What Will Happen If I Rent Out My Mortgaged Property?

Renting a mortgaged home could change your loan terms.

Renting a mortgaged home could change your loan terms.

Growing numbers of Americans rent out their homes. Recent Fannie Mae statistics show that single-family home rental units rose from 30.8 percent in 2005 to 33.5 percent in 2010 -- the largest increase among all rental property types. But tread carefully if you want to lease out a mortgaged home. Your lender and your homeowner's association, or HOA, may balk at the move, and you’ll have to crunch some numbers to see if it makes financial sense.

Mortgage Woes

Renting a mortgaged home could change the terms of your loan, since some banks and mortgage guarantors limit rentals in the initial loan agreements. With loans backed by the U.S. Department of Veterans Affairs and the Federal Housing Authority, for example, the owner must occupy the home for at least one year before renting out the property, says Tony Drost, a property manager at First Rate Property Management. Conventional loans backed by Fannie Mae and Freddie Mac also require at least one year of owner occupancy before renting. State assistance programs for first-time buyers may have longer restrictions. A mortgage holder may call the note due upon rental, forcing the owner to refinance at a higher interest rate. Even if you don’t plan on renting out your home right away, get familiar with your lender’s policies in case you must lease your property later.

HOA Issues

Some HOAs limit rentals, and Jay Kacirk, senior vice president at Eugene Burger Management Corporation, advises checking your HOA documents before renting. Run afoul of those rules and you could face fines. Some owner associations require input into tenant screening, lease approval and community orientation prior to tenant occupancy. Some associations cap the percentage of rentals allowed in the community, while others require a minimum lease period of six months or more. Also, association rules may bar you from using common areas, such as swimming pools and recreational areas, once you rent out your home, or might prohibit tenants from using neighborhood amenities, which could discourage prospective renters from leasing your property.

Business Expenses

Your homeowners insurance policy doesn’t provide enough coverage if you rent out your home. You’ll need to convert your home owner's insurance policy to a landlord or business owner’s policy for extra liability coverage and to pay for lost rent if the home is uninhabitable due to natural disaster or repair work. Other potential business costs include advertising, property management fees and legal expenses in cases of unpaid rent or landlord-tenant disputes. Competing with other rentals could also require upfront renovation costs. To attract residents, a rental must be in equal or better condition than a home for sale, because renters don’t have as much leeway to improve a property with fresh paint or new flooring. Furthermore, renters are less likely to take care of a property in poor condition.

Benefits

Renting may be worthwhile if you don’t face tougher loan terms or HOA restrictions. Landlords can deduct property depreciation and maintenance expenses, and mortgage interest and property taxes. Renting is also an option for a homeowner who must make a job-related move to another city for a year or two, but wants to return home. For a homeowner who must move permanently, but who’s under water on the mortgage, renting is a bridge to appreciation. Consider a home valued at $200,000, with a mortgage of $225,000. Selling would require a $25,000 payout to the bank, plus another $15,000 or so in closing costs, Drost says. Rent the home in a market with annual appreciation of 4 percent, and the home could be worth $245,000 after five years.

Is It Worth It?

Determine the rent you can charge by scouring newspaper and online classified ads for the going rate in your neighborhood. Once you know the rent you can charge, subtract expenses including mortgage payment, insurance, property taxes and utilities. Set aside 30 percent of the rent in a reserve account to cover repairs or other unexpected expenses, and take away another 3 percent to 10 percent if you hire a property manager. Factor in income taxes, and what's left is your potential profit.

References

About the Author

Jennifer Alyson started writing professionally in 1995. Her work has appeared in the "Chicago Tribune," the "New York Post" and "Where" magazine. She covers business and real estate, but writes about topics ranging from rock-climbing to jewelry design. She holds a Bachelor of Science in journalism from University of Kansas.

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