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Mortgage  Question?
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Should I sell my home or use it as rental property?

I own a condo worth $90,000 with a $60,000 mortgage balance? Should I sell the condo and buy a new home or pay off the mortgage in two years, use it as a rental property and buy a new home then? Or should I take out a home equity loan on the condo and use that for the down payment on a new home?

Michael Jensen, Mortgage and Finance Guru
, Mortgage and Finance Guru

The answer to your question depends on your personal and financial objectives. If your first priority is to buy a more valuable home in the near term then our recommendation is that you sell your condo and apply the proceeds and your savings to the purchase of a new home. Selling your condo and buying a new home now enables you to take advantage of the equity you have in your current property and lock-in a new mortgage at current low interest rates. Mortgage rates hit a three-year low following the Brexit vote in late June and although it is impossible to predict how interest rates will change, it is more probable than not that rates will be higher in the future.

If your overall goal is to develop a portfolio of investment properties that generate rental income then you should consider using a portion of your savings to pay down part of the mortgage balance on your condo. Additionally, if you are able to pay off the condo mortgage balance in full within two years then the property could generate meaningful cash flow for you depending on other housing expenses such as property taxes, homeowners insurance and HOA / co-op fees (if applicable).

Please note that there are a couple of points to keep in mind about rental property income. First, lenders typically require that borrowers demonstrate two years of rental property income, as verified by the borrower's tax returns, before the lender gives the borrower credit for that rental income on a mortgage application. So it may take some time before you benefit from rental income from the condo when you apply for a mortgage to buy another property. Additionally, any monthly losses attributable to the rental property are deducted from the borrower income to determine the borrower's ability to qualify for mortgage. For example, if you earn $4,000 in monthly gross income and own a rental property that generates $500 in monthly losses then the lender uses $3,500 in monthly gross income to determine what size mortgage you can afford. You can use our Mortgage Qualification Calculator to determine what size mortgage you can afford based on various monthly gross income and debt levels.

You also asked about taking out a home equity loan or HELOC on your current property to pay for the down payment on your new home. While this may be a feasible financing option, it creates a couple of challenges. First, you will likely be limited to a combined loan-to-value (CLTV) ratio of 80% - 90% based on your existing first mortgage balance and the amount of the home equity loan or line of credit. The CLTV ratio represents the ratio of the total loan amounts on a property to the current fair market value of the property. For example, if your condo is valued at $90,000 and the lender applies a maximum CLTV ratio of 80%, this means that your home equity loan or line would be a maximum of $12,000 ($90,000 * 80% CLTV ratio = $72,000 // $72,000 - $60,000 mortgage balance = $12,000 home equity loan or line). The CLTV limit means that you have less proceeds that you can apply to the purchase of a new home, as compared to selling your condo and using all of your current equity, instead of only part of it, to buy a new home. The other issue is that taking out a home equity loan or line of credit means that you incur additional interest expense which potentially makes it more challenging for you to qualify for a new mortgage to buy another home. Plus you still need two years of history for the lender to include any rental income from the condo when you apply for a new mortgage.

In short, your financial objectives will dictate the mortgage option that is right for you.

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About the author

Michael Jensen, Mortgage and Finance Guru

Michael is the co-founder of FREEandCLEAR. Michael possesses extensive knowledge about mortgages and finance and has been writing about mortgages for nearly a decade. His work has been featured in leading national and industry publications. More about Michael

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