Tips for Buying Rentals

Buying rental property can be an excellent decision and the better informed you are, the more likely you'll have favorable results.  The following suggestions can help you with your decisions.

Real estate is a long term investment affected by supply, demand and the economy.  It isn't an investment that is easily converted to cash.  The costs to acquire and dispose of real estate are sizable and need to be spread over years to minimize their effects on the rate of return.

Invest in average price homes or slightly below average price to appeal to the broadest market not only when you are renting but later on when you sell it.  The average price is relative to the market you are in and those specific prices.

Lower-priced homes will rent for more relative to higher-priced homes.  There is an inverse relationship between rent as a percentage of the price.  As the price increases, the rent as a percentage of the price decreases.  For example, a $200,000 home might rent for $1,750 a month or 0.88% where a $400,000 home might only rent for $2,250 a month or 0.68%.

Choose predominantly owner-occupied neighborhoods because when you sell the home, it will appeal to a homeowner who will most likely pay a higher price for the home.  Homes in predominantly tenant-occupied neighborhoods tend to sell to investors who pay lower prices and will not be emotionally involved with the purchase.

Purchase a property with the idea of selling it in mind.  You may be able to get a property for a bargain price today but if it is due to a functional obsolescence like a bad floorplan or not enough bathrooms, that problem will still be there when you're ready to sell the property.  Identify what the problem is and what solutions are available.  The property may rent fine in that condition but before you sell, it will need to be corrected.

Get the home inspected before you purchase it.  Having the property checked out can save thousands in unanticipated expenses. 

Consider getting a home warranty on your rental.  The annual premium can limit the out of pocket expenses for repairs and maintenance.

Risk can be minimized by understanding the investment and what is involved in the acquisition, operation and disposition.  For the typical homeowner, rental property is something that they can relate to because of the similar attributes of the home they live in.

Homeowner Advisory

Similar to an annual wellness physical, homeowners should consider an annual review of the financial elements of their home. It’s particularly valuable based on the fact that their home and its equity is generally, one of their largest assets.

• List of similar properties recently sold and currently available
• Information on challenging property tax assessment
• Refinance Analysis to:
  • lower your rate
  • shorten the term
  • make improvements
  • eliminate mortgage insurance
  • remove a person from the loan
  • eliminate credit card debt
  • combine loans
  • take cash out of the equity
• Equity Accelerator to retire the mortgage within a specific period of time
• Repairmen and contractors recommendations
• Information on rental property opportunities

We’d be happy to provide this information at no obligation as part of our on-going commitment to providing homeowner information, both in general and specifically, to our contacts. It is part of a long-term strategy whereby we hope to earn your loyalty and referrals when you do need our services to buy or sell.

Is Understanding Costing You Money?

People tend to fear what they don’t understand. Homeowners understand fixed rate mortgages and

remember the horror stories of people who lost their homes because they could no longer afford them when their adjustable rate mortgages went up.

Interest rates on fixed-rate mortgages have been so low for enough years, that borrowers haven’t even given much consideration to an adjustable rate mortgage. Changes in the way adjustable rate mortgages are now made make them much safer for borrowers who understand how they work but also know they’ll only be in the home for a limited period of time.

Adjustable rate mortgages can go up or down according to an index that the lender has no control. The amount that can be adjusted is limited by caps for each period and for the life of the loan. While there are different periods for ARMs, the most popular lock the first period for five to seven years and then, can adjust annually after that.

One quick and easy way to determine whether an adjustable may be a viable alternative to a fixed would be to determine the maximum payment adjustments possible to find out when the savings from the early years are exhausted which would be the breakeven point. If the borrower is certain they’ll move prior to that date, the ARM will definitely provide a lower cost of housing.

The breakeven point for a $250,000 mortgage would be 8 years 3 months comparing a 2.9% 5/1 adjustable-rate with 1 and 5 caps to a 3.8% fixed-rate mortgage. In the initial five-year period, the payments on the ARM would be $124.32 lower and the unpaid balance would be $3,522 less than the fixed-rate to make a total savings of $10,981.



Whether you’re buying or refinancing, get some good advice from a trusted lending professional about the adjustable-rate alternative. If you’re only going to be in the home a short time after the mortgage is made and your tolerance for risk allows you to feel comfortable, the ARM may be the best choice for you. Check out this ARM Comparison to use your own numbers.

It's Your Advantage

Technology has certainly streamlined the home buying process and introduced things that help purchasers make better decisions. Buyers have enthusiastically embraced video tours, digital signatures and the enormous amount of information available about a home, neighborhood, schools and neighbors.

The ironic thing is that buyers are ignoring the one single thing that can help them secure the “right” home. Talking to a lender or using a financial calculator is not pre-approval.

Pre-approval requires written verification on employment and income and ordering a credit report for the purpose of obtaining a mortgage. A mortgage credit score is different than what a person might see from credit reporting websites. 

Pre-approval gives buyers the confidence to know the amount they can borrow which can result in bargaining power when dealing with a seller or competing against another offer. Transactions can close quicker once a buyer has been pre-approved.

If any issues are discovered in the initial process, the purchaser and lender will have more time to correct them compared to trying to get it done during the loan approval period as stated in the sales contract.

Most lenders best interest rates are only available to the best borrowers. You might get approved on a loan but at a higher rate than you expected which could make a significant difference in the monthly payments.

