What the play here? Sell or Rent first home?

Question

Looking for some opinions on what the best approach may be in this situation. I decided to sell my first home, and buy a new home, feeling like the market isn't terrible as a buyer if you are also selling. Under contract for the new home at 410k, 20% down. My current home is under contract to sell for 350k. I owe 115k for 22 more years. I planned to roll all proceeds from the sale of the current home into the new home. Then I started to consider renting it, and it has sent me into what seems like a never-ending path of possibilities. I want to get started in real estate investing, and this seems like an opportunity. Rent in the area for my house is 2100 easily. Mortgage with escrow is about 1200.

I'd love to use this as my opportunity to get started with a rental property. My doubt begins because I originally only considered buying a new house knowing I was selling and cashing in on the sale, and keeping my new mortgage low by rolling all the proceeds in. Further, the 20% down wasn't necessary, but helped us be competitive with our offer. If we aren't selling, the 20% down needs to be pulled from savings/investments I am hesitant to touch, but will if it's worth it.

I know there are a lot of intricacies that are absent here, but any thoughts or insights would be helpful. I've been calculating this every which way I can for the last week, and haven't determined which makes the most financial sense. Can someone help point me in a direction? Thanks!

Jake Wiley · Answer

@Mike Lettko - Really depends on what your goal is here.    Are you looking for cashflow?   Are you looking for equity?

One thing to consider is that you don't have to close with 20% down.  You can still work with your lender on an FHA loan or another alternative.  It would likely just void your financing contingency, meaning if you changed the loan type to a 3-5% down the type of loan and for some reason you didn't close due to financing, you could lose your earnest money.    As long as you close, cash is cash to the seller.   I've closed many single family properties that I had no financing contingency with loans to make the offer more competitive.     So... there's one thing for you.

One thing to consider is that you are selling your primary home and have had it for more than 2 years as a single person you have a $250k gain exemption from taxes, as long as you were in it for 2 of the last 5 years I believe.   So if you start renting it out you could lose that option after the three-year mark.   The benefit to selling is to then take the gain tax-free and plunk it down on a new property.   You have around $200k to use as down payments on properties, which at 20% down is about $1.0M worth of properties.  If you can do an FHA-type loan on your primary, you will then have around $175k to put down on investment properties.   If you can find some good rental properties that will not impact your DTI ratio (generally speaking this is the case when rents multiplied by 75% covers your PITI) then that $175 could lever up to 875k in rental properties which is really strong.

Hopefully, that is helpful and good luck!

Jake

Canesha Edwards · Answer

@Mike Lettko

Hey Mike-

Here’s my 2 cents.

If your current home is under contract, how long do you have to decide whether you want to sell or not?

Secondly, if you’re looking to break into real estate investment, consider this strategy.

Since your current property has so much equity, why not refinance?  I would see if a lender would refi the property at 65-75% of the appraised value (which I’m assuming to be $350k). I like to leave a decent amount of equity on the table as a buffer should the market take a downward turn.  Take the proceeds from the refi and roll that into your next property and rent the current property.   I would reach out to a lender to get a general idea of what the new monthly payment would be after refi so you can analyze the potential of your current property as a rental.

Hope this helps.

Best,

Canesha

Jon Kelly · Answer

@Mike Lettko Your head is spinning now. Slow down. You're in a great position and really can't go wrong. You have 3 options in the near-term: (1) Sell your home and roll equity into your new home, (2) Rent your current home, (3) Sell your home and keep proceeds in savings / invest (we'll consider options for this money later)...

(1) Roll equity into new home - This is the safest play. This comes down to the age old question, "Should I pay down my mortgage or invest my money elsewhere?" This is a personal choice. However, if you're borrowing money very cheap at 3.5% on your new home why would you want to pay it off faster? Can you earn more than 3.5% if you put your money somewhere else? Most likely.

(2) Rent your current home - Decent option. Gets you into the real estate investing game and may produce a little bit of monthly cash flow. However, I would encourage you to run the numbers on your current home as a rental. Rent is 0.6% of purchase price... it doesn't come close to the 1% rule. The good thing is you know the property intimately and are aware of upcoming repairs. After expenses and reserves for vacancy, repairs and CAPEX I assume your cashflow will be minimal... (3) Sell your home and keep proceeds in savings / invest - This is my favorite option. This is the real estate investors dream. You worked your butt off to pay down your mortgage, got a little lucky with appreciation due to market timing, and now have $235k+ in built up equity. Let's assume closing costs on the sale are 10% ($35k). You will walk away with $200k after the sale ($350k - $115k - $35k). Assuming 25% down on investment property(ies) you can buy up to $800k worth of real estate investment property(ies). This is your chance to get into the game. You're in a great market and I'm sure you can find plenty of options near you. Take the plunge.

Jon Kelly · Answer

@Mike Lettko For what it's worth I don't like option #2. I would treat buying your new home and whatever you choose to do with your existing home as two completely different transactions. It's likely not the financially best decision to buy the $410k home, but you're doing it for other non-financial reasons. Then, I'd look at what to do with your current home (e.g. rent or sell). To make the decision on rent vs. sell you should consider it as if you were buying it today. Would you buy your home for $350k as an investment property? Run the numbers on how it is today. What you bought it for years ago is irrelevant for this decision.

Option 3 is a great option. You're home is already under contract, so you're halfway there. Now you just need to find an investment property(ies) to start your REI journey!

Mike Lettko · Answer

Jon, Thank you. You are spot on with your opening statement there. I'm feeling the time pressure, and don't want to look back and wish I had approached this differently. I really appreciate you taking the time to provide this information and insight.

My struggle with renting (option 2) is it seems that the cash-flow is almost negated by the fact my new home mortgage is higher as a result of not paying the larger down payment. But I'm not sure this is the right way to look at it. Also, with the 1% rule you mention, should that be looked at from the current market value, or from the price I paid, or owe? On the plus side, most of the big ticket repairs on this house have been completed, and recently.

Option 3 sounds like a great path that I haven't been considering. Definitely something to factor in. Thank you again!

Mike Lettko · Answer

Thanks Canesha, I appreciate the reply. I haven't really run the numbers with a refi in mind, so I'll check that out. I was mainly focused on leaving the old home loan as-is, since it is a decent rate, low payment, and I assumed would create the most cashflow. But its definitely worth taking a look at. Thank you!

What the play here? Sell or Rent first home?

Most Popular Reply