Stick to my current plan, or is a second mortgage a better route?

[Grodinsm]

Hi there, new to the forum and haven't found much talk about this topic so I figured I'd ask.



As a bit of a background, I've got a rental in Hamilton that I bought 2 years ago with a nice sized down payment (60k). I've been doing a lot of research lately and am getting ready to start looking for property #2. My current property has good cash flow but after all of the research I've been reading, I could do much better with my money and other properties, so I'm going to be listing it for sale soon. Property pricing in the area has positioned me to walk away with $82-100k after all of the expenses (realtor fees, mortgage cancellation, etc...). That cash range obviously is dependent on what it actually sells for, I wouldn't let it go for less than the 82k profit mark.



Once it's sold, I'd take the money plus cash I currently have and look to buy 1-2 other properties with better cash flow and better ROI.



What I'm wondering is if my current plan makes sense, or if it's common practice in this type of situation to take out a second mortgage on the property to leverage the invested capital, market value and cash flow to use as a down payment on a second property with the additional cash I have on hand.



I see the idea of 2nd mortgages thrown around a lot, but nobody has really posted something on the best strategies of using them.



Your input is greatly appreciated!



Stu

 

[mortgageman]

I have several thoughts for you:



1. If you sell you will trigger many hard costs you have mentioned (realtor fees, legal fees, etc.) as well as a capital gains tax liability which you haven't mentioned.



2. If you add a second mortgage you may find that while the interest rate, lender fee and broker fee can be significant, the overall long-term cost is lower than selling. That being said the cash flow will be lower than it currently is and potentially lower (or higher) than buying two new properties. It may or may not impact your ability to qualify for a mortgage on a new property.



3. You may or may not have difficulty finding a lender to do the second mortgage, depending on the loan to value on the property.



4. If you have a collateral mortgage as the existing mortgage you're not going to be able to put a second mortgage on the property as any lender in second position can see their security disappear if the first lender decided to increase the amount they'll let you borrow.



5. It's usually better to take a second mortgage to access equity than it is to sell a position in your existing property to access more equity.

 

[Sherilynn]

What about a home equity line of credit (HELOC) against the property? Some banks won't do these on rental properties, but you don't need the HELOC with the same bank as the mortgage.



HELOC's have great interest rates and you only pay interest on what you use. Plus they are acceptable forms of down payment.

 

[Thomas Beyer]

Real estate is a long term wealth creation scheme - like a three course meal - by allowing you to tap into THREE profit centers:

a) cash-flow (appetizer)

b) mortgage paydown (main course), and

c) equity appreciation through inflation and value improvements (dessert)



Thus, to build sustainable growing wealth you need more properties that all cash-flow and allow you to tap into all three, but primarily the second one.



Rather look at refinance options up to 80% LTV, or re-advanceable LOC behind the first at prime + 1 !



Selling an asset incurs costs: realtor fees, lawyers, taxes and: no more upside or tapping into those profit centers. A re-finance has only minor appraisal and legal fees - and no taxes - and you still own the asset.



Second mortgages (at 8% or far higher often) are NOT a good idea if
you can get first mortgages at sub 3%, seriously eroding cash-flow and
asset accumulation options ! A second mortgage should ONLY be used
short-term, say for property upgrades, or a short term flip, or as a
bridge between two events a few months apart - maybe 12 months max.

 

[invst4profit]

You do not state it in your post but I assume your Hamilton rental is a single family home. I am not a fan of single family properties as rentals as they generally have very poor positive cash flow unless large amounts of equity are tied up in the property. Single family rentals also generally attract families, with destructive kids and pets, which are far more ware and tear on a property than individuals or adult couples.



For this reason I would advise you definitely sell the property and invest in a multi unit. Safer income security and better positive cash flow when purchased right.



You would definitely incur costs to make the move but in my opinion you would be far better off in the long term investing in multi units than holding single family rentals.

 

[Grodinsm]

Wow guys, thanks for all of the quick feedback! I knew I came to the right place.



