Take mortgage on primary residence to buy rental property?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
MWS
Posts: 1
Joined: Mon Apr 13, 2015 8:55 am

Take mortgage on primary residence to buy rental property?

Post by MWS »

Here is the scenario: someone has a primary residence with their mortgage fully paid off, and would like to purchase a rental property. She will be taking out a mortgage to purchase this rental property. Her two options are:
1) Taking out a mortgage on her primary residence to purchase the rental property, or
2) Taking out a mortgage directly on her rental property

The rate for the mortgage on her primary residence is lower.

Questions: If she does scenario 1...can she still expense her mortgage interest against her rental income (as long as the cash is traceable to be used to purchase the rental property)? Is there a difference in the tax treatment of the two scenarios? Or, would she deduct the interest expense as she would with a primary residence? Does it matter which home she takes the mortgage against? Pros/cons of either scenario?
Goal33
Posts: 2004
Joined: Sun Apr 12, 2015 12:30 pm

Re: Take mortgage on primary residence to buy rental propert

Post by Goal33 »

From a tax perspective, both are equivalent. I don't know about from a financial liability perspective though.
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: Take mortgage on primary residence to buy rental propert

Post by alex_686 »

For taxes, it does not matter which property is used for collateral, assuming that the loan does not exceed the house's value.

You can get a slightly better mortgage, in terms of rates, convents, etc., if you use your primary. So, slight upside here.

On the other hand, if things go south, the lien is against the primary home. Slightly more tricky, and emotionally harder, to hand the keys over to the bank.

Personally, I would lean towards getting a modest mortgage on my primary - say no more than 60% LTV. However, I have a high ability and willingness to take risk.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Dandy
Posts: 6701
Joined: Sun Apr 25, 2010 7:42 pm

Re: Take mortgage on primary residence to buy rental propert

Post by Dandy »

If things go south would she rather have her home repossessed or the rental property? That is the risk the reward is lower rate.
Lafder
Posts: 4127
Joined: Sat Aug 03, 2013 7:56 pm
Location: East of the Rio Grande

Re: Take mortgage on primary residence to buy rental propert

Post by Lafder »

I would not mortgage my home to buy a rental. Wait til you have a down payment saved, then take the mortgage on the new rental.

I know successful real estate investors who have told me they will never pay off their home, they prefer using the equity for more investments.

I want a paid for primary home. What do you want ?
lafder
User avatar
White Coat Investor
Posts: 17409
Joined: Fri Mar 02, 2007 8:11 pm
Location: Greatest Snow On Earth

Re: Take mortgage on primary residence to buy rental propert

Post by White Coat Investor »

I agree. Mathematically you won't get a better debt than a mortgage on your home. Usually tax-deductible too.

However, there is additional risk there. Certainly don't pump out as much equity as you can get in order to put the minimum down on multiple other properties. Keep the leverage reasonable and it's okay as long as you have a back-up plan if something happens to your income or your investment property value etc.

You might enjoy a book called The Value of Debt.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
ryman554
Posts: 1635
Joined: Sun Jan 12, 2014 8:44 pm

Re: Take mortgage on primary residence to buy rental propert

Post by ryman554 »

alex_686 wrote:For taxes, it does not matter which property is used for collateral, assuming that the loan does not exceed the house's value.

You can get a slightly better mortgage, in terms of rates, convents, etc., if you use your primary. So, slight upside here.

On the other hand, if things go south, the lien is against the primary home. Slightly more tricky, and emotionally harder, to hand the keys over to the bank.

Personally, I would lean towards getting a modest mortgage on my primary - say no more than 60% LTV. However, I have a high ability and willingness to take risk.
But is it equivalent?

Mortgaging primary home = itemized deduction and has $1M and/or income limits, whereas mortgaging rental = schedule E(?) and can only offset your rental income, but can carry over to next years.

