for people to ask questions on financial investment strategies. One call struck my interest, so I want to share it with you as well and give you an example of how I compare scenarios and loan structuring.
An Arizona resident called in with the following situation: He owns a $400,000 home and carries a $100,000 1st mortgage. He also has a $250,000 equityline on that home with zero balance. He wants to purchase a condo in his same town for $200,000 and asked Ray Lucia if he should take a mortgage on that investment property or if he should draw on his equityline to buy the condo, treating it as an “all-cash purchase.” By doing so, he would own the condo “free and clear” of any liens, but would increase his primary home’s payments and liability.
From my professional standpoint, I would think this through by comparing interest rates, monthly payments and advantages/disadvantages to both options. Let’s take a look:
1st option: Drawing from his primary home’s equityline.
Equityline: Currently Prime + 0% (4.50%). At a $200,000 Interest-Only payment, his monthly payment would be: $750.00
Advantages:
- Low monthly payment
- No additional closing costs
- Able to close escrow on the purchase within a few short days
Disadvantages:
- Equitylines are adjustable and the interest rate and monthly payment is dependent on what Prime Rate is, so he will definitely assume risk on adjustments.
2nd option: Taking out a mortgage on the Investment Property.
Based on today’s rates, the rate would roughly be 7.5% (APR: 7.638%). He would still be required to put a down payment on the property, so he may have to draw from his equityline for this.
Advantages:
- Secure Interest Rate fixed for the life of the loan (If Prime increases to above 7.5% (which it will), then he’ll end up saving interest over the long term).
- Forced to pay down on the loan’s principle.
Disadvantages:
- Must pay closing costs for the loan
- Higher monthly payment in the short-term
- Longer Close of Escrow time since the loan must go through lender review.
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But here’s the really valuable thing that Ray Lucia mentioned that not many people would consider:
If there’s no mortgage on the investment property, there’s no one to share the risk to getting sued or of something happening with the property. When a bank has an interest in a property, they share that liability with you, so it may serve you better to carry that mortgage as a protection of your investment.
You’ll end up on top if you consider and weigh different loan structuring options, but you’ll benefit even more so from thinking everything through, including legalities. This is why it’s important to have a team of professionals working for you. Not every realtor or mortgage broker will think about your liability as an investment property owner, but your estate planning attorney or financial advisor just might.
