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Buying a new home is often an exciting and thrilling experience, but it can also be daunting. With all the decisions that need to be made, one of the most critical is what to do with your current home. In most situations, the answer is relatively easy, sell it! Often those looking to buy need the $ trapped in the equity of their current home to pull this off. But what if you could buy a new home without utilizing the equity in your existing home? Would you consider turning your current home into a rental? This blog post will discuss the Pros and Cons of keeping your current home and turning it into a rental property.
About the Author
I, Todd Davidson, have been a landlord for 20+ years. It's been rewarding and profitable for me and my family. That said, it hasn't been without its headaches and stress. I'm also a mortgage broker and am well-versed in getting a mortgage in this or any other situation. For more info on me, CLICK HERE.
The Pros:
Steady rental income: One of the biggest pros of becoming a landlord is the potential for regular rental income. By renting out your property, you can generate monthly rental payments to help offset the costs of owning the property, such as the mortgage, property taxes, and maintenance expenses. Depending on your mortgage payment and how much you can rent the home for, it's possible to generate a positive cash flow. Even if it's not right away, rents will likely increase over time, and your payment will stay about the same (taxes/insurance can go up), so renting the home for more than your payment is possible.
Principal Reduction: When you make your mortgage payment every month, the principal balance decreases. How much depends on your loan amount, loan term, and how long you've had the loan. Regardless of how much the amount is, when your principal balance decreases, it's essentially like putting $ in a savings account, as you'll get those $ back someday when you sell the home, and the decreased loan balance means you'll pay slightly less interest each month. You don't see or feel the benefit of this right away, but long term, this is one of the biggest pros of becoming a landlord.
Tax saving benefits: As a rental property owner, you'll get several tax benefits, including deductions for mortgage interest, property taxes, repairs, maintenance expenses, and, last but not least, depreciation. Check with your accountant, but in most instances, what you paid for the home (not counting the land) can be depreciated over 27.5 years. Your property tax statement should show you the value of the Land & Structure to help you/your accountant figure this out. It's possible to break even or even cash flow yet show a tax loss creating a deduction for you. Again, speak with your accountant!
Appreciation potential: Real estate markets tend to appreciate over time, which means that the value of your property may increase over the years. Holding onto your property may generate a significant return on investment over time. This is the first pro everyone thinks of when they consider becoming a landlord, and it's one of if not the biggest benefits!
Investment opportunity: Turning your residence into a rental property can be a wise investment strategy, particularly if you want to diversify your portfolio. Real estate can be a valuable asset class providing long-term financial benefits.
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The Cons:
Rental management: One of if not the biggest cons of becoming a landlord is rental management. Owning a rental property requires active management, including finding and screening tenants, collecting rent, and addressing maintenance issues. If you are not prepared to take on these responsibilities, consider hiring a property management company to handle these tasks for you, but that will erode your potential income.
Potential for vacancy: Depending on your market, its possible rental properties can be vacant for extended periods, which means that you may not be generating rental income during these periods. Additionally, you will need to cover the costs of the property during these periods, including mortgage payments, utilities, and maintenance expenses.
Taxes > Loss/Reduction of Capital Gains Exclusion: One of the biggest tax breaks the IRS affords us is the capital gains exclusion on the sale of your personal residence. If you've lived there for two years, you can exclude up to $250,000 of the gain if you're single, or if you're married, filing jointly, you can exclude up to $500,000. By turning your personal residence into a rental, you don't necessarily lose this exclusion. If you have lived in the home for at least two of the past five years, you may still be eligible for the capital gains exclusion on the sale of your primary residence. If you exceed that threshold, you can potentially lose some or all of the exclusion. Check with your accountant regarding all the tax implications before turning your personal residence into a rental.
Wear and tear: Tenants may not treat your home the same as you did when you lived there, which can result in increased wear and tear, and can increase maintenance costs. From experience, this is a big con of becoming a landlord. Many tenants don't treat your home like you'd want it to be treated. On the flip side, I've had tenants leave and the home was immaculate. It really depends on the person.
Legal responsibilities: As a landlord, you will be responsible for complying with various legal requirements, including fair housing laws and lease agreements. Failure to comply with these requirements can result in fines and legal penalties. Hiring a professional property manager can help with this.
Emotional attachment: If you have an emotional attachment to the property, it may be challenging to see it as a rental property, making it hard to make objective decisions about the property, such as setting rental rates and making upgrades and repairs.
Conclusion:
Turning your personal residence into a rental property can be a wise financial decision, but you should consider the pros and cons before deciding. If you are prepared to take on the responsibilities of owning a rental property and are willing to accept the potential risks and challenges, it can be a profitable and rewarding investment opportunity. However, if you are not prepared to take on these responsibilities, selling the property and investing in other assets may be the better decision.
Below are a few tips and things to look into:
Talk to your current loan servicer - Before turning your personal residence into a rental, you should check with your loan servicer, though if you've had your mortgage for more than a year, there will likely be no problem doing this.
HOA - If you have an HOA, check with them first. Many have restrictions on turning a personal residence into a rental, and all will have rules governing rentals in the development.
Current rental market - Know your market, how quickly things rent, and how much you could reasonably rent your home for. You will lose $ quickly trying to rent for too much or leave $ on the table by not renting for enough.
Accountant - Talk to your accountant about the tax laws and potential deductions. Or research online. If you only plan to do this for a few years, it might not be advantageous tax-wise.
Lease agreement - Your best resource for this is to look online. You can get a lease through many legal/document sites. Google "State" Lease Agreement.
Insurance - Talk to your agent before turning your personal residence into a rental. Insuring a rental is slightly different than the home you live in. You might consider Umbrella insurance (extra liability insurance) as well.
Property manager - This adds to the expense. You can expect to pay around 8% of your monthly rent plus re-leasing fees (some are more, some are less). Check around and make sure and factor this into your budget if you go this route.
If you manage yourself - Be prepared for a call when you least want it. Not always, and probably not that often, but if you're a landlord long enough, it will happen. Also, get to know a good handyperson if that's not your thing.
Are you buying another home? - You have to live somewhere, right? There are rules on the amount of rent you can count as income for purchasing your new home when qualifying for a mortgage. If you'll need to use the rental income to qualify, reach out to me. Happy to discuss this with you. https://www.livinginoregon.net/todd-davidson-mortgage-broker
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