Maybe it all works out in the end, but there are MAGI (for ROTH contributions) and other impacts that tend to make the mortgage on the rental more tax friendly, aren't there?
fidelio
Posts: 217
Joined: Sun May 04, 2008 5:28 pm

Re: Take mortgage on primary residence to buy rental propert

Post by fidelio »

i did something like that in executing my retirement plan, which included a rental property. i purchased a condo from a bank, in terrible shape, but in a high end building, and paid cash, obtaining the needed cash in part from implementing one of the options discussed by the op, mortgaging my almost-paid-off home and applying the cash to the purchase price of the rental. there was a lot of money, stress and sweat involved, but it all worked out eventually. i did not even consider retiring until i had the condo rehabbed and leased for some time. i also have a pension and all the other retirement goodies from a golden handshake.

however, i'm not sure i would recommend this strategy to everyone (or even anyone!). frankly, the reason it worked was that i purchased the rental with cash from a bank during the great recession. the bank didn't give it away, but it was a bargain of sorts. rehabbing it was very complex and costly, involving delayed permits, all a giant mess i won't go into here. i was a nervous wreck for a long time, and it was dumb luck on my part that the whole thing flew, but i'm ahead in the deal due to the upswing in residential property values during the past few years. note that if i had purchased a rental in good condition in a private sale, things would look very different, possibly bleak. the key is in not paying too much for the investment property, and good luck with that in the current market. there is no way a lending institution would have given a loan on this property in the condition in which i bought it, it was literally uninhabitable. in any case, overall, i would not want to own a rental unit with a mortgage on it -- just too much expense during the inevitable down times between tenants. i know some investors own many rentals, and have formulae that work (mostly involving paying cash) but that would not be an enjoyable activity for me.

one of the good things about owning income-producing real property is tax advantages that can be enjoyed (although i understand that the feds are tightening up some of the regs on this, although i think the dreaded 1031 exchange still exists), another subject for other threads, but the main thing is the positive cash flow -- steady income is the name of the game in retirement. with the monthly rental income, pension, and swr, i'm in good shape.
Johno
Posts: 1883
Joined: Sat May 24, 2014 4:14 pm

Re: Take mortgage on primary residence to buy rental propert

Post by Johno »

ryman554 wrote:
alex_686 wrote:For taxes, it does not matter which property is used for collateral, assuming that the loan does not exceed the house's value.

You can get a slightly better mortgage, in terms of rates, convents, etc., if you use your primary. So, slight upside here.

On the other hand, if things go south, the lien is against the primary home. Slightly more tricky, and emotionally harder, to hand the keys over to the bank.

Personally, I would lean towards getting a modest mortgage on my primary - say no more than 60% LTV. However, I have a high ability and willingness to take risk.
But is it equivalent?

Mortgaging primary home = itemized deduction and has $1M and/or income limits, whereas mortgaging rental = schedule E(?) and can only offset your rental income, but can carry over to next years.

Maybe it all works out in the end, but there are MAGI (for ROTH contributions) and other impacts that tend to make the mortgage on the rental more tax friendly, aren't there?
I agree the tax effect of home mortgage v. mortgage on a rental property is broadly comparable not identical. Plugging the alternatives into Turbotax (etc) and seeing what happens is a much better way of analyzing it than general qualitative statements which don't take the specifics of the individual into account. The risk of future changes to tax treatment of personal v 'business' loans might be another aspect to consider.

Another issue is recourse v non-recourse. In states where recourse mortgages are standard for owner-occupied homes, it might still be possible to get a non-recourse loan on a rental property, especially multifamily (size wasn't specified). Non-recourse loans are the only prudent way to ramp up RE investing past a property or two IMO. And I'm not sure I see the point of being a landlord without the intention to scale up at least eventually, though that's an individual judgment. Anyway, building up a series of leveraged properties, usually in the same area, where you're on the hook for the whole value of each one in the worst case is an unacceptable risk position to me. If non-recourse loans are more expensive, that's just a cost of doing the business which you either accept or don't get into the business. Also multifamily commercial type loans have typically different terms, shorter maturities, perhaps balloon, which is a potential plus/minus.

Conceivably in states where typical home mortgages are non-recourse, a bank might still be able to seek recourse on a non-owner occupied home, which would be another advantage for the owner occupied mortgage in that case. I live in a recourse state and am not familiar with that, but recourse is among the important topics for the person to consider.
Post Reply