Jack and Judy purchased their first house before the birth of their first son. Over the years, they have settled the mortgage loan for this 2-bedroom apartment and while their second child is on its way, they are planning to move to a more spacious home.
Since the market is not doing well, the property they liked is available at a beneficial rate, but at the same time, the deal for their existing home isn’t giving good returns. When they discussed the situation with their mortgage broker – Mr. Harris, he suggested Jack and Judy rent out the existing property that eases out their mortgage loan for the new house.
At Mares Mortgage, we’re providing easy options to refinance your home. Here’s everything you need to know about renting out your house to buy another.
Related: Questions to Ask a Mortgage Lender
What you Need for Renting
In certain conditions, when the existing house is no longer suitable for the family and they plan to go for a different house, they are left with two choices for the existing property – Selling or Renting.
Selling is the simple economic process of giving a product or service in exchange for money. Once sold, the seller no longer holds any right of ownership over the product or service.
Renting, on the other hand, is the process of allowing someone to use goods, services or property owned by the individual themselves in exchange for monetary benefits for a certain period of time. In real estate, the agreement for using the property is known as a lease and is fixed for a certain period of time. In most cases, the lease is fixed for twelve months, post which the owner has the right to get the house evacuated or increase the rent or both.
Weighing the possibilities
When managed wisely, real-estate is often considered the most reliable investment vehicle for securing a financial future. But that doesn’t mean all those who invest in it are making wise choices. One needs to be very cautious while investing in real estate and consider the downsides while renting a property:
- While it is considered to be the most desired investment, the real estate market is volatile and keeps fluctuating more often than not which can lead to bad investments.
- Depending on these market fluctuations, the rate of owned and rental property varies which can cause severe financial losses to the owner.
- Maintaining the property and getting reliable tenants is a dream for all house owners which seldom comes true.
- In case there are no suitable tenants available for renting, the vacant property turns out to be a costly affair to maintain.
While there are some downsides of renting a property, there are some things to count on too:
- It ensures a stable and fixed cash flow for a long duration.
- In some cases, renting provides extra income as long as the rent is higher than the installments of mortgage loans.
- While it depends on the market, but as a general norm, the rent of a property goes up every year which increases cash flow over the year.
- In case the real estate market is down, renting prevents from closing a bad deal and one can wait for better rates when the market bounces back.
- In some cases, the income from the rented property also provides a considerable tax benefit.
Related: Reasons to Refinance Your Home
Renting vs Selling
Is the move temporary or permanent? Is the move to get rid of the property or make financial gains? While it depends on an individual’s financial health to some extent, renting and selling is pre-determined by the purpose of conducting the activity.
As an owner of the house, if one is relocating or upsizing or downsizing from the existing property, below are some points to keep in mind when to sell and when to rent out the property.
When to sell?
- When trying to escape a dropping market.
- When requiring the equity from your current has to put as a downpayment on your new home.
- When you are not willing to get into the hassle of finding the tenants and maintaining the house.
- When looking for exclusion from paying capital gains tax on the sale of a primary residence property.
When to rent-out?
- When the move out is temporary.
- When the market looks good in the future.
- For making extra income out of an unused property.
- When the rent easily pays off the mortgage loan installments and covers the repair and taxes too.
In a nutshell, if an individual is simply looking to dispose of a spare property, selling or renting depends on the market condition.
If the real estate market is doing well and if the individual is able to get an appropriate return on their investment over the years, it might be beneficial to sell the property while the market allows.
However, if an individual finds the existing property unsuitable and decides to move to a different one and/or is relocating temporarily, they should consider renting the house rather than selling it.
Learn how Mares Mortgage is making the refinancing process easier than ever.
How to calculate rent
While calculating the rent of a property, various factors are to be taken into consideration. For example, the age of the property, i.e. how old is the construction, quality of construction, location of the property, availability of amenities and neighbors. While these factors affect the rent, below are some steps one must follow before finalizing the rent of their property.
Find the current monetary worth of the house in the market. Depending on the market health, the amount could be high or low from the amount at which the house was purchased. Mostly the rent of a house is a percentage of its market value that ranges between 0.8% to 1.1%.
If the property is rented out to pay the mortgage loan installment, then ensure the rent is slightly higher than the installment to factor in the cost of repairs and taxes involved.
Ascertain the rules and regulations involved at a state level for finalizing the rent of a property as in some states, the housing department regulates the property prices.
Consider doing a comparative market analysis to determine the competitive prices for a similar property.
Tax implications as a landlord
Once the individual rents out their property, he or she observes the role of a landlord which is entirely different from that of an occupant or an owner. While, as a landlord, one can’t claim the mortgage interest deduction, he or she can deduct some amount of expenses from their rental income while filing their tax returns which in turn proves equally beneficial to them.
As per the IRS Schedule E, some of the major expenses that can be deducted from the rental income include mortgage interest, property taxes, HOA dues, insurance and property maintenance fees among others. Furthermore, as a landlord, an individual also enjoys the benefits of depreciation depending on the current market value and/or editions made in the house.
Look for a Mortgage Broker
A mortgage broker is an individual or organization who assists in buying, selling or renting of real-estate property. They have a deeper understanding of market movements and are in a better position to gauge the rate of a property.
While the real estate market is highly competitive and volatile, a mortgage broker simply ensures getting the best deal for the house.
They are on board with the idea of finding and finalizing a suitable tenant for the property and extends to ensuring a smooth transition of ownership from the landlord to the tenant.
They are responsible for taking care of all the backend services such as placing an ad for the property, qualifying and managing clients, documenting the terms and agreements of the lease of a property once the deal is finalized.
Buying a second home
Before looking for a new property, one needs to asses the purpose of buying the same. Some of the reasons people tend to look out for a second home are:
When there is a house and family settled in a place, the chances of relocating are slim but not unacceptable. It can be in search of a new opportunity or availability of a better one that an individual relocates and move to a new city, state or country. In case the rental scenario in a new city is expensive or if relocation is permanent, it is advisable to buy a second home keeping in mind about the utility of the first one.
While the reason varies from affordability to need, an individual can look for a smaller house. They can choose to sell or rent out the first one depending on the financial needs.
When the members of the family are expanding and the existing house is no longer sufficient for the residents, one certainly looks for buying a second home that not only justifies the need but is also cost-effective as compared to purchasing two smaller homes.
4. Monetary Benefits
For some individuals, who have a monetary surplus, buying a second home is more or less an investment that allows them to enjoy tax benefits and put the surplus money to good use.
The Bottom Line
Real estate investment can be a scary but rewarding proposition if one keeps in mind the implications of their activities and are willing to inherit the risks involved. With a bit of due diligence – and sometimes smart cashflow acrobatics – transitioning from one house to the other can be not only seamless, but profitable.
Now that you know about renting out your house, contact Mares Mortgage to find about various refinancing and loan options.
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Related: A Guide for Avoiding First-Time Home Buyer Mistakes