Rental homes can be a natural alternative investment choice for homeowners because they are already familiar with houses. Maintenance on a rental is not that much different than on your personal home. The same plumbers, painters and other workmen can be used to make repairs.
Single family homes offer an investor high loan-to-value mortgages at fixed interest rates for long terms on appreciating assets with defined tax advantages and more control than other investments.
- High loan-to-value mortgages – most investments require that you pay cash but rental properties can be purchased with 20% down payment.
- Fixed interest rates – most commercial loans are based on a floating rate such as prime interest plus one or two percent compared to real estate loans as fixed rates for the term.
- Long terms – commercial loans are generally short-term such as six months or a year with the possibility of being renewed for another six months or a year unlike real estate where a 30-year mortgage is commonplace.
- Appreciating assets – real estate has a long-term history of going up in value.
- Defined tax advantages – many investments are taxed as ordinary income but rental real estate enjoys a non-cash deduction called cost recovery, the profits from sale are taxed at lower long-term capital gains rates or may be eligible for a tax-deferred exchange.
- Control – rental homes don’t require partners and afford the investor more options than investing in mutual funds and other traditional investments.
The demand for good rentals is strong and the rents continue to go up in most markets. There are people who choose not to buy or cannot buy a home who would prefer to live in a single family home rather than an apartment.
It is estimated that seven million out of 50 million homeowners could save money by refinancing their existing mortgages. Obviously, if the replacement mortgage has a lower rate than your existing one, you will save money.
If you bought a home before 2011 and are paying mortgage insurance, you should investigate refinancing to eliminate that requirement. Even if you don’t get a lower interest rate, the savings could amount to hundreds of dollars a month.
If a home you purchased since 2011 has appreciated enough, it could easily justify refinancing to eliminate the required mortgage insurance. Most loans don’t require mortgage insurance if the loan-to-value is 80% or less. There are some programs for 90% mortgages that don’t require mortgage insurance. It is certainly worth investigating with a trusted mortgage professional.
Continuing to pay mortgage insurance that could be eliminated is like having a broken cell phone and continuing to make the monthly payments for something you can’t use and don’t need.
If your current mortgage is several years old, instead of getting a new 30 year mortgage, you might consider a 15-year term. The money you save with a lower interest rate could help you to retire your loan in a shorter time so that your home would be paid for.
You’ve saved the money and are ready to pay cash to build a new pool for your home. However, that’s just the beginning of your soon to be increased expenses which will include maintenance, higher utilities and higher taxes.
Homeowners obviously benefit by a larger equity when their home increases in value due to appreciation. A not-so-obvious effect that will also more than likely take place is that their property taxes will increase. In most cases, a property’s assessed value is generally tied to market value to calculate the property taxes based on the tax rate for that year.
Similarly, a homeowner can affect the value of their home by making capital improvements. Some small items may never be recognized by the taxing authority but items that require a permit, certainly are brought to their attention. Items such as a fence, roof, remodeling, windows, new rooms or swimming pools can easily increase the assessed value of a property.
Most states have an established time frame in which to challenge the current tax assessment for that year. The process is relatively simple and doesn’t require professional representation. It generally involves showing that there is an error which has overstated the value or that current comparable sales indicate a lower value.
If you’d like more information or need the comparable sales data, please let us know. We would be happy to help you investigate the possibility of lowering your property taxes.
Real estate lost a lot of value during the recession but most areas have rebounded considerably. In some cases, the homes are worth more than they were before the housing bubble burst.
The dynamics are classic for this type of market: inventories are low, mortgage rates are low and demand is high. All price ranges are on the rise with some at an even higher rate because the short supply is causing competition among buyers.
Another reason many homeowners’ may have more equity is simply not staying current with what is going on in the market. In a recent FNMA study, it indicates that 23% of owners believe they have negative equity in their home when actually, it is 9%. 37% believe they have greater than 20% equity in their home when actually 69% of homeowners do.
Even if you’re not planning to sell your home, knowing the value helps you understand your financial position better. The interest on home equity debt up to a $100,000 limit is tax deductible and can be used for any purpose. Owner’s commonly refinance to eliminate mortgage insurance, consolidate mortgages, pay off higher interest rate debt like credit cards or student loans or to buy out an ex-spouse’s equity.
Be aware that an automated value model like Zillow Zestimates uses algorithms to determine a price and while it might be in the ballpark, AVM results may only be accurate about 20% of the time. A comparable marketing analysis or broker’s price opinion will be more accurate due the subjective approach that will be used by an agent with personal experience in the area. An agent will consider factors like condition, floorplan, marketability and demand.
There is an infrequently-used mortgage program available that could be the solution to a buyer’s or seller’s problem.
A temporary buydown is fixed rate mortgage that the seller has prepaid interest at closing to lower the payments for a number of years. The borrower must qualify at the note rate but gets the benefit of lower payments for the early years.
A 2/1 is a common buydown that the first year’s payment is calculated at 2% lower than the note rate and the second year’s payment is calculated at 1% lower than the note rate. The third through thirtieth years’ payments are the note rate.
Let’s set the scene. A buyer is using their available cash for down payment and closing costs to get into the home. They’d like to put their own touches on the home when they move in but may not be able to for a year or two since most of their cash was used.
In this example, a $250,000 home is purchased with a 3.5% down payment and a 4% mortgage for 30-years. Normally, the principal and interest payment would be $1,151.76 for the full 30-year term. If the seller will pay the lender $4,736 at closing, it can be applied to pre-pay part of the interest for the first two years.
The first year, the buyer’s P&I payment will be $891.71 for 12 months based on a 2% interest rate or 2% lower than the 4% note rate. It is $260.06 lower per month in the first year. The second year, the buyer’s P&I payment will be $1,017.12 for the next 12 months based on a 3% interest rate or 1% lower than the 4% note rate. It is $134.64 lower per month in the second year.
A bonus for the buyer will be that the cost of the buydown paid at closing by the seller becomes prepaid interest that is deductible by the buyer in the year of purchase. The buyer gets lower than normal payments for the first two years and a sizable tax deduction.
This type of program can be very beneficial to a seller who wants to offer terms to improve the marketability of their home rather than lower the price. The challenge will be explaining it to not only potential buyers but even agents who are not familiar with this program.
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.
If I tell you it’s going to rain, you can put the buckets on the porch.” If you grew up in the south, you may have heard this expression when a person is testifying to the veracity of his word. If you know a person and/or their reputation, you know whether you can trust their word or not.
However, with a stranger such as a buyer, the seller doesn’t know whether they’ll live up to the terms of the contract or not. Buyers submit earnest money along with a contract to demonstrate their commitment to the terms of the offer.
The more earnest money that the buyer deposits indicates to the seller a higher level of commitment to the contract. Except for stated contingencies in the sales contract, if the buyer fails to close on the sale, the earnest money may be forfeited. Significant earnest money makes the seller feel more secure that the contract will close.
There certainly are a lot of things that can dictate how much earnest money is appropriate. Local customs, price of the home and type of mortgage can all help to determine the proper amount. In some areas, it may be common for it to be 1-5 percent of the purchase price. In other areas, it might be a specific amount like $1,000 to $10,000 depending on the sales price. It really comes down to whatever the buyer and seller agree is the proper amount.
Another strategy is to put up an adequate amount initially until you get through the inspections or contingency period and then, to put up an additional amount when the contingencies have been removed.
The earnest money demonstrates the buyers’ sincerity in making the offer and proceeding according to the agreement so the seller can take their home off the market and start making plans to move and give possession of their home. Ultimately, both parties want to close as anticipated according to the contract and the earnest money helps facilitate that.