Buying an urban townhouse, living, than leasing

9 Replies

Looking for some financial and practical advice on my investment idea.

1. I have an income of $60,000 per year.

2. I want to buy a three bedroom townhouse for $290,000, with a down payment of 10%. I'm thinking an FHA loan around 4.00% so my payments would be on or a little more than $2000 a month.

3.  I want to rent each of the two extra rooms for $700 each.  Which would bring by net mortgage expense down to $700 or so.  

4. I can probably manage a monthly payment of around $1000, so I'd need the renters. 

5. Eventually, I'd like to rent the property out completely and repeat the cycle.  Eventually, I'm hoping to be able to sell the property and make a buck or two on it.  

Can a lender take into account the possibility of "renting" out one or two rooms in my townhouse?  IE: With your income, we cannot loan you X amount because you can't afford the payments.  But since you anticipate an extra $1400 coming in, we can get you the loan.

It's great that you're looking to start investing in real estate! I actually got my start in real estate by buying a 3br/2ba townhouse in the NW suburbs (Streamwood). I lived in it for one year so I could take advantage of the low down payment and interest rate and then began renting it after 1 year of ownership. 

For the deal you are looking at, a lender would not factor in rent from other tenants when approving you for a loan. The only way another tenant would help the approval process is if they were co-signing on the loan. Typically, lenders do not recognize rental income on a property until it has been owned for two years and the rental income has been documented on the prior two year's tax returns.

Here are a couple of options you may want to consider:

You could purchase a duplex or triplex. You would live in one unit and rent out the others. I know you are from Elgin, and there are lots of cheap duplexes, triplexes in Elgin. I actually just purchased a fourplex in downtown Elgin (closing in two weeks). 

Another option is purchasing a townhouse where the payment is $1,000 or less per month (based on your budget). Live in the property for one year and then rent it out. You would want to make sure that the homeowner's association allows rentals. You would also want to do an in-depth financial analysis regarding current rents for those units, annual expenses, etc.

Hope this helps! Hit me up if you want more ideas of how to get started in this area or would like help analyzing some deals in Elgin.

I'm actually more interested in property in Chicago.  Too bad property is so much more expensive down there! 

Let's say I did the townhouse idea out here in the NW suburbs.  I lived in it for year, then rented it out completely.  I'd still have the mortgage in my name on the townhouse.  Would that hinder my ability to get a new loan on a new property in Chicago?

Sean,

What you are describing is a large chunk of our business model. My husband is active duty navy so we move around a lot. We buy single family home live in hem and move out when he is transferred. We have many friends who have done your idea. My website is all about this business model. 

Some thoughts

* location is very important and ability to rent it out whole- so make sure that when you leave you can rent it as a typical rental unless you have a different exit strategy. 

*convention is a cheaper kind of loan- we put 5% in to have our tenant pus the loan

*45% is the "rules" for qualify - that means that your debt can't exceed  $2,250 based on 60k . So if you have no other loans (rent doesn't county) you should be able to qualify for the mortgage all on your own.

Requalifying- this is an interestingness topic as it depends on the Broker some want income on the tax returns (some count roommate, others don't), some a lease is fine etc.

The theory behind your idea is definitely there as this is a large part of our plan.  My website is new but I am covering this philosophy extensively.

Rule of thumb is that you can personally afford to purchase and live in a property that is three times your annual salary, so look for something in the $180K range.  I agree with @Scott Moe when he recommends a multi-plex (3.5% down with FHA) and renting the other units. Plus, after a year you can legally rent out the entire multi-plex with the FHA in place and move to purchase another property.

God Bless You!

"Let's say I did the townhouse idea out here in the NW suburbs. I lived in it for year, then rented it out completely. I'd still have the mortgage in my name on the townhouse. Would that hinder my ability to get a new loan on a new property in Chicago?"

It would hinder your ability to get a new loan on a property near Chicago. The rental income  from your first property would need to be reported on two year's tax returns before it would be considered an income property (meaning a lender would no longer see it as debt or factor it into your debt to income ratio). Some lenders may be more lenient on the two tax return rule, but most follow this guideline.

@Scott Moe  - Actually only Freddie backed loans require 2 years of rental income.  Fannie lets you use the leases and 75% of the rental income.  So if you used a broker you could make sure the loan is shopped out as Fannie conforming.  

@Sean McGovern  - I also think that as long as you have leases on the rooms for rent and report it on your Schedule E than it is treated as rental income no matter if it is just a room for rent.  Isn't that correct @Albert Bui  ?

The problem you are going to run into is that you can only have 1 FHA loan at a time (unless you have a qualifying event like a job transfer 500+ miles away) so if you bought the townhome with a 3.5% OO loan then you need to wait till it gets to a 80% LTV to refi conventional to get into another FHA. That could take 8+ years making regular payments

@Brie Schmidt  Thanks for the info! Can you explain a little more in-depth about "making sure the loan is shopped out as a Fannie conforming"? How would I go about doing that?

I'm on my phone so I can't tag you... But any broker I have ever worked with was able to shop my loan out to meet my needs.  A good broker with have multiple banks in mind who will take your deal

Originally posted by @Brie Schmidt:

@Scott Moe  - Actually only Freddie backed loans require 2 years of rental income.  Fannie lets you use the leases and 75% of the rental income.  So if you used a broker you could make sure the loan is shopped out as Fannie conforming.  

@Sean McGovern  - I also think that as long as you have leases on the rooms for rent and report it on your Schedule E than it is treated as rental income no matter if it is just a room for rent.  Isn't that correct @Albert Bui ?

The problem you are going to run into is that you can only have 1 FHA loan at a time (unless you have a qualifying event like a job transfer 500+ miles away) so if you bought the townhome with a 3.5% OO loan then you need to wait till it gets to a 80% LTV to refi conventional to get into another FHA. That could take 8+ years making regular payments

With Sean's situation if he lived there for one full year and subsequently rented it out for one full year after then it most likely should be claimed on the tax return. In this case it is underwriter call to mostly likely use whatever is claimed in the schedule E on your personal tax returns or the 75% X income - PITIA rule. Most underwriters will use the 75% guideline unless if taxes are filed then in that case they would revert to using tax returns. 

Just make sure you can qualify under both methods of calculation so you don't get burnt at the last minute going through the loan process if income is tight.

I have a file right now where the borrower only claimed 3 months of income at the end of 2013 on the tax return because they acquired their rental at the end of Sept 2013. The underwriter used the 3 month average income /3 = monthly average income. 

In regards to the FHA comment above about not being able to have 2 FHA loans, yes thats true unless Sean can qualify for one of the 4 exceptions (relocation, family size, divorce/separation, co-signor).

You would need to wait till the loan is 80% of market value if this property is 2 units but if its a single family residence you could refinance up to 95% of the market value and not have to wait or pay down your principal balance. There will of course be mortgage insurance however you can get rid of this by paying through the rate in a one time payment call "single premium," so there will be no monthly mortgage insurance.

So in this explanation it would be better to refinance the property into conventional prior to converting it to a rental to free up your FHA qualification capability by using a 95% conventional loan if its a single family residence that you'll be converting to a rental soon. The downside if its 2-4 unit is even with conventional you'll need more equity to refinance out into conventional since its max 80-75% LTV because while single family or SFR/condo is max 95% up to 417k loan.

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