Renting out your home could be the right choice if you want to buy another home. The choice to rent out your original home could create additional cash flow that your budget has been waiting for. So, if you are wondering how to rent out your house and buy another, you are in the right place.
Let’s explore how to rent out your home. Plus, consider whether or not this option is the right fit for your finances and lifestyle.Click here to see if you're eligible to rent your home and buy another (Feb 1st, 2023)
In this article:
- Should you rent your house?
- How to afford two homes
- Tips to rent your home
- Lending rules
- Pros and cons
- Property managers
- Being a landlord
- House rental FAQ
Should you rent out your house?
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, Illinois. “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.”
Peterson says the situation really depends on the price of your house and what you paid.
How to afford two homes
Before we continue any further, you may be wondering how on earth you can afford two homes. You’ll need to evaluate your finances to determine if your budget can handle another home.
Down payment options for a second home
There are a few options for sourcing the down payment for a second home. First, you can always use savings to purchase a second home. But if you don’t have a down payment in the bank, it doesn’t mean you can’t buy a second home.
Another option is a cash-out refinance or Home Equity Loan or HELOC on your existing home to cover the down payment on your new home. This can be a good option but keep in mind that this will reduce your equity in your current home. Plus, if your current home is still mortgaged, you’ll be responsible for a second monthly mortgage payment.
Loan type options for a second home
If you have the down payment covered, the next step is to find funding.
Conventional loans can be a great option. You’ll need to meet some financial requirements that include having a good credit score and the income to support this new home purchase.
Government-backed loans can be used to purchase a second home but note that most require the financed home to be your primary residence so you’ll need to plan to relocate to the second home (and you’ll likely need to demonstrate a good reason to be moving out of your existing home).
Tips to turn your home into a rental property
Ready to turn your home into a rental property? Here are some tips to help you move forward.
Consider your emotional attachment
Peterson says that another scenario that many people don’t take into consideration when renting their old house is the emotional attachment they have to 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.
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 numbers game — an income-producing building,” Peterson says.Click here to check today's investment property mortgage rates (Feb 1st, 2023)
Read the fine print of your mortgage
Many lenders will allow you to rent out the house while you still have an outstanding mortgage balance, but not all of them.
Take the time to read the details of your mortgage agreement. If you have questions, reach out to your mortgage lender to uncover the rules. You don’t want to violate the terms of your mortgage agreement. If you do, you could face legal consequences.
The good news is that you can potentially refinance the loan with a rental-friendly lender if your current lender doesn’t allow this.
Understand the lending rules when renting out your home to buy another
Lenders will impose certain rules for homeowners converting a primary 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 a new mortgage on top of your existing debt, 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 Form 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 the 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.
Talk to your homeowners insurance company
If you move forward with renting out your home, you’ll likely need to add more coverage to your homeowners insurance policy. That’s because most traditional homeowners insurance policies don’t cover rental-related issues.Click here to check your eligibility to rent your home to buy another (Feb 1st, 2023)
Pros and cons of renting out your house
Every financial decision comes with advantages and disadvantages. Here are some things to keep in mind when learning how to rent out your house and buy another.
Let’s start with the pros:
- Generate income
- Build equity through renter’s payments
- Increase your assets
- Explore real estate investing
Now for the drawbacks:
- Complex tax implications
- Responsibility of a landlord
You’ll need to weigh these out for yourself to decide which path is right for you.
Tips on how to rent your house and buy another
If you are up for the challenge, renting out your house to buy another can be a lucrative move. Here are some tips to help you get started.
Know your local rental market
Peterson suggests talking with someone who is knowledgeable such as a local realtor if you are considering renting, buying a second property and renting your old one. 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 and what your property taxes might be.
Run the numbers
If you want to profit from your rental, take the time to run the numbers. Consider the range of rates you could earn from the rental. Check to see if that range would cover the expenses related to the property.
What are the advantages of owning investment property?
“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 current home 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 for sale.
“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 a 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 when you buy a second home, Peterson says.Click here to see if you qualify to buy another home (Feb 1st, 2023)
Should you hire a property manager?
Laura Adams, a 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 and credit scores, you need to show the home sometimes over and over again, you need to figure out a lease agreement, and then you need to see if you can be happy with these people living in your home. Property management can help with this.
“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 then 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.”
Can you afford to be a landlord?
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 comes up, like the furnace going out?
“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 (Feb 1st, 2023)
How to rent out your house and buy another FAQs
Can you rent out your house and get another mortgage to buy a new house?
Yes, renting out your current house and getting another mortgage to buy a new home is possible. However, you’ll need to meet the financial requirements of a mortgage lender to be approved for the new loan.
Can you own a house and rent another?
Yes, it is entirely possible to own one house and rent another. Even if you don’t have experience as a landlord, you can work with a property manager to make a home a profitable investment. Consider talking with a knowledgeable real estate expert to discuss the details of your unique situation.
How much equity do you need to buy a second house?
If you want to use some of the equity in your first home to buy a second house, it is possible. But most lenders will only allow borrowers with good credit to take out up to 85% of the home’s current value.
For example, let’s say that your home is worth $100,000. In this case, you would only be able to take up to $85,000 in equity out of your home. But if you owed any remaining mortgage balance, that amount would need to be subtracted from the $85,000. So, if you still owe $15,000 on the mortgage, you’ll only be able to borrow up to $70,000.
Can I use my house as collateral to buy another house?
No, only the home being purchased can be used as collateral for a loan.
However, you can take out a home equity loan to take advantage of the value you’ve built in your first house to fund the down payment for the second.
Keep in mind that defaulting on a home equity loan would lead to losing the first home.
Can you rent your house if you have a mortgage on it?
If you still have a mortgage on your house, you may or may not be able to rent it out. The decision lies with your mortgage lender. With that, you should read the details of your mortgage agreement or talk to your mortgage lender before renting out your home.
How long do you have to live in your house before you can rent it out?
As a rule of thumb, most lenders will expect you to live in a home with owner-occupied financing for at least 12 months. However, life can change rapidly. With that, you may find yourself with a legitimate reason to rent your home sooner than that.
But you’ll need to talk to your mortgage lender to determine when you’ll be allowed to transition your home into a rental property.
Can I live in my investment property?
In some cases, you can live in your investment property. For example, let’s say that you have a property with 2 to 4 units. You’ll be able to live in one unit and rent out the others. Additionally, you can live in an investment property without any other tenants. However, you’ll need to consider that the expenses associated with the property will no longer be tax-deductible.
Is being a landlord worth it?
The financial reward of being a landlord can add up quickly. However, you’ll need to run the numbers to determine exactly how much you should expect to make.
Sometimes, you might decide that the time commitment is too much. That’s okay! Consider hiring a property manager or finding another way to put your money to work for you.
Bottom line: Should you rent your house or just sell it?
Now that you know how to rent out your house and buy another, it is time to decide whether this is the right move for you and your finances.
In some cases, the financial win will be an obvious choice. But in some cases, you might decide to enjoy the profits from selling your home and skipping the hassle of renting it out.
If you decide to move on to your next home, consider our favorite mortgage lenders for a streamlined process.Click here to see if you are eligible to rent your home and buy another (Feb 1st, 2023)