Can I Afford It?
With the current economic it's becoming more and more popular for homeowners to become landlords. There are several reasons for this, you got married or had a baby (congratulations) and you suddenly need more space, or you've found a great deal on a property, even better you just looking to diversify your portfolio by adding real estate. No matter the reason, you should make sure you learn as much as you can about what's involved, to not make significant financial mistakes.
The first question to ask is can I afford it? This is the first and most important question that anyone looking to become a landlord should ask himself or herself. This simply does not mean "can I make the 20% down payment, required by most lenders today". I'm talking about the expenses that will be incurred during ownership. But lets not get ahead of ourselves.
The most cost effective rental property is your current home. Before you buy, you should consider turning your current home into the rental property even if just for a year. Reasons for doing this include:
- You know the property. You know where all the light switches are, and what they do, where the loose boards and cracks are; you know what works and does not work. You know how to change and where to find the air filters, and more likely you already have some established maintenance schedule setup. Most importantly, you have an idea of monthly costs.
- You have an established "comfortable" mortgage. Typically a 20 to 30 year fixed rate mortgage which you can currently afford.
- Investment properties are harder to finance. A new mortgage on an investment property is typically ½ a point or more higher than what you can get on a primary mortgage.
Knowing all this will help you understand how much money you would need a month in rent to keep things running smoothly. If this final amount is equivalent or lower than other rental homes of comparable size in your neighborhood, then you have a good chance of being successful. If not, don't do it.
A rental property typically does not generate enough income on a monthly basis. (Not that it's not possible, it's just not the norm.) It is an investment that will appreciate over time, so that when you sell it you will reap the profits. If your getting in it to supplement income in the short term your looking at it the wrong way.
Ok, so lets get down to the real nuts and bolts. Today, homes are being sold at a discount from their inflated prices just a few years ago. But how do you know if your getting a good price.
A good real estate agent will pull what are called "comps", which are the prices of comparable homes in the area which have sold recently and how quickly they sold at that price. If it was on the market for a long time, it might mean they where asking a bit too much. You can do this yourself by using sites like zillow.com and coloradohomefinder.com.
Another easy way is to find the counties tax assessors assessment value. And finally contact a contractor and have them tell you how much it would cost to re-build that home (however, this option will cost you a few dollars).
Now that we have our price, we need establish good financing.
The most conservative financial structure involves paying down 20% or more, and financing the remainder in a traditional 30 year fixed mortgage. With a 20% down payment more leaders will be willing to work with you and you stand a better chance of getting a good interest rate.
However, better returns are possible with higher risk, which means looking at 5 to 7 year ARM. These loans will carry even lower interest rates, which translate into lower payments.
I must remind you, that getting this kind of loan would put a timetable on the investment, prompting you to look at re-financing or selling in 5 to 7 years. However, based on the current economic and political climate, it is highly likely things will turn up before then.
To find competitive mortgage rates in your neighborhood, you can use site like bankrate.com. This site also has many calculators to help you determine your monthly mortgage payments.
In addition to your mortgage, there are other expenses that you need to consider when determining your monthly cost. These include:
- Utilities - Gas, Water, Electric (if not billed directly to the tenant)
- Maintenance - HOA fees, lawn (sprinklers), AC and furnace maintenance
To get more details on kinds of insurance coverage available and what the cover, visit lcmainsurance.com.
We'll cover maintenance another day.