Buying a New Home and Converting Your Current Home Into a Rental Property

As it stands right now, in less than six months' time, we plan to buy a new home and at the same time become the landlord of the town home we currently live in. Here's our plan:

Step One – Refinance Our Mortgage

We've already completed this step. By refinancing our mortgage, we reduced our mortgage payment by enough to allow us to rent out the property by at least a hundred more per month than all of our expenses: mortgage, property taxes, insurance, home owners association dues, repairs, and property management fees. Here's what our rental investment should look like per month:

  • Rent – $1,700
  • Mortgage – (850)
  • Property Taxes – (350)
  • HOA* – (175)
  • Insurance (25)
  • Management (100)
  • Misc. (0-100)
  • Cash Flow – $100-$200 a Month
*Includes external maintenance and insurance on the town home.

Step Two – Save Up a New Down Payment

We are in the process of saving up for a down payment on a new home. We should be able to reach our goal of a 20% down payment by next February. The big x-factor is 2011 self-employment taxes. This will be our first full year with only self-employment income, and so I'm not exactly sure where our taxes will land. I plan to sit down with my father (who's CPA firm is now managing my accounting) and get an estimate going. One radical thing we are planning to do to get the down payment quicker is to sell our second vehicle. More on that in a future post.

Step Three – Find a Property Management Company

I'm not interested in going this alone, especially my first time out. I'm sure I *could* do it, but I want the hand-holding, and our expenses should be low enough to afford this and still “cash-flow” the property.

Step Four – Get a Rental Agreement

I've been told by several people that have successfully pulled this off (two mortgages) that we will help our chances of getting a loan for our new house by getting a rental agreement in place prior to applying for the mortgage. This makes sense. A bank needs to know that you are capable of paying both mortgages, one with your business/employment income, and the other with rental income. I'm confident we can do this quickly. Rents are strong right now and getting a tenant should not be a problem, especially using a property management company.

One thing to consider before converting your home into a rental property is the change in tax treatment. You have to pay taxes on any gain from the sale of a rental property. You don't if it's your residence.

Step Five – Get New Financing and Find a Home

This is where it gets tricky. Once we get a rental agreement with a tenant, we will need to move out of the home to make way for them. We want our next house to be the one we are in for a long time (i.e. till the kids graduate). So, I don't want to rush this process. I'm mentally preparing that we may need to rent an apartment or do an extended stay hotel until we can find the right home, close the loan, and move in.

Why We Are Doing This

  1. For starters, we bought this town home with the idea that it could possibly become a rental property for us in the future.
  2. Second, we want a new home with a yard and more space.
  3. Third, selling isn't an option because we cannot stomach the idea of losing money to sell our home. We bought this home at the top of the market in December of 2006 with a 20% down payment. It's now worth $10,000 less than what we paid for it. Neither Mrs. PT or I feel good about selling this home and losing the hard-earned money we put into it. We'd rather take our chances on becoming land lords.

What are your thoughts on our plan? Are we missing anything? Will this be a slam dunk, or will it be harder than we think?

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  1. Hi Phil!
    We took a similar plunge. However, we actually let the house sit empty for way to long before we rented out because it needed some repairs. We used to come up with a good rental price. I found a property manager and they tried to convince to rent for $400 less than what suggested so I met them half way. The tenant had no problem renting at the advertised rent (the house is beautiful after all of the work we put into it), which makes me feel that I probably should have gone with my gut. I’m still trying to figure out when/if to raise it. She’s a good tenant so we’ll sit for now. We’re 8 months through the lease and so far; so good. The property manager is a nice to have but they really don’t do anything but collect the rent. I even have to handle contact maintenance/repair vendors (what good are they?!). I’m thinking about firing them. The most value we got out of them was handling the credit/background checks.
    Another tip – in many states, if you once had a homestead exemption tax on the house, once it’s occupied by tenants, the house it taxed at a different rate. Remember to factor this in and contact the county to have your tax bill adjusted so that you don’t end up with a huge bill of retroactive taxes down the road.
    Also, be sure to change your insurance from residential to landlord insurance on the property.
    We’re barely breaking even but it’s better than nothing.The federal government now allows homeowners to refinance under the Making Home Affordable Plan even if you no longer live in the house so we may look into that to lower the mortgage payment.
    Lastly, we found a house in a neighborhood that we’re likely to buy in the future and just rented it out until we save enough to buy it. Worse case scenario: we won’t like the house after having lived in it but there will be others in the subdivision to choose from to buy once we’re ready. 😉
    Good luck!!!!!!!!!!!