Lets see if I can clear up a few questions and explain my situation a bit better. First of all, I didn't realize you could get a HELOC on top of the mortgage, I thought I would have to break the mortgage and re-mortgage it as a line of credit mortgage and no longer have my interest rate locked down. Great to know I can get the HELOC on the 80% LTV separately, that would unlock a nice chunk of capital. Is the HELOC LTV based on the current mortgage and purchase price or can the house be re-assessed to market value?



MortgageMan, I did account for Capital Gains but forgot to mention it, thanks. From what I gathered from your response using a 2nd mortgage vs. selling is a mixed bag and it all depends on what the banks will allow me to do and what the numbers are on the new property.



My house is a student rental actually, so it has good cash flow thanks to all of the students, but yes there is some damage from that and much higher turnover. The reason I'm considering selling the house is that while it's got decent cash flow and is actually a nice house, there are certain things I can't correct about the house that are making it much harder to rent out to the type of students that I want to be renting to... and so I end up having to grab all of the last-minute house hunters that have no other choice because everything else that's left out there is slummy.



That being said if it doesn't sell, I'll be sitting with a good cash flowing property that I'd like to leverage to get a second property, which is why I'm asking for your advice!

 

[Sherilynn]

The LTV rules have recently changed for HELOC's. I believe the major banks can only offer a 65% LTV, but credit unions don't have the same restrictions and some are still offering 75% or 80% LTV.

 

[mortgageman]

If you only have a HELOC on your property then the maximum loan to value under the new rules is 65 LTV.

You can still go to 80 per cent LTV but 15 per cent of that must be in an amortizing mortgage.

So as an example on a $100,000 property you can have a mortgage/line of credit combination for $80,000. At least $15,000 has to be in the mortgage component. If it was just a HELOC then the maximum you could borrow would be $65,000. It used to be $80,000.

With regards to whether or not you should consider a second mortgage, Thomas is right, they're usually best for extremely short-term solutions. It's an option that may or may not be worthwhile.

I'd need to know more specific information regarding the existing mortgage, loan to value, pay out penalties, etc before I could give an opinion on what your best course of action would be.

If you'd like you can email me at [email protected] and I'll give you a better, more specific answer.

 

[mortgageman]

Sherilyn, you're correct there are still a couple of credit union lenders that can do 80 LTV on a HELOC as they don't fall under the banking rules that has impacted charted banks.

 

[yys2000]

Great Post! Thomas

 

[Thomas Beyer]

[quote user=Grodinsm]I'll be sitting with a good cash flowing property
to achieve wealth you must repeat what works and abort what didn't !



What is better than sitting on one cash-flowing property ?



a) 2

b) 5

c) 25

d) ...

 

[Grodinsm]

The answer is always C!



The one thing I am still wondering is about the home value used for the HELOC, is there an appraisal done on the house when I apply for a HELOC or is it the original purchase price (since it was less than 2 years ago)? If it's an appraisal, how likely are they to appraise it anywhere near what my realtor wants to list it for?

 

[bizaro86]

I've gotten appraisals 50 percent more than my purchase price within 2 years, but they were on properties where I had done a bunch of work, and were still far below what I would list for if I were to sell. They are generally conservative.

 

[Sherilynn]

Most likely they will want an appraisal. Too much can change in 2 years. (Or two months, depending on the timing and location.)



In this situation, the job of a bank appraiser is to determine the most that the bank could be practically guaranteed to sell the place for within 2 - 3 months. The appraiser basically stakes his reputation on it. So to answer your question, it likely won't be anywhere close to the true market value, let alone what your realtor may list it for.

 

[flanabum]

Hi Stu,

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Susan Flanagan , PSP
Franchise Operator- Hamilton
www.PropertyGuys.com
Sell your House, Pay yourself Visit us at Facebook
289-426-5555
[email protected]

 

[Grodinsm]

I've done some work to improve the value/condition of the house but nothing substantial enough to warrant a huge increase like your 50%!



Sherilynn thanks for your input, that's what I was afraid of but since I've never reassessed a home for a refinance I needed to ask. that reaffirms my decision to sell the house and start on a new venture.



You guys are a great resource, thanks for your help with all of this.