Need advice with how to convert current home to rental home

19 Replies

Hello all! I am brand new to posting on the forum but have enjoyed reading your posts to try to learn more about investing in real estate. I have a question that I'm hoping I can get some advice on - we are very new to the realm of rental properties so I'm sure there are glaring flaws in my thinking that need to be pointed out. 

So, we currently own a townhouse in Durham, NC. Husband was just offered a job in Kingsport, TN, we are taking the offer, and it's a significant increase in pay (basically doubles our meager combined annual income). We would like to keep our townhome and rent it out, but aren't sure if that makes the most financial sense.

We bought the townhome for about $145k in 2013, currently have just under $127k left on the mortgage, at 3.5% interest rate FHA. (We fortunately closed right before they changed the rules about MIP on FHA loans, so ours will be canceled in a couple of years once we reach 20% equity, or earlier if we refinance before that). Based off other units in our neighborhood that have recently sold, we could get anywhere from 185-205k for it. We both have 800+ credit scores, but don't have much saved for a sizable down-payment on a new place. The way I see it, we have three options:

  • 1: Sell the townhome, use part/most of the profit for down payment on new home.
  • 2: Based on new income (106k base), we can afford to keep the townhome and get a mortgage for a pretty good house in Kingsport. With this option, we wouldn't have enough saved for 20% down payment, so we'd probably have to have PMI on our loan.
  • 3: Do a cash-out refinance on our townhome, use that money as down-payment on new home. This would allow us to refinance into a conventional loan and cancel the mortgage insurance, however, we would lose the awesome interest rate of 3.5. (I also feel like it could be difficult to find a lender who wants to work with us on that, maybe I'm wrong?)

Does the answer seem obvious? I keep going back and forth on what is the wisest decision. We would love to keep it as a rental, as this area is exploding (especially with possibility of Amazon AND Apple coming to the Triangle), so rent would likely increase in the area soon and steadily. It seems the easiest way to ease your way into investment properties is to convert an existing home. We wouldn't be able to profit much at first, but would be able to cover the mortgage and expenses/emergency savings. But potentially walking away from 60-70k would be hard to do, too.

Let me know if I can provide any more information, I'm really looking forward to any advice you have to offer!

I think we could get 1500 for it based on other units in the area (3 br/3.5 ba). Currently, mortgage (includes insurance and property tax) + HOA is 1150, property management fee would be 10% of rent.

@Callie Brown - another possibility would be to capitalize on the equity that has been built through appreciation by pulling out a HELOC on your townhouse here in Durham. Then you could utilize the HELOC to help fund the downpayment on your property in TN. Of course there are risks associated with that such as increasing your debt, but most HELOC payments are a minimum of 1% of the outstanding balance. I can recommend a couple credit unions in NC that would be good to use, one of which didn't cost anything.

Definitely, you should calculate the numbers before committing to this option, but it's worth looking into.

@Callie Brown ,

I would keep the Durham townhome and rent it, but give no consideration to refinancing it. It doesn't make sense to increase your interest rate, add PMI, and disrupt the nice cash flow you can enjoy currently. Then, buy a "lesser" place in TN than you might think you husband's new salary affords, but nonetheless a nice place in a nice neighborhood. Just be sure to take the time to look for a deal, possibly a forced-appreciation play.

The chances for appreciation in Durham appear to far surpass possible appreciation in Kingsport.  In your shoes, I would worry about the possibility of selling in Durham to buy in Kingsport, missing out on an appreciation boom in Durham, and three years from now, selling the Kingsport home for little profit when you two move for the next job opportunity.

As long as it's properly maintained, you should easily generate $1500/month now, and more in the future.  With adequate PM, there should be little to no vacancy, as the Durham rental market is incredibly strong.  At this point, you're playing with House money (almost no pun intended) in Durham -- it would be a shame to prematurely cash out unnecessarily. 

The only reason to cash out now would be to qualify for a big loan for a nice big forever home in Kingston.  I say postpone that dream and let the Durham property help set you two up even better later on.

$1500 rent on a 200K property is too low. You will not make any money, possible negative cash flow long term, I would sell it now without hesitation. It is not a good choice for a income investment propery.

@Callie Brown What are your goals? If your goal is to start adding to your portfolio as an investor then you should strongly consider keeping it. Acquiring the property as a primary property, moving out, and renting is an inexpensive way to add to your portfolio. You can always sell it as a Plan B if you don't like dealing with it out of state. 

For the downpayment on the new home - the HELOC option as @Eric Weireter mentioned is a great option but it will take away from your little bit of cash flow. This is very easy to do through a local credit union and essentially the new tenant will be 'paying' for that monthly payment when the numbers are good. That draw is good for many years and can be used over and over again for future investments. 

I'd personally hesitate to buy right away in a new market with a new job as I've seen people move for a job and it not really work out the way they expected. If you do buy in TN, decide whether it's the 'forever home' or a possible investment so you buy with the right eyes. 

@Callie Brown Difficult decision based on your list of options. First, let me ask a few questions. 

  1. Have you already been pre-approved for a second home loan in Kingsport? Lenders can be annoyingly thorough about having a second home with a mortgage. If you can't get pre-approved, your only choice may be to sell. 
  2. Will your FHA lender approve of you renting it out? Generally, FHA insured means owner occupants only but there are loopholes (i.e. owner occupied after X years).
  3. Will your HOA allow renters? The answer isn't always yes.

If all 3 are yes, then I would likely rent it out. I lived in RTP for several years and have a friend who just put her house on the market yesterday (probably go under contract within a week), so I know the area is booming. Even if you're only cash flowing $350/month ($1500 rent estimate - PITI - HOA) less property manager fees, you're still cash flowing fairly well unless there is something I'm missing.

