Can I Rent My House and Buy Another?

Renting out a current home while purchasing a new one presents both significant opportunities and distinct complexities. This approach allows homeowners to retain an asset that may appreciate in value, potentially generating additional income, and building long-term wealth through real estate. It can also provide a strategic path to acquiring a new residence without immediately liquidating a prior property. However, this transition involves navigating a different set of financial considerations, legal requirements, and management responsibilities compared to a traditional home sale and purchase. Understanding these interconnected elements is important for anyone considering this housing strategy.

Assessing Your Financial Readiness

Before committing to renting out your current home and buying another, a thorough personal financial assessment is important. Evaluating your current home equity is a primary step, as the amount of equity available can influence your options. Home equity is calculated as the difference between your home’s current market value and your outstanding mortgage balance. Lenders may look for 20-30% equity if you plan to keep your current home as a rental property and obtain a new mortgage.

Understanding your current debt-to-income (DTI) ratio is also important, as it indicates the percentage of your gross monthly income that goes toward debt payments. Lenders use DTI to assess your ability to manage additional debt. Acquiring a new mortgage while retaining your existing one will impact this ratio, even if you plan to generate rental income. A DTI ratio below 36% is considered favorable, though some lenders may approve higher ratios, especially for conventional loans.

Projecting potential cash flow from the rental property involves estimating future rental income and offsetting it against anticipated expenses. These expenses include the existing mortgage payment, property taxes, homeowner’s insurance (which will need to convert to a landlord policy), and ongoing maintenance costs. It is important to factor in potential vacancies (5-10% of the year) and allocate 10-15% of rental income for repairs and maintenance. Having an emergency fund specifically for both properties, ideally covering three to six months of expenses for each, provides a financial cushion against unexpected costs or periods of vacancy. This internal financial health check helps determine if you can comfortably manage the obligations of two properties.

Financing Your New Home

Lenders assess applicants differently when they plan to convert their current primary residence into a rental property. A significant factor is how future rental income from the old home is considered in your debt-to-income (DTI) calculations for the new mortgage. Lenders do not count 100% of the projected rental income, using only 75% to account for potential vacancies and maintenance. This means if your current home could rent for $2,000 per month, a lender might only credit you with $1,500 of that income when assessing your ability to qualify for a new loan.

To account for this income, lenders require a signed lease agreement or a professional appraisal, such as a Fannie Mae Form 1007, which estimates the fair market rent for the property. This documentation helps the lender verify the anticipated rental income. While your current mortgage payment will initially be counted as a debt, the projected rental income can help offset this liability, making it easier to qualify for the new loan.

Several mortgage types are available for financing your new primary residence while retaining your old one as an investment property. Conventional loans are common, requiring a strong credit score (620 or higher) and a down payment ranging from 3% to 20% or more, depending on the loan program. FHA loans, designed for low to moderate-income borrowers, permit down payments as low as 3.5%, while VA loans offer 0% down payment options for eligible service members and veterans. Jumbo loans, for amounts exceeding conventional limits, require higher credit scores (700 or above) and larger down payments (20% or more) due to their increased risk.

Transitioning Your Current Home to a Rental

Converting a primary residence into a rental property involves important practical and legal adjustments. One immediate step is changing your homeowner’s insurance to a landlord or rental property policy. This specialized insurance provides coverage for risks associated with tenants, such as liability for injuries on the property and damage caused by renters, which standard homeowner’s policies do not cover. Landlord insurance costs 15% to 20% more than a standard homeowner’s policy.

Understanding state and local landlord-tenant laws is also important, as these regulations govern the relationship between property owners and renters. These laws cover various aspects, including security deposit limits (one to two months’ rent) and the timeframe for returning deposits after a tenant moves out. They also dictate eviction processes, which involve specific legal procedures and notice periods that vary by jurisdiction, and establish habitability standards, ensuring the property provides safe and livable conditions.

Drafting a comprehensive lease agreement is important for clearly outlining the terms and conditions of the tenancy. This document should specify rent amount, due dates, late fees, pet policies, maintenance responsibilities, and the duration of the lease (12 months). Thorough tenant screening practices, including credit checks, background checks, employment verification, and rental history reviews, help identify reliable renters. You can either self-manage the property, which requires handling all aspects from tenant relations to repairs, or hire a property management company. Property management companies charge a monthly fee (8-12% of the gross monthly rent) for their services, which include tenant placement, rent collection, and maintenance coordination.

Understanding Rental Property Taxation

Owning and renting out a property has specific tax implications that differ from those of a primary residence. Rental income must be reported to the Internal Revenue Service (IRS) on Schedule E (Supplemental Income and Loss) of your federal tax return. This income includes not only regular rent payments but also any additional amounts received, such as application fees, late fees, or security deposits that are not returned to tenants.

Many expenses associated with operating a rental property are deductible, which can reduce your taxable rental income. Common deductible expenses include mortgage interest, property taxes, insurance premiums, and costs for repairs and maintenance. Other deductible items are advertising fees, utilities paid by the landlord, and professional fees for services like property management or legal assistance. Depreciation is another deduction, allowing you to recover the cost of the property over its useful life (27.5 years for residential rental property).

The IRS also applies passive activity rules to rental real estate. Losses from passive activities, including most rental properties, can only be deducted against passive income. However, a special allowance permits taxpayers who actively participate in their rental real estate activities to deduct up to $25,000 in passive losses against non-passive income, subject to income limitations. If the property is eventually sold, capital gains tax implications arise, which differ from those of a primary residence. The Section 121 exclusion allows homeowners to exclude capital gains from the sale of a primary residence (up to $250,000 for single filers and $500,000 for married couples filing jointly), only applies if the home was used as a primary residence for at least two out of the five years preceding the sale. If the property was converted to a rental, only the portion of gain attributable to its use as a primary residence may qualify for the exclusion, while the remaining gain from its rental period would be taxable.