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How to Buy a Second Home and Rent the First Out

December 04 2018
by Leisl Bailey

Illustration of two houses next to each other

Getting your start into real estate investing can take some time. Unless you already have the property available. If you’re getting ready to buy but don’t want to give up your first home, here’s how to buy a second home and rent the first.

Why turn my home into a rental?

There are definitely perks and drawbacks to turning your home into a rental property. The most obvious drawbacks are:

  • Being a landlord
  • Vetting tenants
  • Repairing damage
  • Evicting (when necessary)
  • Managing the property long distance (if you move more than a few hours away)
  • Two mortgages
  • Difficulty getting lending for a second property
  • More complex tax return

The good news is most of these are fixable with a property management company. The issue with a management company is that they aren’t typically worth it for only one property. If you are planning on making this the first of many investment properties, it’s wise to learn how to be a landlord with your first property before handing it over to a management company.

The perks to turning your home into a rental are:

  • Rental income
  • Tax benefits
  • Great way to start real estate investing

The benefits list is a bit smaller than the drawbacks, but they can easily even each other out with the right tenants.

Real Estate Taxes

One of the major things to consider when renting out your home is the tax implications. Owning a home comes with tax credits, but if you have a mortgage that is larger than your allowable credits, you could end up paying quite a bit in taxes.

Some breaks you can expect when renting out your property is:

  • Deducting your mortgage interest, insurance, property taxes, and other rental expenses
  • Collect depreciation benefits
  • Selling one rental property and using the proceeds to purchase another without paying taxes on the capital gains

If you are considering turning your house into a rental, talk to a tax attorney. They’ll be able to tell you what it will do with your taxes and how much (if any) you’ll be able to write off.

How to Buy a Second Home and Rent Out the First

As you may have already figured out, there’s more to buying a second home and renting out the first than sticking up a For Rent sign in the window of the first and applying for a loan. In fact, many lenders may hesitate when asked if they will lend you money for a second mortgage.

Before you apply for a loan and rent out your primary residence, here are a few financials to think about.

Loan Basics of Two Homes: Renting Out Your House

Lenders often make it difficult for you to get two mortgages—this is on purpose. With one mortgage payment, most people have a lot on their plate. Add in more mortgage debt, and your debt to income ratio skyrockets along with your level of risk.

FHA, Fannie Mae, and Freddie Mac loans often have a clause in their contract that states that your house must be owner-occupied for a certain amount of time before you rent it out. Before you pack your home and rent it out, check out what your mortgage says about using your home as an investment property.

How to Afford Two Homes

Getting a second mortgage not only comes with added stress, it comes with higher interest rates. If you’re just beginning your journey of investing in real estate and are unsure of how to afford your second home, here are some options.

Crunch the numbers.

If you can afford two mortgages without the help of your rental income, that eradicates a lot of paperwork and verification of your homes future loan value.

Take out a HELOC.

If you already own one home, do what other investors do and leverage that debt! With rising mortgage rates, refinancing your first home and using that equity toward your second home is a great way to make a dent in the home price (and by association, the lending amount).

While a home equity line of credit probably won’t cover your second mortgage entirely, it will help up your lending appeal.

Take out a loan.

If you do need to take out a loan, you’ll first need to request Fannie Mae form 1007. Your appraiser will use this sheet to compare your house to other rentals in the area to see what rental income you can feasibly expect from your property.

Beyond that form, you’ll need to prove that you have money available to pay your mortgage if you are not making rent. The amount of money you need to have in reserves depends on the amount you are borrowing for your second mortgage but can include retirement funds, investments, and savings.

As with your first mortgage, you should shop around for the best rate. While your mortgage rates will be higher with a second mortgage than with your first, you’ll get the best deal by shopping around a bit.

What to Look for in a Second Property

Chances are you are looking for a new home because you have outgrown the first. While this is all good and exciting news, remember that you will pay a larger amount on the second home than you did on the first, and you’ll probably even end up footing the mortgage for both homes at certain times in your life.

With this in mind, it’s probably best to stick within your means and not by your extravagant home quite yet. Once you have an established rental portfolio you’ll be able to leverage your investments to purchase the house of your dreams. For now, look for a home that you can either a) fix up and rent out, b) rent out immediately, or c) that you can afford with minimal financing.

Turning Your Home Into a Rental Property

Becoming a landlord takes a bit of work to get the hang of. Here are a few tips to get you off in the right direction.

Finding Tenants

Getting the right tenants is crucial to having a good investing experience. Bad things will most likely happen (so budget for it!), but you can definitely do your part to make sure it doesn’t happen often.

When looking for tenants, make sure you run background and credit checks, and look at their rental history. You should also ask for and get in touch with their past landlords and references. It may also be a good idea to get a copy of the last three months worth of bank statements to verify their cash flow.

Managing the Property

While no one likes to get a call late at night requesting you to come to unstop a toilet, you should create a cordial relationship with your tenants and be available for them to access in an emergency. Make sure you outline in your contract what you do and do not require them to maintain themselves.

Schedule regular checks to make sure the property is in good shape. One way many landlords work this out is to come to change the batteries on the smoke alarm every 3-6 months. This allows you the opportunity to walk through the house and get a feel for how well they are taking care of the place without being intrusive.

Collecting Rent

Collecting rent is often uncomfortable to those who are not used to doing so. It’s a good idea to outline expectations in your contract that specifically state how your tenant will pay rent and what the penalty will be for late rent.

A common practice is to set up a separate bank account at a local bank for them to deposit their rent in every month. If they are late, you can charge a late fee and make sure you enforce it! Setting boundaries and maintaining those boundaries is the best way to create a great tenant/landlord relationship.

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