Owning a house has long been considered essential to achieving the American Dream — a sign that you have made it or are well on your way to financial stability. However, having your own house is just the first step for many people today.
The second is venturing into the world of real estate investment. Buying additional properties is an ideal way to supplement your income. Overall options to grow wealth through property investments, renting properties continue to be one of the most popular and viable options.
As homeownership rates go down and more millennials, the largest generation by population, renting homes out of financial necessity and preference, buying a second property to rent out can be incredibly lucrative.
Still, becoming a landlord isn’t for everyone. Here’s a quick primer on how to become a landlord:
How To Purchase a Second House
If you’re buying a second home to rent out, you’re most likely already familiar with the process of buying a house. You’ll go through much of the same process when purchasing a second home.
However, there are several different considerations you need to bear in mind that will greatly affect your purchase. Below is a complete list of steps to take and things to consider when buying a second house for renting out.
Check Your Finances
First of all, determine if you can afford to take out a mortgage for a second home. You’ll need cash reserves for at least a 20% down payment, savings for unexpected expenses or repairs, and more.
Many people find it harder to meet the financing requirements of buying a second property than when they bought their first. This is especially true if you are still paying off the mortgage loan you took out on your first home.
You’ll need sufficient income to cover both mortgage payments and still maintain a good debt to income ratio of at least 36% and no more than 41% or 43% at the most. You also need a minimum credit score of 620.
Obtain Mortgage Preapproval
Once you determine your finances are sufficient, get started on the financing process as soon as you can. It’s always best to get preapproved for a mortgage loan before you start browsing properties seriously.
Getting early preapproval gives you a more concrete number of how much you can truly spend on your second house. It also gives you greater buying power.
Additionally, getting preapproved helps you avoid potential financing hurdles when you’ve already found a property you want to buy.
Choose the Right Location
Finding the right location for a rental property is crucial. You don’t want to get stuck with a rental home in an area that does not get a lot of long-term or even short-term lessors.
Look for a city, locale, or neighborhood with positive population growth. Places with revitalization plans, a growing job market, or have a sizable millennial population are all ideal locations.
Other things you need to consider include:
- Low property taxes
- Good school districts
- Nearby amenities, such as parks, food places, and retail stores
- Low crime rate
- Accessibility to public transportation
- Proximity to tourist attractions
Hire a Local Real Estate Agent
Look for a reliable and experienced real estate agent who works in the area. A local agent knows the area best and can offer better advice than a regional agent. They are more familiar with the local real estate market and can provide insight into neighborhoods to consider.
Begin Searching for a House
Establish your criteria for the property to help narrow down your search. Aside from your budget, your criteria should include factors like the number of bedrooms, square footage, and yard space.
It may also help to limit the search according to the type of property, such as single-detached houses, townhomes, or condominiums, and the architectural style.
Close the Deal
Once you’ve found the property you want to buy, work with your agent to ensure a smooth negotiation. Prepare all the necessary documents, including title insurance and homeowners insurance.
Similar to when you bought your first home, remember to schedule home inspections before closing the sale and renegotiating the offer if needed. Make sure to arrange a final walk-through of the property as well to make sure it’s move-in ready.
Types of Mortgages
Taking out a mortgage is never an easy decision. Before you decide on the perfect second home to start your career as a landlord, you’ll need to first decide on the type of mortgage loan to help you finance your investment.
There are many types of mortgage loans, each designed to address different borrowers’ needs. Below are five of the most common types of mortgages.
As the name suggests, the interest rate for this loan will remain unchanged throughout the loan. This type of mortgage is best if you want payment predictability.
The 30-year fixed-rate loans are the most popular, due to their lower monthly payments, followed by 15-year fixed-rate loans, which have lower interest rates than long-term loans.
Adjustable-rate mortgages have lower initial monthly payments. The initial rates can be locked for the first several years before increasing or adjusting periodically.
This type of mortgage is best if you’re comfortable with taking on the risk of larger payments in the future. As such, this loan is also recommended if you don’t plan on keeping the property long-term.
These are home loans insured by the Federal Housing Administration. Like other government-insured loans, this is ideal if you have a low credit score since they accept scores as low as 500. FHA mortgages also have the advantage of allowing less than 20% down payments/
If you have an excellent credit score, high income, and are looking to invest in an expensive house, then a jumbo mortgage may be your best option. These loans require at least 700 credit ratings and a down payment of at least 10%.
This type of mortgage has an interest-only payment period, during which the payments will not go towards paying off the loan balance or principal. It will only pay off the interest charge. As such, consider this loan only if you have the discipline to make periodic principal payments.
