Updated: Aug 4, 2021
So you’re ready to move on from your first home. Perhaps your family is growing, or maybe you actually want to downsize after your kids left the nest. But you’re also considering keeping your first home as a rental property to earn a bit of extra income.
Turning your current home into a rental property can be a great investment. But knowing where to start can be overwhelming. How do you rent your first home and buy a second home simultaneously? To help you get started here is everything you need to know about buying a second home and renting the first.
Should I buy a second home as an investment strategy?
Buying a second home and renting out your current home can be a smart investment strategy, earning you extra income from rent payments. And while there are great advantages to renting out your home, you’ll want to understand the process and potential drawbacks before you invest in a rental property.
One major factor to consider is your finances. Will you be able to cover two mortgages at once? What if you have trouble finding a renter or your tenants miss a rent payment? Will you have enough savings to cover your mortgage costs?
You may also have to dip into your savings if anything breaks down or needs repairs in your rental property. You will be the one your tenants call if the plumbing stops working or the washing machine breaks. You want to ensure you have enough financial reserves for any needed repairs — for both your rental and your second home.
Taking on the responsibility of a landlord can be overwhelming, especially if you’ve never managed property or dealt with tenants before. Ideally, your renters will be the perfect tenants. However, note you may have to deal with uncomfortable situations such as noise complaints, collecting late rents, or possibly even eviction.
One factor that may take you by surprise is the emotional attachment to your first home. You’ve likely created a lot of memories and hit many milestones within those walls. A lot of your personality, energy, and effort went into making the house a home. Seeing someone else move in and rearrange, redecorate, or perhaps even neglect to maintain your home can be difficult.
After careful consideration of the potential hurdles to investing in a rental property, if you’re ready to take the next step, here is how you can rent out your home and buy another one.
How do I buy a second house and rent the first?
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Before you buy a second house and get your rental property going, you want to ensure you qualify for a second mortgage. So unless you’re paying for your second home in cash, the first step is meeting with your lender.
In the eyes of lenders, buying a second home and turning your current property into a rental comes with additional risk, especially if you’ve never managed another property before. Your lender will want to be positive you can cover two mortgages.
If you have enough savings to cover two mortgages without the help of rental income, the loan process will be much quicker and easier. However, if you are counting on future rental income to put towards your mortgage payments, you’ll need to fill out a bit more paperwork.
In this latter scenario, you can request Fannie Mae Form 1007. This form is a “Single Family Comparable Rent Schedule” which helps an appraiser determine the potential rental income of your home. A licensed appraiser will compare your home to similar rental properties in the area and then provide an estimate of your monthly rental income.
This appraisal helps your lender determine if you qualify for a loan. And as a bonus, the appraisal gives you a decent idea of what you can charge tenants for rent.
However, you will also need to prove you have enough savings to cover mortgage payments in case you’re unable to find tenants or your renters can’t make their monthly payments. Generally, you’ll need to show your lender you can cover 2% of the unpaid balance of all mortgages, not including your new second home. If you have more than four financed properties, you’ll need to be able to cover a higher percentage.
For example, if the home you plan to turn into the rental property has $250,000 in mortgages, you’ll have to prove to your lender you have $5,000 in savings.
You’ll want to work with a tax attorney to help you navigate tax implications with your rental property. They will help you determine if your property is considered an investment property or vacation rental, which taxes you’ll have to pay, and what deductions you can claim.
Also, be aware of potential capital gains tax. If down the line you want to sell your rental property, you may be subject to capital gains tax. For example, if you bought your home at $150,000 and over the period you rented out the home it appreciated in value by $50,000, that $50,000 profit becomes taxable income.
Potential Rental Market
Turning your existing home into a rental property can be a great investment, earning you some extra income. But this only works if you’re able to find tenants. You’ll want to thoroughly research your rental market to determine if renters will find your home and location desirable.
For instance, if your home is near the highway, you may have more difficulty finding renters than if your home was situated next to a park. Consider talking with a local real estate agent to help you discern what is in great demand and the potential your home has for attracting a consistent stream of renters.
Managing Your Rental Property
Are you ready to take on the role of landlord? Be prepared to vet potential renters, checking their credit scores, looking at references, drawing up a lease agreement, and conducting background checks.
You’ll also need to be ready to fix any repairs, maintenance issues, or address any complaints. But, if you don’t feel comfortable handling landlord you can pass off those duties onto a property manager.
Hiring a property manager to deal with your tenants and any issues that arise can relieve a ton of stress. And especially if you’re planning on moving to another state or city, a property manager can take care of everything.
Keep in mind, hiring a property manager can cost you anywhere from 8% to 12% of your monthly rental income. Be sure to calculate whether you can afford to pay both a property manager and cover your mortgage payments.
Preparing Your Rental Property
Once you have your loan approval, understand your tax implications, and know you have a hot rental market, you can start preparing your home for renters.
You typically won’t need to make any major renovations or remodels. You will want to consider cosmetic repairs such as a fresh coat of paint, new hardware on the cabinets, or a carpet cleaning. Work with your real estate agent for guidance on which repair projects you should focus on to attract renters.
How much do you need to put down on a second home?
When purchasing a second home, you’ll generally be subject to higher interest rates, run into stricter income requirements, and yes, will need to offer more on a down payment.
Your down payment for a second home will be higher than what you put down for your first home. Expect your down payment to be around 20%, though in certain cases you could be required to go as high as 30%. Also note, renting out your first home makes you ineligible to deduct the mortgage interest on your second home.
To help you cover the costs of your down payment, you can take out a home equity loan or a home equity line of credit. Just be sure you can pay back the loan or you risk losing your home.
Work With A Real Estate Agent
Buying a second home and renting the first requires extensive research and planning. Consider working with an experienced real estate agent to help you through the entire process. Your agent can provide expert guidance on your rental and housing market and how to best market your home to potential renters.
A top local agent will also be able to help you purchase your second home. They can connect you with sellers and lenders to make sure the entire home buying process goes smoothly and you get the best price possible.