How To Buy a Second Home and Rent the First
- May 08, 2023
- 6 min read
Building long-term wealth and generating passive income is more achievable than many might think. The strategy and process for how to buy a second home and rent the first are the first steps toward creating a real estate portfolio and establishing a plan for buildable wealth.
In this guide, we’ll walk you through the process so you can get started on making your assets work for you.
What Should You Look For in a Second Home?
Before you search for a second home, ask yourself a few questions about your future. Are you comfortable purchasing a forever home, or do you foresee selling?
Forever homes are often larger and customized and require more upkeep. If you see yourself selling the house or potentially pursuing another rental opportunity, look for a property with more mass appeal.
Other factors to consider in a second home include the following:
- Neighborhood characteristics: Do school districts affect your options? Is there proximity to shopping, medical clinics, or recreational facilities? Would it be easier to stay in the same neighborhood as your current home?
- Cost vs. property size: Does your budget align with your wants and needs in a new property? Will you need to make upfront investments in renovation? Can you manage the financial demands of both properties?
- Rental market: Is there a demand for rentals in your area? What is the average cost of a rental home with the same specs? Does your home offer amenities that would attract potential renters?
- Mortgage status: Do you still make payments on a mortgage for your current home? Does your lending agreement mention whether you can rent the property while still making mortgage payments?
Some lenders place clauses in the lending agreement that regulate turning the home into a rental property. For example, some require you to wait a certain period, and others may not mention it all.
Consider your financial status and ability to manage assets when buying a second rental property or home. What are the demands of managing two houses, and do you have a trusted property management company to handle day-to-day, on-site assistance?
Affording and Managing Two Homes
Being able to afford a second home means having a firm grip on your financial health and what funding options are available to you. Presumably, you already went through the buying process once to purchase your current home. However, depending on how long ago that was, there may have been substantial changes in the loan process and the market. Therefore, start by considering your loan options, talking to a real estate agent, and looking for a property management team.
Understand Your Financial Health
Before you meet with potential lenders, gather your financial documents:
- Credit scores and credit history
- Down payment calculations
- List of your assets
- Most recent tax returns
- Bank statements
Proof of income and employment history is critical. Lenders want evidence of income stability and a reasonable ratio comparing the home value to the desired loan amount.
Consider Your Loan Options
While the plan is to make a profit off rental payments for your property, securing a mortgage with favorable terms will play a key role in just exactly how much you’ll make. Remember that you’ll be supporting two (or more, depending on the loan size) mortgage payments, so your rental price needs to offset your payments considerably.
Buying a second home or rental property requires financing unless you can pay cash upfront. Home equity loans are the most common option for funding your second property. They allow homeowners to borrow against the equity of their first home and sometimes subsidize the down payment. However, interest rates vary among lenders, and you must carefully consider the risk of losing your home if you default. You’ll want to consider what those monthly home equity payments look like and what the going rate for rentals would be in comparison.
With robust financial health, you may qualify for a conventional loan. Credit score requirements are typically higher for a second mortgage, often around 680, and your debt-to-income ratio should be less than 43%.
Another thing to consider: interest rates tend to be higher on a property if you buy it as a non-owner-occupied property. Depending on what your loan officer advises, the best strategy is usually to buy the new property to occupy it as an owner to get the best rate.
Once financing is complete, you move into the next phase of renting the first property.
Look for a Property Management Company
Before you decide to take on property management responsibilities, consider the upcoming burdens. Moving into your new home, preparing the rental property, boxing and unboxing your things, and planning renovations are all part of the process. Does the idea seem overwhelming?
When you work with a property management company, they offer everything you need to manage a property effectively. Their tasks include ensuring lease compliance, collecting rent payments, coordinating maintenance, and more essential services. A property management team takes over the burdens of landlord duties so you can collect the check without the fuss.
Having a management company you trust to deal with the everyday responsibilities of your property can take away a good portion of the stress in managing your investment. So all you need to do is collect the money! Be sure to factor in any management costs when considering what to charge for rent.
Decide Whether To Work With a Real Estate Agent
The financial balance of owning multiple homes is something real estate agents see daily. Working with a qualified local agent ensures you find a second home within your budget. Additionally, they can help you find and vet renters often through personal relationships they have with established clients.
It’s good to get experts involved who deal with this sort of thing every day. They can guide your decision-making process and ensure you don’t get in over your head to maximize your investment.
What Are the Pros and Cons of Renting Out Your Home?
The most obvious pro to renting out your home is the rent payment. A well-vetted renter will provide a stable monthly income to cover the mortgage and maintenance.
Consider other lesser-known pros:
- Tax benefits: Deduct operating expenses and travel costs if you move far away. You can use a depreciation deduction to reduce your taxable income as well.
- Building wealth: The cost of a home has been on an upward trajectory for over a decade. Holding onto your first house means you could sell it in the future for much more than you paid.
- Move-back option: If your second home does not work out, you have somewhere to go. Or, you could rent out the house you moved into.
You must weigh the pros with the cons. The most common complaints from rental property owners include the burden of being a landlord (which you can alleviate by hiring a property manager), the additional expenses, and the complexity of taxes.
However, the tax benefits arguably outweigh the annoyance of filing complex forms, and adequate financial planning will ensure rental rates cover additional costs.
Are You Ready To Buy a Second Home and Rent the First?
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