The “right” home without financing will never have the buyer’s address. Getting pre-approved with a trusted mortgage professional is one of the first steps in the buying process. It can definitely be an advantage that will benefit you in negotiations and ultimately, during the time you own the home.

More Equity...More Options

The more equity in your home, the more options you have. Since equity is determined by the difference between value and what is owed on a property, when homes lost value during the Great Recession, homeowners’ equity decreased.

Negative equity occurs when the value is less than the mortgage owed. According to CoreLogic, 91% of all mortgaged properties have equity and only 4.4 million properties remain in negative equity at the end of the second quarter in 2015.

A homeowner, who qualifies, can release part of their equity by refinancing the existing loan and taking out additional cash or by getting a home equity loan. The benefits include:

• To get a lower rate on your current mortgage
• To finance capital improvements on your home
• To payoff higher interest rate debt such as credit cards or student loans
• To purchase items that would not have deductible interest like personal cars, boats, etc.

It could be as simple as waiting for positive home equity so owners can move to another home without having to pay out-of-pocket expenses to sell their home.

Discussion with your Insurance Agent

Insurance and homeowners go together like peanut butter and jelly. Lenders require fire insurance at a minimum for homes with a mortgage but many owners opt for a more comprehensive coverage with a homeowner’s policy.

However, comprehensive doesn’t mean that everything is covered. Filing a claim is not the time to learn that you don’t have the right coverage. Discuss the following issues with your insurance agent to get a better understanding of your policy and whether some adjustments might be in order.

• Flooding?
• Rising water? 
• Mold?
• Earthquakes?
• Pools?
• Termites?
• Certain kinds of pets or breeds of dogs?
• Limits on jewelry and cash?
• Deductible amount?

The whole concept behind buying insurance is to transfer the risk of loss that you cannot afford for an annual premium that you can. Price and coverage need to be considered when comparing policies. Call your agent and make sure you understand what you’re insured for and if there are alternatives available.

Real Cost of Housing

In this example, the down payment of $8,750 grows to almost $94,000 in seven years due to appreciation and amortization of the loan. Owning a home is one of the few investments available that allow these personal and financial benefits.

A variety of factors have led to a shortage of rental units, especially single family homes, and as a result, rents have been steadily increasing nationwide. In most markets, it is considerably less to own than to rent.

In some cases, the total house payment is less than the rent for a similar size and condition home which supports a purchase. However, when you factor in some of the financial benefits like principal reduction, appreciation and tax savings, the difference becomes even more dramatic.

Let’s look at an example of a $250,000 home with 3.5% down payment and a 4.50% mortgage for 30 years. We’ll assume a 3% annual appreciation, 25% federal tax bracket, $1,200 annual maintenance and current rent of $2,100 a month.

The total house payment with property taxes, insurance and mortgage insurance premium would be $1,834 a month. Once the principal reduction, appreciation, tax savings and maintenance have been considered, the net cost of housing is about $673 a month. It costs a tenant over $1,400 more a month to rent than to own which would amount to $17,000 in the first year alone. That’s almost twice as much as the down payment to get into the home.

One of the obstacles in the past five to seven years has been a borrower’s inability to qualify for a mortgage but new programs and relaxed requirements have allowed more people to be eligible for mortgages. The important step is to talk to a trusted mortgage professional very early in the home search process. Your REALTOR® can make recommendations based on experience from actual closed transactions.

Use the Rent vs. Own calculator to see what the benefits might be in your price range.

Finding the Best Mortgage

As rates are inching up but still very affordable, buyers should remember that there is an alternative to a fixed rate mortgage that can provide the lowest cost of housing for the homeowners who understand the parameters.

A $300,000 fixed-rate mortgage at 4% has a principal and interest payment of $1,432.25 per month for the entire 30 year term. A 5/1 adjustable mortgage at 3% has a $167.43 lower payment for the first five years and then, can adjust, up or down, based on a predetermined index.

Another interesting fact is that the unpaid balance on the ARM at the end of the first five years is $4,624 lower than the fixed-rate mortgage. The total savings in the first five years on the ARM is $14,669.00.

Adjustable rate mortgages are not the right choice for everyone but buyers should at least consider the options based on their individual situation. It could be an obvious choice for a buyer who is only going to be in the home for five years or less.

Use the ARM Comparison worksheet to see what possible savings you could have based on your actual numbers. A trusted mortgage professional can help you to understand the advantages and disadvantages based on your situation. You need the facts to make the best decision.

Cut Mortgage Insurance

Making additional payments toward the principal of your mortgage will do three things for the homeowner: save interest, build equity and shorten the term on fixed rate mortgages.

These things should be beneficial enough to justify the extra payments but another huge advantage is available to those who have private mortgage insurance on their loan. Mortgage insurance rates vary but can range from seventy-five to two hundred dollars a month on a $200,000 mortgage.

Lenders are required to automatically terminate mortgage insurance when the principal balance reaches 78% of the original value of the property. It is important for homeowners to monitor their balance because sometimes lenders may inadvertently fail to terminate the coverage.

Mortgage insurance is a necessary but expensive requirement for many people who are limited to a down payment of less than 20%. Eliminating the need for it can save thousands of dollars over time.
The Consumer Financial Protection Bureau, CFPB, issued a compliance bulletin on August 4, 2015.