How to Buy a Second Home and Rent the First

The median U.S. 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.

This can be a great opportunity to start building a real estate portfolio and potentially make some extra cash. Of course, it means you can’t count on using your equity in your current home to help purchase your second. However, this is completely doable if you’re working with the right real estate experts, according to April Gongora Brown, a New Orleans-based agent who has sold 73% more properties than the average agent in her area.

“Get with an experienced agent that can walk you through the process because it is overwhelming whether you’re just buying or you’re selling at the same time as buying,” she says.

Let’s walk through the steps it takes to plan out renting your current home and finding a new place to live simultaneously.

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1. Assess the feasibility

First, you want to determine if your home is quote-unquote “rentable.” For example, a one-bed-one-bath might be harder to rent out compared to a two-bed-three-bath or three-bed-three-bath, but you should work with your agent to see what’s in demand in your area. Once you get into four-bedroom territory, renting it out could also get increasingly harder.

You’ll also need to determine how much you can realistically charge in rent while still being able to pay your current mortgage — especially if you plan on taking out an additional mortgage on your new place. If you can’t pay for your new home upfront in cash, the idea of carrying two mortgages can be scary, so you need to make sure you can swing this plan financially — especially if you can’t find a tenant right away.

But according to Brown, it is possible to pay your mortgage with rent as long as you have good tenants and a good interest rate on your existing mortgage.

2. Think about managing tenants

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. In order for a property to be considered a rental property, the owner will have to have a rental agreement, a deposit, and first month’s rent, in order to obtain financing for the second home that they’re going to live in.

“If not, then it’s all considered debt, and they won’t let you calculate any of the rental income as income,” she says.

You also need to consider whether the theoretical rent payment plus your income will cover your financial needs, and whether you can afford two mortgage payments (or have enough savings) if a tenant unexpectedly moves out or doesn’t pay rent on time.

But Brown believes an experienced agent can help assess the market and determine a realistic rent as well as whether you could get tenants for that rate.

How do you plan on managing your rental? If you live nearby, it’ll be easy to be there to fix a leaky faucet or replace a missing set of keys. But if you’re moving across state or city borders for your new home or are nervous about becoming a landlord, you might want to enlist help from a property manager. That can cost between 8% and 12% of the monthly rent you collect, which could affect whether or not you can comfortably afford your mortgage payments.

3. Look at your current home’s mortgage loan

Next, you need to double-check whether you can legally rent out your home by looking at your current loan agreement.

Most loans on your primary residence will stipulate that you have to live in the house for a certain amount of time — usually 12 months — before you can rent it. Other loans may prohibit you from renting your home at all, so it’s important to read the fine print, or you may need to refinance your loan to go through with this plan.

Depending on where you’re living, there may be restrictions within your homeowners’ association (HOA) that limits your ability to rent. But Brown says these restrictions are likely geared toward short-term vacation rentals rather than year-long leases.

4. Sort out the finances

Before you even think about renting out your first home and looking into buying a second, you’re going to need to sort through your finances with some assistance from your lender, insurer, and a tax expert. With two properties, you’ll typically pay higher interest rates, will have to offer increased down payments, and lenders have more stringent income requirements — but experts can help walk you through everything.

Lender considerations for a second home

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 (PMI) that will add to your monthly costs.

There’s also the option to take out a home equity loan or home equity line of credit (HELOC) on your current home. This can be used to fund a down payment on an additional mortgage loan, but you risk potentially higher interest rates and the chance of losing your home if you’re unable to repay the loan. There may also be occupancy restrictions that come along with that new loan that will prevent you from renting that property for a period of time, so be sure to fully explain your plan to your lender.

Talk to your insurer

Since you’ll be responsible for a property, you’re probably going to want to get rental property insurance — a.k.a. landlord insurance. This will cover everything from property damage to liability costs to loss of rental income.

Talk to your insurer so you can switch up or add to your insurance policy. Also, don’t forget to set aside some extra cash for maintenance and other costs; luckily you’ll be able to claim some of these expenses as a tax deduction.

Consult a tax attorney

Owning a rental home will change the way you’ll file your taxes, so it’s good to have a tax attorney walk you through the implications — starting with whether your home qualifies as an investment property or vacation rental. Plus, you’ll need to consider the taxes you’ll have to pay on your rental income as well as the deductions you can claim, such as repair and maintenance costs, Realtor commission fees, mortgage valuation costs, eviction costs, and depreciation costs. Be sure you set some money aside for these taxes and maintenance, and factor both into your budget.

Consult your loan officer

Some good financial news! You might be able to use your rental income to help offset your debt-to-income ratio when applying for a mortgage on a second home, so be sure to talk to a licensed loan officer about that possibility. Using a Fannie Mae Form 1007, a rent schedule completed by a licensed appraiser will compare your home to similar rental properties in the area. The lender can then use this appraisal to assess your loan-worthiness, and it will also give you a good idea of what you can charge for rent.

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.

5. Get your house ready to rent

Once your finances are in place, it’s time to get your home in rentable shape.

Brown recommends looking at the place with a fresh set of eyes as if you’re going to sell it. Although you probably won’t need to make any major renovations as if you were selling it, you will need to make repairs like scraping and repainting peeling paint or fixing a leaky sink.

A good agent can also help you understand what a rental-value home looks like in your area so you don’t overdo it (or, potentially worse, underdo it), and not pay for fixes without a good return. Brown also recommends having strong communication with your tenants, so they know to notify you of any issues before they potentially become costly damages.

Your agent can also help with the simultaneous process of finding a new home and finding renters. Brown suggests working with one agent who knows the time frames and the pressure you’re under to fill and find a home, as well as an agent who is committed to finding tenants who will pay rent on time and will treat the property with respect.

Make your transition

So, you’ve taken all the necessary steps to prepare your first home for rental. You’ve taken out your home equity loan, made small repairs for the tenants, and found tenants who will be ready to move in soon. Now, it’s your turn to find your new place to live.

Ideally, it will be a place you can grow into for a few years until you’re potentially ready to move back into your first place or move on again. Again, a top-rated agent can help you with this house-hunting process under these stressful conditions and time restrictions and keep things streamlined the whole way through.

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