Question: I own two rental townhouses worth about $140,000 each, thanks to skyrocketing property values. The mortgage balances are only $50,000 each at 7.50 percent. With today's low rates, I think it's foolish to tie up so much money in the equity in these homes and I'm considering buying another property that's on the market for $100,000. It needs quite a bit of cosmetic work but it's well priced. In fact, you could say that the property has been "trashed."

Do you think it's a good idea to refinance my two rentals so I can pay cash for the third property? I'm worried that I won't be able to get a loan on the property until I fix it up. The only other property I own is my primary residence that's worth over $500,000. I have a $150,000 mortgage balance with a 6.25 percent fifteen year loan and I'm accelerating the payments in hopes of paying it off early. Thank you for your comments.

Answer: A lot of folks who own rental property like to keep these properties completely separate from their primary residence. The primary residence is a home -- a "nest egg." I've never understood this logic. As a mortgage broker, it's my job to advise my clients in the matters of optimizing the allocation of mortgage debt.

Here's what I mean. You currently have a 6.25% fifteen year loan on your primary residence. Presumably, your goal is to pay off this loan as soon as possible so that your "nest egg" will be free and clear of debts.

That's a great goal. But when establishing a financial objective, such as paying off the loan on your house, you need to consider your entire financial picture. For example, you are accelerating the payment of a mortgage loan that carries an interest rate of 6.25 percent. Meanwhile, you have $100,000 of additional mortgage debt that carries an interest rate of 7.50 percent.

Rule number one: If you're going to pay off debt early, pay off the expensive debt first. I've had clients who have $60,000 in high interest credit card debt (that's not tax deductible) who wanted to refinance to a 15 year loan so they could pay off their house early. And at the same time, these folks acknowledge that the higher mortgage payments resulting from a 15 year loan would prevent them from paying down their massive credit card bill.

Go figure. It just makes no sense unless you're planning for bankruptcy.

But let's get back to your situation. You are right to be concerned about the ability to obtain a mortgage secured against a property that's "trashed." Lenders like the property to be in marketable condition.

But refinancing your two rental properties will be expensive for several reasons. Statistically, investor loans carry a higher risk than loans secured against a primary residence. That's reason number one why the lender's going to jack up the rate. Compounding the problem is the fact that you're seeking "cash out" from the rental properties. Expect the lender to raise the rate a bit more.

And finally, you're taking out two loans. Two loans mean two sets of closing costs. Double county recording fees, double appraisal fees, double settlement fees, etc.

You get the idea.

So my advice is to abandon the notion that your rental properties and primary residence need to be "separate." You have $350,000 in equity sitting right under your nose in your primary residence. Fifteen year loans are running around 5.50% these days, and that's with little or no fees. If the payment's too high on a fifteen year loan, 30 year products are running about six percent -- again with little or no fees.

If you want to buy this trashed rental property, my advice would be to refinance your primary residence and take out $100,000 cash. Who cares whether the hundred grand is secured to your "nest egg"? The bottom line is that it's a cheap source of money -- a lot cheaper than cashing out rental property equity or a credit card advance.

Published: April 11, 2003

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, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.