For many landlords, the initial draw of buying properties to rent out comes from the naïve idea that these homes will always bring in surplus income. The idea of collecting rent is that the home will pay for itself, right? Unfortunately, this isn’t the reality. If all goes well, renting will help you recoup costs in the long term, but the correlation isn’t direct. If you spend too much on a home, even a home to be rented out, you could find yourself in unmanageable debt.
If buying a home to rent out is going to work for you, there are a number of factors you’ll need to understand. That means that if you’re not someone who keeps a budget now, you’ll need to start. Understanding the finances that go into buying and maintaining a property is a big job.
For starters, take a look at your income and your other expenses, like utility and grocery bills. You should also consider factors like your level of job security, any possible employment fluctuations of other parties involved, and life changing factors like planning to have a child. All of these are important when considering if you can afford to invest in property right now, as well as how much property you should buy.
One of the biggest expenses you’ll incur when purchasing property is the down payment. Although the minimum down payment on a property when you have an FHA loan is only 3.5%, paying the minimum will result in other fees, such as the mortgage insurance. This additional fee can actually diminish the size loan you can take out, so be careful and aim to pay a larger down payment. It’s also very uncommon to pay this small of a down payment – more typically the rate is about 20%.
Paying a larger down payment is especially important when there is a surge in the thirty year fixed mortgage rate. The rate is currently about 4.25%, but if your fixed rate is substantially more, cutting your down payment will cost you big over the years. Alternatively, a larger down payment will also allow you to pay smaller monthly amounts towards your mortgage, giving you wiggle room to save for a car, pay off other debts, or put aside money for emergencies.
The Location Trap
Where your property is located can play a big role in how much your pay for it and how much rent you can collect from tenants. While a home in a popular school district or in a higher income neighborhood may come at a greater cost, homeowners in these areas actually tend to be in better financial shape than their peers in lower value markets.
There are a few reasons why homeowners with high value properties are fighting less debt than their counterparts. One likely aspect is that these homeowners entered the market with a higher income and more professional stability than those with the lower value homes.
For owners who rent out their property, tenants are willing to pay far more for these high value homes on a monthly basis. They pay for the privilege of a good location. On the flip side, tenants in undesirable locations may try to leverage that fact in their favor in an attempt to cut rent costs – and to be clear, this may be the only way you can get the property leased out at all. But that can leave you in a financial mess.
Buying a home within your price range will ultimately be more rewarding than stretching for that dream home; no one counts on their future life drama including backbreaking debt. That doesn’t mean bigger and better properties aren’t in your future, but it does mean that they aren’t in your “right now.”
If you’re hoping to keep moving up in the world, there are a few ways you can try to pay down your first property faster. One strategy that works well is to make biweekly payments on your mortgage instead of monthly ones. You may not have quite enough to stretch for a higher amount at one time, but the influx of cash from a mid-month pay period can give you some budgetary leeway.
Another good way to pay off your property faster is to refinance. Typical home financing is done over a thirty year time period, but you can really wrack up interest over that period of time. When you refinance, you consolidate your typical payments into a shorter period with the goal of also decreasing your interest rate. This can be a great tool in your financial toolkit if you get a raise. If rates don’t look good, pay ahead instead. This will run out your mortgage early and you don’t risk getting stuck with a bad interest rate in a different housing market.
Finally, be realistic about your expenses. When reviewing your budget, consider which expenses are necessary and which are luxuries. The goal isn’t to eliminate everything, but rather to assess which ones offer pleasure equal to their cost and which are a financial sinkhole. If you can, identify a few items to cut back on and immediately shift that money towards your mortgage payments. Otherwise, it’s very easy to funnel that money into other unnecessary things.
If you’re working to establish yourself as a landlord, Green Residential can help you navigate the financial landscape. With over thirty years of Houston area property management experience, our family-backed team of experts has seen the best and worst of the housing market. That means we can help you climb out of debt when things are bad and keep the cash flowing when things are good.
Being a landlord isn’t just about handling the rent and minding property upkeep – it’s a full commitment to homeownership. So when online mortgage calculators are no longer enough to keep you on track, contact the professionals.