Should you rent out your current home to buy again? Figure out the tax implications, whether you qualify, and even the emotional attachment to your home.
“Becoming a landlord can be intimidating if you’ve never done it,” says Phil Peterson, managing broker at RE/MAX in Schaumburg, Ill. “There are definitely pros and cons to renting out your house. I’ve been there. But at the time, I wasn’t aware of all those ups and downs.”Click here to see if you are eligible to rent your home and buy another.
Peterson says the situation really depends on the price of your house and what you paid.
“Part of the advantages of owning investment property, you get to write off all improvements and all the maintenance. But when you sell it, as the value appreciates, you have to pay capital gains on all the profit. It can be a big expense especially if you bought a house back in the day when prices were appreciating a lot.”
For example, let’s say you bought your house for $100,000, and now it’s worth $200,000. You decide to rent it for a few years. You get tired of being a landlord and put it on the market to sell.
“That $100,000 that has appreciated in your home becomes taxable money. But if you had sold that house when you were still living in it, that $100,000 is tax free. That’s the big difference,” he says.
On the other hand, if you bought your house in the upper end of the market for $200,000, and it’s still worth $200,000, there is no capital gain problem. Then, it could be a good idea to keep it for an investment, Peterson says.Click here to see if you qualify to buy another home.
In this article:
- Lending rules
- Local rental market
- Should you hire a property manager?
- Can you afford to be a landlord?
- Our recommended lenders for home loans
Lenders will impose certain rules when converting a principal residence into a rental property. They need to be sure you can handle two homes, especially if you don’t have landlord experience.
First, you should see if you qualify for two homes without the help of rental income. If so, you eliminate the need for extra paperwork that verifies future rent on your home.
But let’s assume you need that income to qualify for the new home.
You need to request Fannie Mae From 1007, which is a Single-Family Comparable Rent Schedule. It’s like an appraisal, but for rental income instead of home value.
This form is completed by a licensed appraiser, and can be ordered by your lender. The document compares your home to similar rental homes in your area. It estimates the monthly rent you could earn.
Besides being a loan requirement, the 1007 can give you a good idea of how much rent you can charge.
But even with this form, you need to prove that you have financial reserves to make the payment on the vacated home, should you be unable to rent it. The amount you need in savings, retirement, and investment accounts depends on the mortgage on the home you’re vacating, and the number of financed properties you have.
You will need, in the bank or investment account:
- 1-4 financed properties: 2% of the unpaid balance of all mortgages
- 5-6 financed properties: 4% of the unpaid balance of all mortgages
- 7-10 financed properties: 6% of the unpaid balance of all mortgages
Keep in mind that you don’t need the above-stated reserve amount for the property you’re buying, nor does the new property count as one of the financed properties.
Most buyers who are renting out their house to buy another will have only one financed property by this definition.
For instance, you are living in a home now that you plan to rent out. You have $200,000 in mortgages on the property.
The lender will require that you have $4,000 in available funds as “reserves.” Plus, your lender will provide Form 1007 to determine estimated rent.
Again, you can skip all these requirements if you don’t need the rental income on your current home to qualify for the new loan.Click here to check your eligibility to rent your home to buy another.
Peterson suggests talking with someone that is knowledgeable such as a local realtor if you are considering renting your old house. That person would know if the rental market is strong, how much you could possibly get per month and what it takes to be a landlord. Also, by contacting your accountant before stepping into the landlord world, you can find out information about all the new tax laws that could affect you.
Peterson says that another scenario that many people don’t take into consideration when renting their old house is the emotional attachment they have for it.
“This house was your home. Your children grew up there. Your memories are there. So all of a sudden, you have these really nice tenants, and they move out in a few years,” he says.Click here to check today's investment property mortgage rates.
When you go inside to take a look at it, you realize that these nice tenants didn’t take care of the home the way you did. There are stains on the carpets, and scratches on the wall.
“That emotional attachment to that particular house is very hard to overcome. But if you just buy an investment property that you never lived in yourself, then it just strictly becomes a number game — an income-producing building,” Peterson says.
Laura Adams, personal finance expert in California and author of Money Girl’s Smart Moves to Grow Rich, has had a lot of rental properties over the decades. When it got overwhelming, she hired a property manager.
“They got me higher rents than I thought I could get and they did a great job of getting quality tenants,” she says.
But if you want to attempt renting your old house, looking for the right tenants can be quite time consuming. You need to check references, you need to show the home sometimes over and over again, you need to figure out a lease, and then you need to see if you can be happy with these people living in your home.
“The majority of people renting their old homes find it to be cash positive. They have somebody paying off that asset. Eventually, that asset will be mortgage free, and you can sell it or have money for retirement or to buy another house,” she says.
But knowing realistically what you can get from the property in a rental situation should be important information to know before you decide anything, she says.
“If you think you can get $1,000 and it’s really only worth $750, than that won’t work with your plan. Go online if there are rental properties and compare them to yours. That’s a good starting point,” Adams says. “If you can make it a wash or just earn a little cash more than what your mortgage is, that generally could be a good idea.”
Another important issue is whether or not you can afford two mortgage payments.
“If you do decide on turning your old house into a rental, you have to go into it knowing that a renter could leave you. You could go months without rental income on that property,” she says. “Having a savings or reserves fund earmarked for that rental property is ideal.”
What if some really expensive repair like the furnace goes out comes up?
“If these expenses come up, you don’t have the luxury of waiting to fix it. You’ve got to be prepared with a line of credit or savings for unexpected problems. If someone has no savings, then being a landlord is very risky,” she says.Click here to see if you are eligible to rent your home and buy another.