6 Considerations When Converting Your Home to an Investment Property
At some point in life, an opportunity may arise that allows you to move somewhere new, whether for a job, education or simply to start fresh. But what if you’re not ready to part with your home? Maybe you plan to return eventually, or perhaps it holds sentimental value and you want to keep it in the family. Fortunately, there’s a way that will allow you to keep your current home without having to pay a mortgage and juggle another mortgage or rent payment on a new home, as well – that’s where the term ‘investment property’ comes into play.
What is an investment property?
An investment property is one that is used for the purpose of earning a return on the investment (the price you paid for the home), either via renting all or part of it out, purchasing a fixer upper to rehab and resell, or a combination of both. In the event you choose to rent out your primary residence (or part of it), it’s more likely that it’s a longer-term endeavor and can be used to cover the mortgage and perhaps a little extra to put some cash in your pocket.
Implications of owning an investment property
It may sound like the decision to rent out your home is as simple as popping a For Rent sign in the yard, but you should know that there are quite a few rules and regulations that come along with investment properties. Certainly from the rental side, but it also has implications for you if you intend to secure a mortgage on another home elsewhere.
1. Homeowners association rules
Is there a [homeowners association HOA in your neighborhood? If so, you’ll want to check your covenants or governing documents to ensure that renting out your home is feasible. For example, in the neighborhood where I purchased my first home, only 20-30% of homes could be renter-occupied at any point. If we wanted to rent our home instead of selling, we would have needed to request permission from the HOA and if the percentage of leased homes was at the max amount, we would have been turned down.
It’s very important that you do this research up front, to avoid spending time and money preparing your home for rent if it’s not an option due to HOA rules.
2. Becoming a landlord
A big consideration before turning your primary home into an investment property is whether you’re ready to become a landlord. It’s not for everyone – but if you’re willing to take on the responsibility, there’s the potential for a big reward. Just breaking even on your mortgage can be a huge load off your shoulders when renting out your home, but when you have the ability to earn an income from collecting rent, that can be an exciting feat. Just don’t forget to make the following considerations:
Hands-on landlord vs. property management company. Managing the property on your own means you keep all the money in your wallet. However, if you’re moving out of the area, you’ll need to hand over responsibility to someone else to take care of the home.
Hire a lawyer. Sure, you can find anything on the internet these days – even a sample lease. But it’s a good idea to work with a licensed attorney to draft a lease for your property, ensuring you’ve included important rules and requirements of tenants who live in your home.
Obtain insurance. Work with an insurance professional to determine the type of coverage you need for your property to ensure you’re fully protected as a landlord.
Do your homework. When it comes to choosing renters, don’t skip the vetting process! Credit checks and references can go a long way in determining the type of tenants who have applied to rent your home.
3. Tax considerations
If done properly, owning an investment property can pay off in a big way. But the bigger the paycheck you receive, the bigger your tax bill will be. That’s why it’s so important to understand the tax implications, in order to find ways to save on taxes. Fortunately, you’ll be able to deduct mortgage interest and real estate taxes on the property (like all homeowners), but there are additional write-offs you may be eligible for as well specific to being a landlord, including:
Certain utilities
Insurance
Repairs & maintenance
Yard care
Association fees
Depreciation costs over time
Note that your tax situation will differ if you’re renting out only part of your home while you continue to live there, as you’ll need to divide up expenses between rental use and personal use. Be sure to consult a tax professional before pursuing an investment property.
4. Home value
Something you may not have considered is how your home’s value will be affected by renting it out, in the event you plan to sell or refinance in the future. For one, it’s a common fact that many renters simply don’t take the type of care an owner would when living in the home.
However, if you’re very careful in the vetting process, you may find tenants who love your home as much as you do – so don’t skip that step!
5. Changes to equity qualifications
In the past, there was a Fannie Mae requirement in place that stated the owner must have a minimum of 30% equity in the home before the residence could become an investment property. This rule has since been removed, and more favorable terms have been implemented that make it easier for you to buy a new home while renting your current home.
6. Your loan terms
Some loan products have primary residency requirements where the borrower must be the one occupying the home. Be sure to contact your lender to discuss your loan’s specific terms before making any rental decisions. If you’re considering renting out your primary residence and buying a new home, contact a mortgage banker to learn more about the process before taking the leap.