The loan is different
Lenders treat a property you will not live in as a riskier bet. Expect to put down 15 to 25 percent, pay a noticeably higher interest rate than on a primary home, and show cash reserves of about six months of payments. Lenders typically count only 75 percent of expected rent as income when qualifying you. A true second home gets better terms, but describing a rental as a second home or a primary residence on a loan application is mortgage fraud.
The gentler entry is a building of two to four units bought with an owner-occupant loan. You live in one unit for at least a year, the down payment can be as low as 3.5 percent, and the other units pay toward the mortgage.
Run the numbers conservatively
- Start with realistic market rent, taken from comparable units that actually rented.
- Subtract 5 to 10 percent for vacancy, which is about one month a year.
- Subtract property taxes, landlord insurance and any association dues.
- Subtract maintenance of about 1 percent of the property's value a year.
- Subtract 8 to 10 percent of rent for a property manager even if you plan to manage it yourself.
- Subtract the mortgage payment.
What is left is cash flow. A quick screen used by investors is monthly rent near 1 percent of the purchase price. If the deal works only when nothing breaks and nobody moves out, it does not work.
Taxes and insurance
Rental income and expenses go on Schedule E of your tax return. You may deduct mortgage interest, taxes, insurance, repairs and depreciation, which spreads the building's cost over 27.5 years. Depreciation is taxed back when you sell, and the capital gains exclusion for a primary home does not apply to a rental. A homeowners policy does not cover a rented house, so you need a landlord policy.
The law of being a landlord
The federal Fair Housing Act bars discrimination in advertising, screening and terms, and many states add protected categories. State law sets deposit limits, notice periods, habitability duties and the eviction procedure, which must go through a court. Changing the locks or shutting off utilities to force a tenant out is illegal everywhere. Many cities require a rental license, and many cities and homeowner associations restrict short-term rentals, so check before you buy on that assumption.
Tip Open a separate bank account for the property on the first day, and keep at least three months of its expenses there.
