Sell or rent out your old home? Considerations

By Amy Fontinelle
Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Posted on Feb 5, 2018

You have decided to move out of the home…real estate you have owned for several years. Your first thought is to sell it. But after a comment from a friend, a tip from your real estate agent, or several months on the market with nary a nibble, you start having second thoughts: maybe you should keep your home and rent it out instead of selling it.

Real estate can be viewed as an excellent long-term investment, so why not get some tenants to pay off the rest of your mortgage? After that, you will have an asset that generates passive income for life. (Related: Downsizing in retirement: Is it better to rent or to own?)

Becoming a landlord is not this simple, but it may be a viable option provided you think through your individual situation and resources.

First you need to consider why keeping your old home as a rental property might make sense.

  1. It is an affordable way to enter the rental market.

When you do not need the equity in your existing home to purchase your new home, converting your real estate to a rental property may be a great opportunity.

“If you go out and purchase rental property, you typically need a 20 percent down payment. Your current home can be converted with no funds and no change in your mortgage terms,” said Trina Larson, a Certified Public Accountant and a Realtor with Berkshire Hathaway HomeServices PenFed Realty in Bethesda, Maryland. Interest rates on loans to acquire investment property are typically higher than interest rates on loans for a personal residence, so if you have a favorable rate on your current mortgage, keeping it might make sense.

  1. You do not want to take a loss on your home sale.

If your home’s real estate market value has dropped since you bought it and selling it would result in a loss, you might want to hold it because it may increase in value while you pay down the mortgage during your holding period, Larson said.

The combination of more equity and, hopefully, increased real estate market value will give you the option to sell your home for a gain later—or continue to rent it out if you are enjoying being a landlord.

“Over the long term, prices have increased in most areas,” Larson said. “Even if there is little to no increase, you will have equity because the mortgage balance is decreasing, and you are using your renters’ money to make that happen.”

  1. Rents in your area are high.

When market rents — what you can earn from renting your home — exceed your monthly mortgage payment, renting your old home might make sense. Check rents in your area with real estate sites like Zillow, Rent.com, and HotPads. You will want to come out ahead or at least break even after paying all the other expenses associated with owning the home and leasing it out.

If one or more of these reasons applies to your situation, consider what the experts say novice landlords should know before listing their former home as a rental…

  1. You must adopt a business mindset.

“The number one question anyone should ask to determine whether they should sell their home or turn it into a rental property is: Am I ready to become the CEO of my own small business?” said Thomas Miller, a Realtor with Keller Williams Capital Properties in Washington, D.C. He added that homeowners should also ask themselves, “Am I ready to take full ownership of all things related to profitability, including strategy, expense management, customer relations, operations, and financial planning? Am I really fully prepared to treat this like a business and not a fun hobby?”

Most people who jump into being a landlord do so without thinking through these questions, Miller said, and it is possible to get in over your head and lose a lot of money if you do not treat it like a business and focus on profit. At a minimum, you need to understand basic concepts of finance such as revenue and expenses, how to make a financial forecast, how to keep track of expenditures, what the market rate for rent is in your area, and how to make a budget. You also need to have excellent interpersonal and customer service skills.

  1. Rent minus mortgage does not equal profit.

The math for making money by renting out your old home might not be as simple as you think.

“People make the mistake of thinking the money they will make is the rent they receive minus the mortgage payments,” said real estate investor Mark Ferguson, who owns 16 rental properties and writes for the real estate blog Invest Four More. “However, there will be maintenance and vacancy expenses when you rent a home that can be 10 to 20 percent of the rent. Losing money every month on a rental can be a very stressful process, especially if the reason you are not selling is because you have no money to take a loss on the property.”

Maintenance expenses include everything you would have to pay as a homeowner, but you may need to do things like repaint the walls and replace the carpet more often because of the additional wear and tear renters often cause compared with homeowners. You will need a landlord’s insurance policy, which may cost 25 percent more than a standard homeowners policy.

 “Some investors view future appreciation as part of the overall return and don’t mind losing a small amount of money on a monthly basis if they think they can make it up in a rapidly rising market, but that is risky,” said Tom Hume, a 23-year veteran Realtor with The Hume Group in north Tacoma, Washington. “Markets do go down.”

If your house is already paid for, however, you could earn a profit every month indefinitely. Another option is to leverage your investment by refinancing it and using the extra money to buy more houses to rent out and pay down in time, Hume said.

  1. Management costs time and/or money.

“If you have never been a landlord, you will want to either hire a property manager or learn how to market a rental, screen tenants, and where to get lease paperwork,” Hume said. Researching how to be a landlord is very doable, or you can hire a property manager for a fee of about 10 percent of your gross rental income. Hume advised shopping around, because some property managers will charge an additional 10 percent of the first year’s rent just to place the tenant.

Management tasks consist of determining how much rent to charge, collecting rent, collecting and refunding security deposits, finding and screening tenants, managing leases, keeping records, evicting bad tenants, and dealing with complaints, repairs, and emergencies.

Miller said it is important to have a good sense of self-awareness regarding what tasks you feel comfortable handling and which should be delegated to professionals.

  1. You must be able to qualify for two mortgages.

Assuming that your old home is not paid in full and that you cannot afford to pay cash for your new home, you will need to qualify for two mortgages to make your rental plan work.

Lenders may not count the rent from your former home as income until you have established a track record, Hume said.

Even if lenders do count your rental income, they may only count 75 percent of it to account for vacancies, Larson said, which could hurt your ability to qualify for a mortgage on your new home. (Related: Retiring with a mortgage)

  1. Choose your tenants wisely, but plan for wear and tear regardless.

As a landlord, you will need to get up to speed on local fair housing laws to make sure you do not violate any rules in advertising or screening tenants. Before accepting a prospective tenant, you should run a credit check, verify their bank account balances, speak with their employer, and speak with their previous landlord. You should also learn your local eviction laws to see how difficult it would be to manage a worst-case scenario and whether it is something you think you could handle.

Larson offered several strategies for minimizing wear and tear as well as its associated costs:

  • Do a walkthrough with the tenant before the lease begins and document all issues.
  • Collect an adequate deposit up front. The amount you can charge is limited by your state or municipality as well as by what people are willing to pay. Two months’ rent is more than most tenants will pay, but 1.5 months’ rent will cover damages and protect you if the tenant moves out without making their final rent payment. Also, the higher the deposit, the more incentive the tenant has to take care of the property.
  • Check on your property periodically. Larson said she once talked to a woman who rented to college students. By checking the units once a month and asking the students to pay immediately for repairs and damages, she avoided having damage in excess of their deposits.

The bottom line

Deciding to rent out your old home for extra income or to avoid selling at a loss could be a great choice that helps you build wealth. It could also be a huge mistake, if you do not understand that being a landlord requires a particular skill set and a commitment of your time and/or money. You also need to understand the complete scope of expenses that will eat into your potential profits and calculate whether your rental endeavor is likely to pay off. Indeed for some it may be advisable to consult a financial professional before taking the landlord plunge.

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