How To Buy a Second Home or Investment Property and Rent Out the First

The last time you vacationed in your favorite location, you thought, “Wow, I’d love to buy a place here.” If you’re in the market for a second home, a rental property or a combination of the two, the key is to be in a strong financial position.

You’ll be focused on finding a good property in a neighborhood you enjoy. Then you can figure out how you want to use your property. Maybe you will use it solely for a personal getaway. Maybe you’re interested in renting out your property when you’re not using it.

Buying a Second Home or Investment Property

Depending on your familiarity with the region, this decision could require significant research to find good properties in good neighborhoods. Once you do, it’s important to have a smart, solid plan in place. The strategy should include:

  • What type of property you want to purchase
  • How you will use the property
  • How you will pay for the property
  • How you will sell the property, just in case you want to

It’s best to prepare for all contingencies; otherwise, the cost of owning, maintaining and managing this second property could cause some headaches.

When renting, it’s important to know the local vacancy rates and have a financial cushion in place to weather any slow times during the year. It’s also important to know the average market rate for rentals in order to price your property accordingly.

Expenses related to a second property go beyond the purchase price, property taxes and insurance. There are regular maintenance costs that might come into play more often than with your primary residence. Also, you may be paying for a property manager if you’re a considerable distance from your second home, or a bookkeeper to manage the rental’s finances.

Many real estate investors subscribe to the 50% rule on investment properties, meaning over time, on average, the expenses on a property equal 50% of the rental income prior to paying the mortgage. The point is, go into this with your eyes open. That will help you get the most out of your investment.

When it comes to financing your vacation home/rental property, turn to MaraiD Lending Group for various mortgage options, including fixed rate mortgages, Private Loans, hard Money Loans, and more.

So, you’ve decided to buy a second home or investment house and rent the first one out …  great. Now you have to figure out the steps needed to make it happen. Funding the purchase of your second home, becoming a landlord, and understanding the financial implications of multi-homeownership, sounds like a lot. Get in touch with an experienced real estate agent to help you begin the journey of buying a second home or investment property.

Luckily, we’ve prepared an ultimate guide, jam-packed with all the information you need to make the successful transition from homeowner to a home-owning landlord. Here’s what you need to know about renting out your first home.

Why Turn Your Home Into a Rental Property?

The upfront costs of purchasing a second home or investment property deter a lot of potential buyers, especially those who are already dealing with the costs of their first home. However, shifting the costs of the first home to tenants by renting it out creates potential passive income and tax benefits. Unfortunately, it also means that homeowners take on the job of managing a property and becoming a landlord.

Pros and Cons of Renting Out Your Home

Be forewarned, buying a second home and renting out your first is not an easy venture. Fortunately, it pays off in the long-run, especially if it’s carefully planned and executed. You’ll have to decide if it’s right for you.

5 Pros of Renting Out Your Home

  1. Generates Unlimited Passive Income
  2. Tax Breaks and Benefits
  3. Increase Your Assets
  4. Star Your Real Estate Investment Journey
  5. Long-Term Profits

Cons of Renting Out Your Home

  • Tax Filings are More Complex
  • Act as Landlord and Property Manager
  • Costs

Can you rent out a house you have a mortgage on?

It’s possible for homeowners of renting out a mortgaged home. You’ll need to check the fine print of your lending agreement to find out whether you’re allowed to make your first home a rental property.

Some lenders have clauses against rental properties. Others have stipulations that require you to wait a certain period. If you find that your lender doesn’t allow renting, it may be possible to refinance with another lender that allows the change.

Tax Implications of Renting Out Your House

The classification under which your home qualifies will have a major impact on your tax filings. A tax attorney or CPA are an excellent resources for deciphering the complex language of the IRS. The most important aspect of the tax implications of renting out your home is determining whether your first home qualifies as an investment property or a vacation home.

