So, you have been living in your home for some years. The place is beautiful because you have been fixing it up and making it a cool spot. You have been faithfully reducing the principal balance on the loan as much as possible and the total loan is much lower than when you first bought the house.
Now you get to make the first wealth move of your life. Now you set about to renting your first home and making plans to move to a new home. Once you rent your house, you will go from being a laborer to an investor. Once you get a tenant, you will begin receiving money for which you did not have to get up and go to work.
Once you begin receiving money through having a rental, you will experience the beginnings of financial freedom. There is nothing so sweet as financial freedom. It is much better than a new car or any new toy. Those things give you a fleeting feeling of freedom before the newness fades and the costs begin to add up. Rental income gives you freedom for life.
How to Calculate How Much to Charge for Rent
The internet is your best resource for figuring out what to charge. The average rental rate in the area of your house will dictate what you can charge for rent. Where I live, there is an internet site called WestsideRentals.com. I use their service to look at other rental properties on the market. Basically, I am looking at others houses that are similar in location, size, and condition to my current house. I try to look at five properties that meet this criteria and see what other landlords are offering for rent. I then add up each offer and divide by five; that gives me the exact rental average for that area.
The primary concern for any tenant is the amount of the rent, based on location and square footage. Amenities will not rent your house. Amenities may keep a tenant, after they move in and decide they love the house, and cannot live without that view. But a beautiful view will not get a tenant if the house is in a bad location, is the wrong size, or priced too high. Gauge rents by current rented listings for other houses that are similar in location and square footage.
Analyze Expenses of Owning Your First House
But you have to make certain that the average rental rate will give you a profit! In order to know what to charge for the rent for you first house, you have to first know exactly how must it costs you to own it.
The proposed rent must cover the payment on the mortgage loan, taxes, insurance, maintenance reserve, gardener, and give you a profit, too. The proposed rent must cover all of these things. You cannot pay for another person to live. If the rent does not cover these things, then you are essentially footing the bill for another person to live.
ms. katherine
Look back at the cost of each of these things — the loan, the taxes, insurance, the maintenance reserve, and gardener. Go back through your envelopes and figure out how much you paid in each of these categories for your house. Add up each of these expenses for the entire year. Divide by twelve. That is the minumum monthly rent.
In each category, go back through your receipts and statements, and figure out, per year, how much you spent. The last two years should be used to calculate a repair reserve. And do not forget to add in the gardener as a monthly cost on the house. Tenants will not pay for yard maintenance and you need a good pair of eyes and ears who can alert you to problems.
Subtract the Expenses from the Average Rental Rate to Determine Profit
If the average rental rate can cover the current mortgage payment, yearly taxes, house insurance, repair reserve, and gardener, then technically, you are ready to rent. However, if the amount you will make, after covering all those expenses is very small, it can feel like a great struggle, with little reward. So if your subtraction of the expenses on your house from the current rental rate leaves you either in the red, or you are just barely in the black, don’t despair. You have options. If you still have a mortgage on your house, you can refinance the loan on the first house to a much lower amount.
Strategies for Lowering the Loan Amount to Increase Profits
Again, this is where one of the rules from Money Fundamentals, Step Twelve and Real Estate, Step Five– make as big of a payment as you can, as often as you can – begins to have a positive impact.
If you have been faithfully reducing the principal balance on the loan, your loan on the house will be much smaller than when you first got the loan. You can then refinance the current loan, have lower payments, and have greater cash flow profit from the rental stream.
If you want the house to cash flow more, you can refinance the current loan to a thirty year fixed rate so that the payments are much lower. Here is where you will have to do some financial analysis. Let’s go back to our example and remember the terms. You bought the house for $300,000.00. You contributed twenty percent (20%) to the purchase of the house, $60,000.00, and received a loan from the bank for $240,000.00. The loan had an interest rate of 7.0% with a term of thirty years, making the monthly payment $1,596.73.
Let’s continue, in our example, to assume you have been faithfully making as big of a payment as you can, as often as you can, and reduced the principal loan balance by $10,000.00 every year, and have owned the house for seven (7) years. Thus you will have reduced the loan by $70,000.00 and now owe only $170,000.00. ($240,000.00 – $70,000.00 = $170,000.00.)
Your current loan payment continues to be $1,579.73 because that is the payment term under your original Note. Let’s say you find out that the average rental rates are $1,500.00 for the size and location of your house. That would mean that you would be in the red by negative -$79.73 every month. Not good.