    • Philip Taylor says:

       @atrapp Thanks, good tips about the rent price site and the change in tax/insurance. I’ve read a lot of Mr. Landlord and he actually recommends having a rental price negotiation with each new applicant. Rent is very homogenous in my townhouse community so it was easy for me to find a price. But I can see how negotiating each time with new applicants could work. Good luck to you as well.

  2. John Huner says:

    Good plan and good luck. My plan was to sell an interest in my house to maybe my brother (or someone) as a way to raise some of the next down payment and also share some of the risk (in case there were expense, it wasn’t rented…). But in running the numbers to build a case to convince someone to invest I found the invest so great it was idiotic to give it up. So I kept it and rented it myself. I acted as my own property manager which is kind of a pain. I didn’t get a lease signed before but that is a good idea (mine purchase was in the anything goes days so…).

    Financially it has been a very smart move. It is more of a pain than I would like but the cash is more than worth it.

  3. Vince Thorne says:

    Good going with the upgrade. Sounds like you have planned this is advance which is a big plus. Good call on the property management company. It is good to outsource all the hassle and the price is worth the peace of mind. I would get a lawyer on the team to draw up the lease. legal jargon is something best left to professinals. I would also pass the const of insurance to the tenant or have a clause requiring them to have one by the time the lease is signed.

  4. Another thing: go throught a mortgage broker to get the best rate. You won’t get the best rate if you go through a bank.

  5. Don’t always assume the amount you’re going to get in rent is accurate.
    I have found that in the past I have had to lower the asking price for rent in order to get a tenant. It was either that or have it vacant for a month or two. For me it was better to get someone in there for slightly less. It depends very much on what month you begin to rent it out. September is a popular month. July not so much.
    Try to time your lease to end Aug 31st as well.

  6. Thanks for the insight, Ben. Good point about vacancy. Ultimately if this rental doesn’t cost us anything until the value appreciates to old levels, it will be a win. Another point about vacancy that I forgot to mention above is that we will probably need more than a solid down payment on the new house saved up. The bank will likely want to see if we have enough saved to pay the mortgage on this place for 6 months if it’s vacant.

  7. Hi Phil,

    I think it is a great idea to own a rental property but you do need to ensure you budget in vacancy and maintenance .

    I have owned a rental property for a year now that cash flows $130 per month IF everything goes right. You will want to ensure you factor in maintenance and vacancy costs. I bought a very simple 700 sq ft that was in good shape, and thought little maintenance would be required. But I just spent $4,000 fixing a plumbing issue that couldn’t have been caught in the home inspection.

    When looking at numbers for a rental property there are emotional strings pulling you into the investment, but be sure you take an honest look at what you can expect in terms of unexpected costs. $100 may be too low for misc. Great idea overall! Congrats.

  8. cashflowmantra says:

    We started out by renting out our first home when we outgrew it. I really can’t complain too loudly plus by the time I am able to start drawing retirement, it will be paid off and will add nicely to our income.

  9. krantcents says:

    I recommend this to my students all the time. This is a great way to start your real estate empire.

  10. Matthew Pryor says:

    Phil – We did this very thing last year and I’m confident you too can pull it off. Here’s our first year’s results:

    • Philip Taylor says:

      Thanks for that. Enjoyed the post and learned some things I’ll definitely try to implement myself.

  11. Jenna, Adaptu Community Manager says:

    I’m jumping head first into the “landlord” role taking over the responsibility from my parents, who are a great resource to me. Why not take the plunge to and save yourself $100/month, especially if you get a great long term tenant?

    • Because I’m too busy and I don’t want it to be a burden. I can always do away with it at some point, I guess.