Don’t make the mistake of thinking that’ll you’ll be able to deduct your mortgage interest. Tax laws change all the time and as of 2019, mortgage interest deduction is nonexistent. There are many other deductions that apply to rental properties, common expenses are:

  • Repair and Maintenance Costs
  • Realtor Commission Fees
  • Mortgage Valuation Costs
  • Eviction Costs
  • Depreciation Costs
  • Property Purchase Legal Fees

How to Afford Two Homes

Whether you utilize a conventional loan, take out a HELOC.  You also can look for a Private Loan, Hard Money Loan or pay in cash. Buying a home will have a major effect on your finances. It does not matter which options you use in MaraiD Lending we help you.

To successfully pull off buying a second home, you need to determine your financial health and assess your options. It’s essential to choose the right method of funding the purchase of your second home, here’s what you need to know to help you make the right decision.

1. Evaluate Your Finances

Buying a second home or investment property means double the financial burden. Savvy financing can help to save you money in the long run. Whether you use a HELOC, a conventional loan, a private or hard money loans or buy with cash, you can expect higher interest rates, increased down payments, and more stringent income requirements.

However, consulting with one of our loan specialist can help you understand your financial needs. Anticipating the costs associated with buying a second home is essential as you’ll be taking on a debt that you must pay off on a monthly basis.

2. Take out a Home Equity Loan or HELOC

Home equity loans and HELOCs allow homeowners to utilize the equity of a home borrowing and money against it. These loans are typically used to make renovations on homes. But they can also be used to fund a down payment on a second mortgage loan.

They have many similarities but are two different types of loans. Interest rates vary among these loans and will depend on your lender. One of the biggest drawbacks to using a HELOC or a Home Equity Loan is the risk of losing your home if you’re unable to repay the loan.

3. Talk to Your Homeowners Insurance Carrier

Your current homeowners insurance carrier will need to be notified if you rent out your home. Your rates may change depending on whether you purchase supplemental homeowners insurance or landlord insurance.

People talking with a Realtor

4. Understand the Tax Implications

An experienced tax attorney CPA will ensure that you don’t overpay in taxes on your rental property. And can help to get you deductions that you might not have known your property qualified for. Current tax code allows homeowners to deduct certain expenses such as mortgage interest, insurance costs, property taxes, and other rental expenses. You can also deduct depreciation from the value of your home.

5. Find Tenants

Finding good tenants is imperative to the success of being a landlord. Difficult tenants are nightmares and can damage your home, cost you money, and even force you to take them to court during eviction proceedings. Thorough tenant screenings can help to offset the chance of these things happening. Quality tenant screening consists of:

  • Background checks on all adults over the age of 18 living on the property.
  • Ensuring that the tenant has a stable job.
  • Credit checks.
  • Following the 3:1 rent to income ratio.
  • Obtaining a tenant history.
  • Calling previous landlords.
  • Making sure the tenant has a support system.

6. Decide How You’re Going to Manage the Property

Property managers have a myriad of responsibilities that range from small repairs, landscaping, collecting rent, and communicating with tenants. If you’re renting your first home while maintaining your day job or you’re not handy, it may not be feasible for you to handle property management yourself. Hiring a property manager at the industry-standard rate of 8%-12% of the collected rent income can be a major hit to your profit margin.

7. Set Up Your Financial Infrastructure

Collecting rent, holding on to security deposits, and keeping a healthy savings fund for maintenance and repairs — landlords have the pleasure of handling all these financial responsibilities. Prior to renting out, it’s a good idea to ensure that you have a solid savings account to cover any repair and maintenance costs.

Landlords will have to determine how they want to collect rent from tenants. It’s imperative to keep a record of any rental payments whether they’re collected via mail, an online platform, or you collect the rent in-person. Not to mention, it might be necessary to set up an escrow account to hold on to security deposits from tenants.

Next Steps

If you’ve completed the initial steps in buying a second home to rent out the first, you’re ready to look for your next property. Choosing the right lender and securing financing early on, is the best way to get the process started. Getting connected with a talented real estate in your area will save you a lot of time, effort, and surprisingly, money.

