Buying second home, renting out the first

[John Lindley]

Hello,

My wife and I are looking to get a bigger house and we want to keep the house we are currently in and rent it out.  I've been reading the guides and forum, and talking to some people in the community.  I'm hoping to get some feedback on our financing and loan plans.  If I've missed something in one of the guides or forums, feel free to send me a link.

Home prices in our area have started to come down and we are targeting to try and purchase at the end of this year. Our current home has a LTV of 50% or better. We were thinking to apply for a HELOC now, this way we have this in place when we buy the new home so we can do any necessary repairs on this house and any unknown repairs on the new house. We thought this gave us more flexibility than the Home Equity Loan as we don't know how much to pull out.

We are thinking to purchase the second house with an FHA loan. We can find enough capital to pay for this without using the HELOC.

Are there any concerns or watch outs with this strategy? Could I have problems trying to get the FHA loan so quickly after getting a HELOC? Is there any challenges with getting a FHA loan if I already have another home? As the current home isn't a rental property yet, will that cause problems during the FHA application? Anything else I haven't thought of?

Thank you for your time and advice!

[Dan Schwartz]

@John Lindley I think you asked an investing 101 question and got a lot of Masters/PhD level answers.  Doesn't make them wrong (it's generally sound advice), but it goes way beyond where you may be in this journey.

I don't know your exact numbers or whole situation, but I would strongly consider getting a 5% down conventional mortgage on the new house (since you were looking to do 3.5% down for FHA) and renting out the old house for a maximum of two years.  Know going into this move that you are going to sell old place after two years of renting and before three years has elapsed since moving out.

While it may not be the best investment you can make, and while it might not be the property you'd choose if the world were your oyster, you know your current home.  You know the state of the systems.  You know how close (or far) you are from needing to replace the roof or HVAC.  You seem like someone who has kept it well-maintained, which should minimize the need for excessive repairs and allow you to set aside more of that 50% rule money towards future cash reserves.

It sounds like it's in a good, rentable neighborhood.  You've penciled out that it will cashflow.  Maybe it's cash flowing because of the low LTV on the appreciated value.  Who cares?  It's your first rental and it cash flows.  You'd be farther than 90+% of the people who "want" to do this.

You rent for two years only so you can sell it prior to your Section 121 exclusion expiring (live in it for 2 of the last 5 years).  Take the profits tax free, and, having now been a landlord for two years, you'll have a chunk of cash as a down payment on a replacement rental property.  With two years of landlord experience, you'll be treated better by the conventional lenders with regards to counting rental income towards the new purchase. 

Might the home decrease in value between now and 2025?  Yes.  Might you be able to make more if you start from scratch and buy a different property?  It's possible.  Find me a situation that doesn't have a potentially adverse opportunity cost.

And if you decide in those two years that you hate the whole idea, sell the house anyway, take your tax-free gains anyway, and move on knowing you pursued an opportunity when you were in a good place to do so.  

Good luck!