- The Washington Times - Wednesday, September 27, 2006

Q:I am trying to formulate a plan but am unsure if it will work. Here’s my story: I

currently own a home and make about $55,000 per year. The house is worth about $250,000 and I owe $120,000 with a fixed rate of 5.875 percent. The mortgage payment is $1,020 per month.

I am also in graduate school and have about $110,000 in student loans. The loans are currently deferred, but I expect to be paying about $800 per month when they become due for repayment. The interest rate is 4.65 percent.

My goal is purchase a new home by signing a preconstruction contract with a settlement in late 2007. The purchase price will be in the range of $350,000. I would like to keep my current residence as a rental property. It should rent for about $1,500 per month.

I am fearful that in order to accomplish my goals, I would have to pay off my student loans. Do you think my plan is feasible, and, if so, what do I need to do with my student loans?

A: The student loans are only part of your overall financial picture. I can tell you that from reading your e-mail once, your goals are, indeed, aggressive. Let’s run some numbers and see where you wind up.

Your $1,020 mortgage payment will not be the only expense if you rent your home out. The tenants may pay utilities, but it is a landlord’s job to maintain the property. Let’s estimate $100 per month. If the property rents for $1,500, your positive cash flow will be $380 per month.

Once the repayment of your student loans kicks in, your monthly obligations increase by $800. Assuming you don’t have any other long-term debt such as auto loans or credit card balances, things look good so far.

The problem arises when we look at how to finance the new home. You don’t mention how much money you have saved or invested. You have a lot of equity in your home, and that’s terrific, but keeping the property as a rental means you can’t use this equity as a down payment, unless you take out a large second trust.

Doing so would greatly increase the monthly obligations to the rental property, turning a positive cash flow situation into a potentially hefty monthly obligation.

Let’s assume that you have enough money saved up for a 5 percent down payment. On a purchase price of $350,000, you would need $17,500, plus another $10,000 or so to cover closing costs.

Although there are myriad financing options available that result in varied monthly payments, let’s assume that your monthly payment will be about $2,500, including taxes and insurance.

If we add your new mortgage payment, rental mortgage payment, and an $800 student loan payment, your long-term obligations total $4,320. Your salary is equal to $4,583 per month. Your rental income totals $1,500, making your total inflows $6,083.

Clearly, this scenario is not feasible. Although your gross monthly salary is $4,583, your take-home pay is likely to be far less, thanks to federal and state tax withholding, medical insurance deductions and IRA contributions.

Most lenders offering competitive mortgage rates will be far more conservative in qualifying you. Typically, lenders will only count 75 percent of the rental income, even if you have a current lease. Rental homes are not usually occupied 100 percent of the time, so lenders will make room for a “vacancy factor.”

If your credit is good, there are plenty of “alternative” lenders that will gladly make you a loan for the new home. Expect to pay a significantly higher rate.

The fact is that your ability to obtain a loan is irrelevant. With a salary of $55,000, having a $120,000 mortgage on a rental property, a $332,500 mortgage on a primary residence and an additional $110,000 in student loans is biting off far more than you can chew.

My advice is to be patient. Don’t attempt working a full-time job, attending graduate school and becoming a landlord all at the same time. Managing such a schedule won’t be easy and would be made even more difficult when you have a total debt load to the tune of $562,500.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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