After months of searching, you’ve finally found the right home. But what if you now need to convert this primary residence into a rental property?
Perhaps your life has changed and your home just doesn’t meet your needs or that job you’ve been eyeing suddenly materializes—but it’s out of state?
Rest assured: it’s doable. But you need to know that facts before you jump into becoming a landlord. Let’s break down the basics.
Renting Out Your Primary Residence
Most lenders assume that owner-occupied transactions mean the homeowner will live in the home for at least 12 months. When you close, you sign documents attesting to that intention.
Financing a home as owner-occupied usually means significantly lower down payments, interest rates and other benefits. Additionally, you can often qualify for an owner-occupied refinance with less equity.
If you know that your plan has changed, you must be up front with your lender to avoid being accused of occupancy fraud, a form of mortgage fraud that happens when the borrower lies about the occupancy status of the property. Similar to banking fraud, this crime means fines, penalties and even jail time.
Lenders will usually require higher credit scores for renting out a primary residence. And buying a property to rent usually means a 15-25% down payment vs. zero to 5% down for an owner-occupied residence.
Non-owner-occupied mortgage loans can mean interest rates .5-.75% higher than for owner-occupied homes. Asset reserves may also be required for principle, interest, taxes and insurance (PITI)—usually six months PITI or more.
Don’t forget to provide your new mailing address to your lender so that you receive all important documents directly.
While rental properties can create healthy revenue streams for property owners, it’s important that you continue to plan and save for mortgage payments. There will likely come a time when the residence sits unoccupied between tenants and you will need to be prepared to pay the mortgage yourself.
You also need to assess whether you will make enough to cover the rent and afford a mortgage or payment on a place for you and your family to live.
Let’s take a look at all of the steps you should consider in determining rent. First up is to figure out income and all potential expenses.
It’s important not to fall into the trap of assuming the equation is simply rental income minus mortgage payment. Savvy landlords know to assume that expenses will eat up about 40-45% of monthly income, not including principal and interest payments.
Factors to consider when calculating expenses include the vacancy rate in your area, the age of your home and anticipated repair and property management fees (if applicable).
In the words of one real estate investment pro, “You should be highly focused on the investment aspect of your purchase to ensure that your home is truly an asset to your family and not a burden.”
Your homeowner’s policy no longer applies to a rental property. You will need to reach out to your insurance company and let them know of your plans. You should secure coverage that protects you from damage and loss and offers liability coverage in the event your tenant gets hurt on your property.
Lenders may request additional insurance coverage as you will have tenants moving in and out—and require that your tenants secure rental insurance prior to move in.
There are a number of legal factors to consider which vary based on your state. Research landlord and tenant laws and understand landlord obligations on things like lease agreements, security deposits, tenant screening, etc.
You also need to know about the Fair Housing Act to ensure you are not discriminating against potential tenants.
It will be important to maximize any tax savings. Talk to your accountant to learn the tax rules and know what can and can’t be claimed. Interest deductions for investment properties are different than those for rental properties.
You also need to understand if your homeowner’s association (HOA) allows rentals in your neighborhood. There is great variation in this: some HOAs prohibit them entirely, others allow only a certain percentage of rental homes and some may want to be involved in vetting potential tenants.
Your New Part-Time Job
As a landlord, your job isn’t over once a renter moves in. You may need to serve as real estate agent, repairman and possibly an evictor. And of course you will need to pay the taxes. If you don’t have time to take care of the day-to-day responsibilities, you should consider hiring a property manager.
Getting the Property Ready
Once you have your mortgage set up properly and have researched all of the legal implications, it’s time to get the house ready for renters. Take a look at other rental properties in the neighborhood and see what amenities, appliances and features they are offering. But don’t overdo it!
Every additional amenity means an additional potential maintenance expense. While a Jacuzzi tub sounds nice, it probably won’t bring in any more rent but will bring in big repair costs if not properly maintained.
Go ahead and hire an inspector to assess your property for any issues that may require immediate attention. Clean the home thoroughly and consider staging it and hiring a real estate agent prior to listing it.
You can also look for tenants directly by posting ads online or promoting with friends and colleagues. There are many online platforms that make it easy to list your home for rent from Zillow and Realtor.com to craigslist.
Once the home is officially listed as a rental, you will start receiving rental applications. It’s critical to screen applicants and check on their credit report, employment status and status with past landlords. Here are some of the key questions you should ask when screening a tenant:
- Can they afford to pay the rent on time every month?
- Are they able to move in/move out when you need them to?
- Will they be a respectful and safe tenant and neighbor?
- Are they agreeable to reference, background and credit checks?
And on the flip side, here are some topics that you cannot probe on based on the Fair Housing Act:
- Age of tenant
- Family plans
- Marital status
- Religious affiliation
- Place of birth
“Aspects of an individual’s identity that could be used to discriminate against them (even if it’s not at all your intention) are illegal. Even language that would seem innocuous, such as advertising a unit as ‘Great for young couples!’ shows a preference for one group over another and can be held against you,” notes a relevant post on Avail.com.
There are a number of tenant screening services out there. Here are some of the top ones outlining their capabilities.
The Pros and Cons
Below are some final pros and cons to renting out a primary residence immediately after purchase:
Smart way to diversify income and build wealth
Flexibility to live somewhere else without paying for unoccupied home
Great option if you inherited a property but don’t want to sell it or live in it
Potential tax deductions
Costs to get house ready for tenants
Time, energy and money to repair and maintain property
With market fluctuations, rental income may be less than expected
Risks of damage and missed payments
Potential for vandalism if rental stays vacant
Finding the Right Property
A lot of new investors are often unsure of how to find the right properties to convert into rental income, as some of the best deals aren’t found on MLS. As the largest source of distressed property in the nation, New Western offers investors a steady supply of value-rich, off-market properties ripe for rental.
Our agents serve as your boots on the ground, drawing on a wide array of data and unmatched local market knowledge to consistently source the best deals for you.
We also work behind the scenes to eliminate problems, deliver a clear title and provide a fast, seamless process to close.
Contact us today and open the door to more—and to improve our communities one neighborhood at a time.