A buyer’s agent will help you through buying your second home from getting you showings, putting up an offer on the home that you choose, and finally, closing on the home. Once you’re settled into your new home, you’ll be ready to begin your landlord duties on the first.

Financing Options for a Vacation Home or Investment Property

For many home purchasers, an FHA-insured loan is a prime choice because these loans require a down payment of just 3.5% and lenders offer the loans even for borrowers with lower credit scores, down to 580 or even lower in some cases. However, second home buyers are not allowed to use FHA loans for their purchase; these loans are limited only to homes that are the borrowers’ principal residence.

Option 1: Cash

If you can manage to save enough, an all-cash purchase is the easiest method to pay for a vacation home. In fact, the National Association of Realtors (NAR) survey of home buyers and sellers 21% of all buyers in January 2020 paid cash for their home purchase, and 17% of all homes sold were vacation and investment properties.

Option 2: Home Equity Loan

For homeowners who have substantial equity in their property, a home equity loan may be an option. However, many homeowners have lost equity due to the drop in home values in recent years, so having enough equity to purchase another home is rare. In addition, lenders are less willing to approve a home equity loan that drains too much equity from the principal residence out of concern that home values could continue to decline.

Lenders assume that if the homeowners run into financial trouble, they will be more aggressive in keeping up with payments on the primary residence rather than the vacation home.

Option 3: Conventional Loan

Conventional loans for vacation homes are an option, but be prepared to make a larger down payment, pay a higher interest rate and meet tighter guidelines than you would for a mortgage on your principal residence. The minimum down payment for a vacation home is usually 20% for a mortgage guaranteed by Fannie Mae or Freddie Mac. Many lenders have raised their minimum down payment requirement to 30% or even 35% for a second home.

To qualify for a conventional loan on a second home, you will typically need to meet higher credit score standards of 725 or even 750, depending on the lender. Your monthly debt-to-income ratio needs to be strong, particularly if you are attempting to limit your down payment to 20%. All borrowers need to fully document their income and assets for a second home loan because lenders will need to see significant cash reserves to make sure you have the resources to handle payments on two homes.

Vacation home loans often have a slightly higher interest rate than a home on a primary residence. Lenders base pricing on risk and they typically feel that the borrowers are more likely to default on a vacation home loan than the mortgage on their principal residence.

4- Hard Money Loan

Hard money loans are an alternative financing option commonly used to finance properties that won’t be approved for traditional financing, like a fix and flip. and fix and hold. Investors can secure financing for a property up to a certain percentage of the property’s current or future value (after repair value) and will include the cost to renovate or repair the property into the loan.

This means if you negotiate a great deal with a super low purchase price, and you are within the hard money lender’s loan-to-value requirements, you could possibly purchase the property with no money or very little money down.

Hard money loans are normally short term, lasting anywhere from 6 to 18 months (some times more0, with very high interest rates, around 7% to 12% higher than a traditional mortgage. So this method of buying a rental property with no money down is typically best if you have good credit and plan to do a cash-out refinance after the property is repaired and rented.

6. Private Loan

One of the most common methods of buy a second home or investment house with a little money or no money is to buy an investment property using other people’s money (OPM). You can find a private lender or funding partner willing to partner on the investment, giving you the funds needed to purchase the property. This could be the down payment alone or the entire purchase price in cash in exchange for a return on their investment.

Partners could be family members, friends, or colleagues, and there are a variety of ways to structure their return, like:

  1. A joint venture (JV), where ownership of the property or company is shared in respective percentages. Rental income, equity, and appreciation are typically shared with the partners respectively.
  2. A lending agreement, where the investor receives a preferred return on their initial investment
  3. A private loan, where the partner is repaid with a monthly payment, which could be interest-only with a balloon, or a principal and interest payment.
  4. A combination of the above.

For those who plan to rent their vacation home for extra income, not all lenders will allow the rental income to be considered for the loan qualification. Some will allow only a percentage of the rent payments as income, and others will require a documented history that the home has been consistently rented.

If you are daydreaming about buying a home at the beach or in the mountains, contact us today to review your options at Contact@MaraidLending.com