Find out the steps, rules, and barriers to buying a new house so that you can rent your current home.
Why You Should Rent Your Current Home
Many people want to get involved in rental properties because of the amazing long-term profit that can be made. The ability to own a property that continues to appreciate while someone else pays the mortgage is incredible, and that doesn’t even include the tax benefits that come from rentals.
Of course, buying an investment property outright is expensive. Most lenders require a minimum of 20% down to buy a property and rent it out.
However, renting out your current home has become a popular way to acquire your first rental property because it can usually be done for much cheaper.
The Strategy Behind Buying and Renting
While there are plenty of factors at play, here are the nuts and bolts of how this strategy works:
- Buy your current home – Most people opt to purchase houses using FHA loans, which allow you to pay as little as 3.5% down.
- Refinance your mortgage – You’ll need to refinance to a different type of loan, usually a conventional loan that requires 20% down. This is the trickiest part, as you’ll need to have your property appreciate and favorable interest rates to avoid paying a large amount. At least 7 months must pass before you can refinance, but it will likely take longer than that to build up enough equity.
- Buy your next property with an FHA loan – You’re only allowed to have one FHA loan at a time, which is why most owners must refinance their current property first. Then, you can buy a new house and put down as little as 3.5%
How to Buy a New Home to Rent out Your Current One
Now that we’ve talked about the basics, let’s dive into all the realistic steps and considerations to make this strategy a reality:
- Talk to Your Mortgage Lender
- Ensure Viability as a Rental
- Refinance
- Gather Your Down Payment
- Prep Your Rental
- Manage the Rental
1. Talk to Your Mortgage Lender
The first step is to understand whether your strategy is viable with the lender and what they will require from you. They should be able to help you refinance your current home and purchase your next property, but they may have restrictions in place.
For example, some lenders won’t work with you if you have no landlord experience. Many lenders will require that you have enough money in the bank to handle both mortgages for a predetermined amount of time, such as 6 months.
Whatever they end up requiring, this step will help you begin to understand what’s required and if it’s even possible for you to do this.
2. Ensure Viability as a Rental
Just as important as talking to your lender is understanding the economics and strategies of owning a rental property.
Many owners who desire to be landlords want to skip this step. It’s much easier to rent out the property you already have than to do weeks of research and shopping with a real estate agent to find a potential rental.
This can lead to disaster, as owning a rental can go wrong in many ways. There are many factors that you have to consider.
Neighborhood
Perhaps the property itself is nice, and you believe that it will make a good rental. However, prospective tenants will also look at the neighborhood.
Here are a few things to consider:
- Number of other rentals – Paradoxically, renters want to live in an area with lots of stability, and if there are lots of other renters, there could be high turnover.
- Quality of the neighborhood – Has your area gone downhill recently? Is there more crime? Are the parks trashed? Are there a few homes with boarded-up windows or overgrown yards?
- Schools – Most families are going to consider the quality of nearby schools as a factor in deciding to move in.
- Job Market – While less important in today’s remote environment, people don’t like long commutes. If you live a long way from places of employment, you might have a harder time finding renters.
Rental Income
Do the math: Can you charge enough rent to turn a profit each month? Some people get so excited about the prospect of owning a rental property that they fudge the numbers a little.
For example, you might say things like “I bet we can charge $300 more a month than them!” or “Even if we break even, it makes sense in the long run!”
There are almost always more costs than you can plan for, such as maintenance, repairs, vacancies, and others. If you plan on having a slim margin each month, that could easily turn into negative cash flow.
Property Complications
Now, is the property itself good for renters? For example, a large landscaped yard can turn off renters unless you provide full landscaping services.
Or, is everything inside your house outdated while nearby units are newer?
Do you have the nicest property on the block? You’re unlikely to get proportionally more rent, as most potential renters will settle for cheaper properties nearby.
3. Refinance
Refinancing is the most complicated step because you have to make sure that the math will work out in your favor.
When you refinance, most lenders will only lend you 80% of the property’s value, meaning you’re giving them a 20% down payment.
So, if your property is worth $400,000, a lender will likely only refinance $320,000 of that. If you still have $350,000 on your mortgage, the math doesn’t totally work out in your favor.
It’s also possible that your bank will lend enough, but if mortgage rates have increased, you may end up with significantly higher monthly payments. You may be unable to charge enough rent to cover your mortgage comfortably.
4. Gather Your Down Payment
Next, you’ll need to ensure you have enough cash in the bank to cover the down payment and any cash reserves your mortgage lender requires to become a landlord.
Since you’ve refinanced your property, you should be able to acquire your next property with an FHA loan.
The property you want to move into costs $600k, meaning your down payment could be as low as $21k (at 3.5%). Let’s assume your lender wants you to have 6 months of cash reserves to cover the mortgage for both properties—which could be another $18k. You could make this strategy work for around $40k – $45k.
Another way you can gather your down payment is through a cash-out refinance.
Borrowing from the example in the previous section, let’s assume that your current property is worth $400,000 and that your lender will give you up to $320,000. If you owe $250,000 on your property, you could refinance to a new loan and pocket $70,000!
Of course, those numbers won’t work out that cleanly as other expenses come into play.
5. Prep Your Rental
Now that you have everything in order, it’s time to plan how to attract tenants to your rental property!
In a perfect world, you won’t have to spend much on updates. It probably makes sense to touch up the paint and have the carpets cleaned, but not much more.
If you start upgrading countertops and flooring, you’ll likely be unable to recoup that in rental costs. The exception is if all the neighbors have a certain upgrade except for you. In that case, you might have to make those upgrades to compete.
In addition, you’ll have to do the following:
- Determine if you want to hire a property manager
- Market your rental
- Accept applications
- Screen applications
- Create contracts
- Figure out policies, like collecting rent, communication methods, and due dates.
6. Manage the Rental
One thing that often gets lost in the excitement of owning a rental property is understanding how much goes into managing the rental!
If you’re going to hire a property manager, then much of the work is out of your hands. However, they often charge 8% – 12% of your monthly rental income, so it may not be feasible.
You’ll want to cultivate relationships with repairmen and then empower your renters to call them. You’ll need to be available to handle emergencies, such as if a flood happens.
If you bring in the right renters, you’ll likely not have to be involved too much. However, if you’re preparing to be a rental property owner, you’ll also need to be ready for the stress of ongoing maintenance.