But, wait! – You can now refinance the loan on the house because the balance on the loan is so much lower. If you refinanced the current mortgage of $170,000.00, at a 7.0% interest rate, for another thirty years, the payments on the house would be $1,131.10. At the current rental rate of $1,500.00 per month, you would have a net profit of roughly of $368.90 per month. It is true that you now have to pay the loan for a longer period of time, but you would get immediate cash flow from the property with this strategy. And don’t forget – the tenant now pays the new thirty year loan.
How Interest Rates are Calculated for Different Borrowers
But wait! There is one huge added benefit – you are now likely to qualify for a much lower interest rate! Why? Because you are now an excellent credit risk! You are no longer the type of borrower that can only qualify for the 7.0% range. You are now the type of borrower that can get the really low interest rates – because you have shown that you know how to handle money.
There are three things that will affect interest rates – the Federal Reserve, whether the house being financed is owner occupied, and your credit rating.
ms. katherine
The Federal Reserve
The Federal Reserve sets the interest rates and policies governing interest rates. When the Federal Reserve drops the interest rates significantly, it is always a good time to refinance, even if you are not considering renting. If you can significantly lower your interest rate, you will automatically have lower payments. If you can drop your interest rate by 1.5% or more, refinance! You should always keep an eye on what the government is doing with the interest rates.
Owner Occupied Loan Financing: Refinance Before You Move
The government does not give the beneficial interest rates to investors in real estate. Thus, once you move, even if you keep your first house, you are considered an investor in real estate and will not qualify for the low owner occupied rates. So, refinance your first house before you move to another house.
Borrowers that Qualify for the Very Lowest Interest Rates Get Rich!
Finally, the very low interest rates are given to people with very high credit scores. If you have been following each of these steps, your credit score will rise steadily. If you have been saving 10% of your money, have no consumer debt, own a house, and have been steadily reducing the balance owing on the house, your credit score will rise. The higher your credit score, the better the interest rate you will be offered. You have a demonstrated track record of knowing how to handle money now; so the bank will reward you with giving you a better rate. Even a blind squirrel gets an acorn once in awhile!
So, let’s go back to our example and remember the terms. You bought the house for $300,000.00. You contributed twenty percent (20%) to the purchase of the house, $60,000.00, and received a loan from the bank for $240,000.00. The loan had an interest rate of 7.0% with a term of thirty years, making the monthly payment $1,596.73.
Let’s continue, in our example, to assume you have been faithfully making as big of a payment as you can, as often as you can, and have managed to reduce the principal loan balance by $10,000.00 every year, and have owned the house for seven (7) years. Thus you will have reduced the loan by $70,000.00. Now you owe only $170,000.00. ($240,000.00 – $70,000.00 = $170,000.00.) So, the loan is now $170,000.00.
But this time you will get the killer percentage rate, specially reserved for an excellent money manager like you! Let’s say your new rate is 5.0% and you waltzed out of that bank with the lowest possible rate! Now your loan payment would be $912.60! At a current rental rate of $1,500.00, you would show a net profit of $587.40 per month! Now that is a profit margin you can live on! Celebrate. Get a drink. In fact, for once, drinks all around!
It is true that you would have to pay the new loan for another thirty years. But you would have immediate cash flow every month.
The traditional wisdom is that refinancing to another thirty year term makes the house hard to pay off altogether because you pay so much in interest. But, the counter argument is that you can always refinance to a fifteen year loan, in the future, when the tenant has paid the loan down.
ms. katherine
Remember, you don’t pay the loan anymore, the new tenant does. As you grow richer, you can simply keep making as big of a payment as you can, as often as you can. You are not limited to what the tenant pays you. In fact, you can keep refinancing to shorter and shorter loan time frames. Your next move would be to refinance to a 15 year fix rate loan, paying the loan off twice as fast. Either way, one fine day the whole loan will be paid off, and you will get to keep every penny of that income stream. Go travel. Go to the beach. Go wherever you want, secure in the knowledge that the rental money will come in, month after month, year after year, for the rest of your life.
Summary:
(1) Once the rental rates in your area exceed the mortgage on your current house, plan to move so that you can now rent out your first house. This takes some planning, timing, and you should follow these steps. Begin researching the local market to determine what you should charge for rent, based on internet research for what houses have rented for in specific areas.
(2) You need to do a profit analysis. Determine the average monthly rental from the rental market research. Then subtract your current loan payment, taxes, insurance, repair reserve, and gardener. If you can cover those expenses, you are ready to rent.
(3) If you need more positive cash flow from the property, refinance the house before you move. If you can refinance and get rough 1.5% off of your current mortgage, go for it. Talk to different brokers (or better yet, find one that you trust for life) to help you get a different loan on your house. That way the payments on the house are significantly reduced. Your profit margin from the rental will be increased if you can get the mortgage payment on your house very low.
The goal is make a profit by turning your home into a rental. Chart a course for your future. Begin today.
