Q: We have purchased a new home and were planning to sell our current home. We are now thinking about renting it and taking some equity out to use for the down payment on our new home. Does this make sense?
—J.O., Woodstock, Ont.
A: We don’t love this strategy. While it is possible, we think it is too complex for most people to pull off effectively. Ask yourself some questions before you decide if it is right for you.
First, would this rental business be profitable? Look at how much you could realistically rent the property for, subtract the costs of the mortgage, maintenance, and property taxes and factor in the relevant tax deductions on those expenses to see if you’d be able to at least break even. You’ll need to talk to your lender to see how financing will work between the new home and the rental property to see what your interest expense will be. And be sure to factor into your math higher interest rates down the road. While you’re at it, talk to a professional tax adviser, says Evelyn Jacks, author of Jacks on Tax. You’ll want to make sure you understand the tax issues related to capital gains and the change in use of your home from your principal residence to a rental property.
Second, are you willing to do the work of a landlord? Finding tenants and catering to their needs can be a lot more effort than you might think. Third, what would your total asset mix look like? This strategy may mean most of your net worth is invested in real estate, making you more vulnerable to swings in interest rates and the housing market itself. Fourth, do you have a financial cushion in case things go bad—you lose your job, have to evict a tenant or the rental market softens? Make sure the pros are worth the cons before you move forward.
Bruce Sellery is a frequent guest on financial television shows and author of Moolala. Do you have your own personal question? Write to Bruce at firstname.lastname@example.org.