However, if you have varying monthly income or a high monthly cash flow, an interest-only mortgage may serve you well.
Benefits of Owning a Second House
Investing in real estate comes with its ups and downs. However, many of the downsides to buying a second house are offset simply by the appreciation of the property.
As long as you take care of the property, you can benefit from its increased value over time. If you dutifully pay off your mortgage loan, you can also increase your home equity.
Having higher equity allows you to borrow a higher amount against it as a loan and sell your home for a higher value than your remaining loan while keeping the difference for yourself.
Another benefit of having a second investment property is having the option to rent it out or keep it as a vacation home.
Renting out a second house gives you an additional semi-steady source of income. This alone can help with monthly loan payments, repairs, and upkeep. During periods of vacancy, you can use the property as a vacation home or secondary residence.
How To Find Tenants
One of the most important things you need to know as part of learning how to become a landlord is the art of finding good, reliable tenants. At the same time, this is also one of the biggest challenges you may face as a landlord.
You need tenants who will not only pay rent on time but also take care of your property. If not, you may end up with a business in the red due to costly repairs and lack of income.
Here are a few tips to help you get started in finding good tenants:
- Hire an experienced property manager or rental agent.
- List the property on popular rental listing websites, like Zillow, Craigslist, and Trulia, to find long-term lessors. For short-term rentals, list them on platforms like AirBnB, VRBO, or Homestay.
- Use social media to reach a wider audience, either through your profiles or by making a new account specifically for the property. Leverage social media marketplaces as well.
- Use flyers, newspaper classified ads, and other print advertisements. Erect for-rent or for-lease signs on the house, too.
- Offer attractive incentives, such as discounted rates for moving by specific dates, referral bonuses, and included appliances in the deal.
- Create scarcity or a sense of urgency by advertising the property as a fast-disappearing hot commodity.
- Prepare pre-screening questions to help you find ideal tenants. Ask insightful, open-ended questions but ask all applicants the same questions to aid in objectively judging the responses.
- Ask for and check references, ideally from past landlords, employers, or roommates.
- Run credit checks or ask for a credit report.
What Kind of Income You Can Make
Investing in rental properties can be lucrative. In general, the kind of income you can make depends on several factors that can help you maximize or increase the monthly rental price. These factors include the location, nearby amenities, parks, and more.
To get a general idea of monthly income, check out the average rent in the neighborhood. Pay special attention to how much rent the nearest or most comparable properties charge.
In 2021, the average rental cost for a single-bedroom house or a duplex is over $1,900 while an apartment or condo unit is almost $3,000. The average costs also greatly vary based on the state and city.
However, the monthly rent is your income — not the profit. If you’re only starting in the business, around $200 to $400 is a realistic monthly profit on one property. This takes mortgage payments and other expenses into consideration.
To estimate your potential profit, you’ll need to subtract the following from the total earnings:
- 5% – 10% for property maintenance and upkeep
- 5% – 10% for capital expenditures, including insurance, taxes, and major repairs
- Around 10% for property management fees if you work with a management company
- 10% to offset vacancy periods
This means you’ll have to subtract up to 40% from your monthly income. You’ll then have to subtract the monthly mortgage payment for the property from the remaining amount.
If you’re charging $2,000 per month for a single-bedroom home, that’s $24,000 annual income. When you deduct 40% for all the expenses, you’ll be left with $9,600 per year or $1,200 per month.
Minus the mortgage payment from that and you may have around $600 remaining as your monthly profit. Take note that this estimate is for long-term rentals only.
Is It a Passive Income Source?
No, not really. Still, it can be relatively stress-free with the right tenants.
The truth is that running a rental property business and becoming a landlord requires a lot of time, work, and energy. You’ll be the one coordinating the necessary repairs and general upkeep, ensuring tenant safety, and collecting monthly dues.
If you want a more passive rental income source, your best option is to work with a property manager or caretaker. However, hiring a property management firm to take care of all the day-to-day responsibilities does not mean you will be completely hands-off on the business.
You will still need to keep yourself up to date on rental laws, mandates, and the general housing market situation.
Grow Your Wealth With Rental Property
If you’re looking for an effective, long-term side hustle, there are few options better than investing in real estate to rent. However, entering the market requires a lot of forethought and preparation.
You can’t simply dive headfirst into it. More importantly, you won’t become financially set overnight.
To build wealth through rental properties, you need to fully understand how to become a landlord, the responsibilities that come with it, and the work necessary to make it work.