Everett, Wash.
Published: Sunday, September 30, 2007

Line of credit best option in this case

By Steve Tytler

 Question: I plan to buy half of my son's house and we will use it as a rental as he is buying another house to live in. What is the best way for me to finance this? I have plenty of equity in my house. Should I get a mortgage on my home or on half his house? He would like to keep his present loan.

Or is a line of credit a better option on my house? I have the 20 percent cash down to start with. Is the interest on equity loans deductIble at tax time?

E.F., Everett

Answer: You have asked several questions, so let me handle them one at a time.

First of all, in order to buy "half" of your son's house you must be placed on the title as "tenants in common" with a 50 percent ownership of the house.

This can be accomplished with a simple quitclaim deed, with your son transferring 50 percent ownership of the house to you and filing the new deed at the county recorder's office.

The way you handle the financing on the property would depend on when the deed is recorded. If your son transfers title to you before you get the financing, you could refinance his house as co-borrowers because you would both be legal owners of the property. If you want to get a loan before you transfer title, you could structure a purchase transaction where you obtained a purchase loan with your son as a co-borrower to buy out his interest in the house.

I think it would be easier and less complicated to go on the title first and handle the financing as a mortgage refinance. So let's assume that is what you will do.

You mentioned that your son wants to keep his mortgage. If he has a low, fixed-rate mortgage, that is probably a good idea. However, please be aware that most mortgages include a "due on sale" clause that may be triggered if you are added to the title of the property. Technically, the mortgage lender could force you to pay off the entire loan if they find that you have violated that clause. But realistically, as long as the mortgage payments are made on time each month and your son stays on title to the property, that probably won't happen. I just want you to be aware of that risk.

The next question is how much equity does he have in the home?

You will have to pay him for a 50 percent share of that equity somehow. If you decide to refinance the house that you now own with your son, you would have to obtain a "nonowner-occupied" (investor) loan on the property.

Typically, the interest rate on rental property mortgages are about .5 percent higher than for owner-occupied homes. For example, if the interest rate on a 30-year fixed-rate mortgage for a homeowner were 6 percent, the interest rate for a rental house owner would be about 6.5 percent for the same fees and closing costs.

But the main problem with this strategy is that mortgage lenders have significantly tightened their loan guidelines for investor properties lately, so it would be difficult to borrow much money over and above the current loan balance on the property.

So your best option is to borrow against the equity in your own home. If you use a home equity line of credit, your interest rate would be based on the prime rate, which is now 7.75 percent, and it will change with the interest rate markets. If you own your residence free and clear or have a small mortgage balance, you may be better off getting a "cash-out refinance" to come up with the cash to buy half of your son's house, because you could get a 30-year fixed-rate loan at about 6 percent. Either way you go, with a line of credit or refinancing your current home, the interest expense will be tax deductible. You will also be able to deduct one-half of the property taxes, insurance and maintenance and repair costs on the rental house.

Please consult an accountant for further tax information, this column is intended for general informational purposes only.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206 or e-mail him at economy@heraldnet.com.
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