To be Free & Clear or not?

Question

Here is the situation...I am purchasing two properties. Total between them is $183K. The seller doesnt care how i split up the purchase prices. So it got me thinking, the one property has a likelihood to appraise for the entire $183K.

Does it make sense for me to split the purchase up to $183K for one house and the other for only a $1?

Pros:

I get to pull one HELOC for 75% of the 2nd house and propagate to purchase more houses!

I get a lower interest rate

I save money by only doing one closing

Cons:

When i sell the property I will owe alot of capital gains (but is it worth it??)

Other facts

The brokers that i came across have a minimum loan amount (85K)

If loan is less than 85K I would be forced to pay out of pocket OR get a loan at a higher rate (~1.5% higher)

Thoughts??? I would like to put the contract in place today!!! Been working on a verbal for a while.

Thanks

Dave Toelkes · Answer

@Dave Saveri

If the total purchase price is $183K, most conventional lenders will only loan you up to 80% of the appraised value or purchase price (whichever is less). So, for your purchase, you might expect the lender to loan up to $146,400 to finance your purchase.

If you are planning to use a HELOC on the rental properties as a source of cash to purchase another property, then consider that the total of the HELOC and any underlying loan balance can usually not exceed 75% of the appraised value of the property.  Some lenders may go to 80% on a primary residence HELOC.  Even so, your debt/income ratio will determine the viability of this strategy.

Dave S. · Answer

@Dave Toelkes

Calculations based on your above assessed value method work out to be ~110K and 73K. Saying most lenders dont lend less than 50K, the min for the one property would be 67K anyway. So both methods ironically work out to be about the same value.

Ill work with the lender to see if we can make one loan for both properties and atleast save on the closing costs some. I will have to open up two HELOC to get my total amount out to keep getting houses, which shouldnt be costly.

Steve Vaughan · Answer

Deeds here in WA all (pretty much) say 'in consideration for $10 and other good and  valuable consideration'.  I bet $1 wouldn't be seen as enough or 'reasonable' consideration for the transaction.  It wouldn't be enough for an Option to buy even.

To prevent the 'not enough/unreasonable consideration' argument coming back (from an heir or someone) later, I would make it at least a few grand if you can swing it.

Are both properties bankable @Dave Saveri?   Will repair issues prevent a loan?  That would affect my decision also.

Keep in mind there will be minimum costs for title insurance and recording fees at closing. I would want to make those worthwhile as well, meaning I would at least want a PP of a few grand for the trouble.

Sounds like a nice find.  I would keep one free and clear and put a mortgage on the other most likely.  Keeps more options open.  Blanket mortgages tie things up too much for me.  Can't sell one until you get it released, etc.   Congrats!

Dave Toelkes · Answer

If you are working with a lender who will do a blanket mortgage, then you can have one loan cover both properties. Financing and capital gains are two mutually distinct issues.  Capital gain does not consider the amount of financing you use to acquire the property.

If the seller is selling two separate properties, then each has a purchase price.  Does not matter if you pay all cash for one and finance the other, your purchase price determines your tax basis for capital gains and depreciation calculations.

If the seller is selling both properties as a package deal and not separately pricing them, then, if the two properties are roughly the same value, half your purchase price is allocated to each property for depreciation and capital gains calculations, regardless of how you split up the financing.  If the properties are not the same value, then take the total tax assessed value for both properties and compute the ratio of each property's assessed value to total value to determine the ratio for allocating your purchase price between the two properties.

I don't see that splitting the financing makes any difference in your total cash flow.  You have the same total cash flow whether one property is carrying all the financing or it is split between the two.  Run the numbers to prove it to yourself.  Nor, is vacancy risk reduced if the income from both properties is needed to to cover the total debt service.  Again, run the numbers for your own cash flow analysis to see how it would play out for your situation.

If you are committed to purchasing both properties, then go with the financing plan that costs the least out of pocket and has the least impact on your total cash flow.

Peter Mckernan · Answer

@Dave Saveri

This is a good predicament to have! I would say purchase one @ $183K. This is something that could be hit with capital gains, but that all depends on how you hold that house specifically. If either of these is going to be your primary it would save you from the capital gains position due to the face that you could live it for two years, and when you sell it you can cover up to $250K single and $500K married.

The other possibility is you can 1031 Exchange the property when you are ready to sell and miss all the tax implications! Also,  a pro to having one all paid off is that the cash flow from the one that is all paid off will be throwing a lot out and you can utilize that significant profit to throw at the other property. The all paid for house would be a stress reducer for any long lasting vacancies, and you can make sure the one that is free and clear is the less  desirable (if there is such one).

Just some thoughts! Good luck!