Kingsport is a much different market. Lots of older homes so you have options of buying cheap and rehabbing, but not much in the new construction ballpark. I work in Kingsport quite a bit so let me know if you have any specific questions. 

Thanks for all of your help so far! This has helped me to narrow down what I want. I definitely want to keep the unit as a rental if we can make it work.

@Randy E. I agree that it would be a shame to cash out now while there is so much potential for growth here in Durham. Your second paragraph really helped to put that in perspective, and I don't want to move all of my eggs into the Kingsport basket. Who knows, we may end up in Kingsport forever, but I know the house we buy now would not be our "forever home," so there's no need to max it out.

@Thomas S. Can you explain why you think the rent is too low? I'm new to the game so I don't understand the reasoning. From my understanding, our unit has the potential to be a great investment property. 

@Emily C. We would definitely like to build our portfolio and I agree, we could always sell later if investment properties don't turn out to be "our thing." I'm also trying to be cautious about the home we select to buy in Kingsport as far as resell value, etc. (For me, it's sort of a trade-off - I HATE renting, so I'd be okay paying a little more in the end if it means I don't have to answer to a landlord.)

As for the HELOC, I need to read more about that, but from what I understand, I'm now starting to think that it may be risky to put that much of our equity from the Durham unit (a strong market) into a house in Kingsport. @Eric Weireter maybe a HELOC would be better suited for when we are looking to buy an investment property in a better rental market?

@Matt Castle , 1) We spoke to our current mortgage lender and she told us based on our numbers, we could be approved for a second home. We also got a pre-approval through an online lender, but this is based on the fact that we will have a tenant in place (the timing could be tricky, but doable). 2) I googled NC FHA specifically and haven't found anything yet, but I think since we have occupied the house for 5 years now, we will be in the clear. 3) Yep, our neighborhood has a big mix of owner/renter. If you know anything about Kingsport as far as good areas to buy/areas to avoid (or any other info you think helpful) I would really appreciate that.

If yu can not achieve rent being 1% of value of home th elikley hood is that long term expences will push your cash flow into th enegative.

Insurance, legal, vacancies, evictions, utilities when vacant, routine maintenance between tenants, appliances, flooring, painting etc. etc will eat up any and all cash flow long term.

@Callie Brown - if you are even considering a HELOC start the research before you move out. The reason being is that I'm unsure if they'll do a HELOC for you once it's a rental so you may have to tap it while it's your primary and just have the money available for when you're ready. Check with the lenders.

@Thomas, that would be the case if she were purchasing a home for $200k & renting it for $1,500/month. She stated that they bought the house for $145k. That could work just fine, just need to run the numbers.

@Callie Brown , use the BP rental calculator to make sure you can make money while putting ~5% back for vacancies, repairs, & capital expenditures. Don’t forget the property management if you’re out of state. 

@Callie Brown Look at how much that PMI costs, you don't want it, recently found out how much mine is costing me and I now am trying to remove it to save $30,000 so don't think that PMI isn't a big expense. I recently have been going through the same kind of situation. I found the HELOC looks like the best option because refinancing away from the low interest rate and principal adds a lot to how much you pay the bank when you refinance. Look at how much more you pay on principal and interest and you will think more about Selling or Doing a HELOC to keep your loan with low principal and interest. Im most likely keeping mine as it is in a good area as well. If you refinance to a higher loan principal amount and rate it makes your net worth go down and it will be more difficult to get another property as well so these are things I been thinking about maybe it will help you.

@Callie Brown I would rent out the NC townhouse and find a reasonably priced rental at your new location. 1.You want to learn more about the market in your new location. 2. The economic cycle is quite mature and you may be able to get a better price in TN in the next year or two. 3. You want to make sure your spouse likes the new job and the job security will be there for a new home purchase to make sense.
@Callie Brown sell it, the numbers are mediocre in rent vs value , not counting hoa and management, and you’re not even going to be local. Like most real estate bought as a residence; it makes little sense to repurpose them as rentals.. I’m convinced people only do this out of an emotional attachment

I would absolutely sell it from a tax perspective, because I plan to do the same thing very soon. You can unlock those funds tax free with no stress, worry, or headaches associated with owning 1 rental property. If you had no appreciation in the last 5 years then I would absolutely convert it to a rental. 

The numbers on my current home are very similar. Purchased in 2012, 3.75%, $142,000 now worth around $210,000. When we move I plan to sell to get the tax free gains. Long term if we can save enough I'd want to purchase a rental property in the next downturn. I would like to use mostly cash and avoid giving my profit to the banking industry in the form of interest. 

Refinancing to get into a higher interest doesn't make much sense to me either.

@Callie Brown - Yes, the HELOC would be better suited if you were using it on an investment property. Though, you would have to verify the numbers all worked because you would have to repay your HELOC in addition to any debt you leverage to purchase the investment property.

The idea that @Curt Riffel tossed out is a good point about the tax-free gains. Though, you only need to live in the property 2 of the last 5 years to receive the capital gains tax-free. So, in your situation - if selling the property was your decision - you would have 3 years to sell the property without having to pay any capital gains tax.  

Thanks everyone! We haven’t made a final decision but are planning on renting it out. I will still have a couple of years to decide if we are well-suited to own a rental property before capital gains tax go into effect. Here’s another question (but maybe this deserves a new post altogether): Do people suggest forming an LLC for just one property? Or does it not really matter until you have collected a few? What’s the best way to do this, if we want to buy some more properties down the line?