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If this is you, you could consider buying a second home using the equity in your primary home. If you have built enough equity in your first home, you can refinance to buy a second home. Even then, the IRS may still deem your home an investment property, since they use their own set of rules. Purchasing a second home and renting the first one out isn’t always the best option, but given the rising demand for rental property, it may be something to think about. Be sure to weigh the benefits and drawbacks, evaluate your financial situation, and run the numbers to determine the potential return before renting out your home. A challenge that can be easily overcome is coming up with the money for a down payment on a second home.
Yes, you can live in your investment property, however, there are tax implications if you do so. If you rent out your home for longer than 14 days out of the year, your rental income will become taxable and you must report it to the IRS. If you sell your investment property, it will be difficult to avoid capital gains tax under a 1031 exchange if you’ve lived in the property. The upfront costs of purchasing a second home 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.
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The beautiful thing about buying a home to rent out is that you don’t have to find things that you necessarily like. It’s a home that someone else would want to rent, so your particular preferences don’t come into play. Crunch the numbers to determine how much cash you'll need on hand, how much you may be able to borrow and what your ongoing budget will look like. Comparison shop lenders to make sure you're getting the best possible deal. If you've bought a vacation home that's far from your current home, don't forget to budget for trips between the two properties.
You’re thinking about your legacy.Your legacy goes beyond leaving your home to your family, although that should be a consideration, too. You may want to buy once you’ve found the perfect spot and want to host your grandchildren. The day after Christmas, my dad will head to Florida for the winter to escape the brutal weather in Michigan, where he lives.
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Of course, it means you can’t count on using your equity in your current home to help purchase your second. According to the National Association of Realtors, as of 2018, the median US homeowner owns their home for about 13 years. Many people, therefore, can expect to purchase more than one home in their lifetime. If you’re getting ready for your next move but are curious about hanging on to your current home to generate rental income, here’s how to buy a second home and rent the first. The second lesson is that second home renters can be repeat customers for decades. Determining your rate of return on a vacation rental is made much easier in this regard.
Even though the demand for rental property is strong in most markets, some homes generate more financial return than others. Coming up with the cash for a down payment on a second home may be an obstacle that is easily overcome. A home equity loan or home equity line of credit is a loan used to pull equity out of a first home to fund the down payment of a second home. Other sources for finding money for a down payment may include tapping into a retirement account, doing a cash out refinance, or borrowing from family and friends. According to Brown, there are also new regulations in place — depending on where you live — that help to assure lenders that you’ll have renters before you get the keys to your new home. This can be a great opportunity to start building a real estate portfolio and potentially make some extra cash.
Understand the Tax Implications
You will need a substantial down payment, and a budget of 30% of the assessed value is reasonable. You should also make sure you have enough cash reserves for a down payment and unexpected expenses. You will often need a down payment of at least 20% of the purchase price. Consider all factors and make sure your finances are in order before applying for a second home mortgage.
Try Mashvisor’s heatmap analysis tool and property finder to enjoy choosing from the list of the best investment properties out there! Keep in mind, hiring a property manager can cost you anywhere from 8% to 12% of your monthly rental income. Be sure to calculate whether you can afford to pay both a property manager and cover your mortgage payments. Turning your existing home into a rental property can be a great investment, earning you some extra income. You’ll want to thoroughly research your rental market to determine if renters will find your home and location desirable. However, you will also need to prove you have enough savings to cover mortgage payments in case you’re unable to find tenants or your renters can’t make their monthly payments.
This may influence which products we review and write about , but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services. We believe everyone should be able to make financial decisions with confidence. For many Americans, the equity we have in our home – the difference between what we owe on it and what it’s worth – is our biggest asset. You may be able to share ownership of a second home with another borrower and still make your dream of owning a second home come true.
The type of property, how you’ll find tenants, and how you’ll manage the property are just the tip of the iceberg. But you’ll still need to have reserve funds to prove you can make payments on the loan if you’re unable to rent the property. The reserve funds should typically comprise 2% of the unpaid balances of all of your mortgages for those who have fewer than four financed properties. Keep in mind, you can skip this step if you won’t need rental income to qualify for your loan. Financing requirements of second rental homes are typically more strenuous than those of first homes.
Most likely, you’ll need a down payment for your second home, which is ideally 20% of the property’s cost. If you can’t afford that full 20% amount, you’ll need private mortgage insurance that will add to your monthly costs. In my family, we have experience with second homes in all three ways.
If managing your rental properties seems like a daunting task, you should consider hiring professional property management. To get approved for a second home mortgage, you need to have sufficient income. If your primary residence currently has a mortgage, your income should be enough to cover both mortgage payments while maintaining a debt-to-income ratio below 41%. Otherwise, make sure you first work on your DTI ratio by reducing your total monthly debt payments, increasing your income, or both.
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. 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. So a $300,000 property would cost roughly $3,000 per year to maintain. However, you may want to increase the percentage to 1.5% or 2% if the property is older.
Need more information on how to buy a second home and rent the first? If you choose a cash-out refinance or to open a HELOC, we’ll make the process as easy, quick and beneficial as possible. In addition to funding a second home down payment, a cash-out refinance or HELOC can be used for repairs and remodeling on the first home. Whether you go with a cash-out refinance or a HELOC, using your home equity is a great source for your second home down payment. This allows you to put the equity you’ve built in that first home to good use. It’s essentially a way of making all the money you put into your home over the years work a little harder for you.
She was a trainee lawyer before switching to writing about real estate. Before buying a second home to rent out, you need to consider mortgage shopping. One factor that may take you by surprise is the emotional attachment to your first home. You’ve likely created a lot of memories and hit many milestones within those walls. A lot of your personality, energy, and effort went into making the house a home.
If you're looking long distance and can't visit the property in person, a good agent can be your eyes and ears on the ground. Demonstrating income potential from a home that's already a rental isn't too hard, so long as the seller is willing to share that information. If the home isn't currently rented, the lender may want a rental appraisal to show that the property is marketable. Be sure you can cover costs if you don't get tenants right away or if your short-term rental has an unexpected dry spell. Typically, the right choice depends on your specific situation.
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