Should I Rent My Current Home So That I May Purchase Another? Well...

Choosing to rent one's current home and also purchase a new primary residence isn't a decision to be made lightly. A homeowner's ability to take advantage of this particular arrangement depends on a number of factors about which they may not be fully aware. 

Most obviously, homeowners should consider whether they have the desire to become landlords with all the responsibilities and potential expenses of the role, especially in a State such as Massachusetts in which the laws are very pro tenant. It's relatively easy to find a tenant but not nearly as simple to sever the relationship should it take a turn for the worse. And should a landlord ever decide to sell, the presence of a tenant will play a role in the transaction especially if a buyer plans to finance rather than pay cash. The buyer may also be expected to assume the seller's obligations to the tenant.

If you are serious about buying a new home and turning your current home into an investment rental, here are just a few of the many things you should keep in mind:

• "The best defense is a good offense." Seems like common sense, doesn't it? It isn't. There are countless stories of homeowners turned landlords who regret not doing their homework first. Typically they speak with an attorney after something has already gone wrong with the deal hoping they can now fix a situation that could have been averted altogether with less expense and aggravation.

• Begin by speaking with an experienced loan officer -- emphasis on experienced -- and explain what you hope to accomplish. The LO will tell you what you need to do to successfully obtain financing for your new home in the context of retaining your current home as an investment property. If everything is in order, you should be able to obtain a pre-approval for your next home.

• Expect to be asked about the reason for your desired move (especially if the two properties are less than 50 miles or so apart). Your reason will need to be acceptable by current financing and fraud standards. Your LO and underwriter must prove that you're not engaging in "buy and bail" fraud. Buy and bail is simply buying a new home with intent to dump the previous one -- and lenders are expected by the government to be on the lookout for fraud. Understand that it's nothing against you personally. 

• You may be expected to show sufficient equity in the existing property -- the magic number is generally as high as 30%. Should you lack sufficient equity, ask your loan officer what other options might be available to you (e.g. paying down the existing mortgage to an appropriate level, or using a different loan product that might allow for less equity in the soon-to-be investment property).

• You will only be able to apply a portion of rental income toward qualifying income if you meet the requirements of the specific loan product and lender. In some cases, a signed lease agreement from a renter and proof of the security deposit is sufficient (e.g. FHA), while in others the lender may require a 2 year history of rental income as documented in your filed tax returns. Absent the required proof, you'll have to qualify to carry both mortgages as well as any other debts based solely on your income from sources other than rental income.  

• Secure the services of an experienced real estate attorney. Explain what you plan to do and have your attorney walk you through everything that must be accomplished from a contractual perspective, especially your obligations to the tenant (and vice versa) once you assume the role of landlord. While you're at it, ask your attorney to explain what will be expected of you should you ever decide to sell the property. 

• When you do finally go home shopping, if you fall in love with a home that is currently occupied by the seller's tenant get your attorney involved right away before making an offer. Your goal is to fully understand and assess the opportunity up front to avoid headaches, unanticipated expenses and disappointment later.

[UPDATE 3/21/2014] There are a number of other factors and considerations beyond those highlighted above. For example, you'll pay for two appraisals, one for each property. You'll be expected to show several months of liquid reserves for each property beyond the funds required for closing (i.e. typically as much as 6 full mortgage payments per property). Your credit history and scores will have an impact on everything from the cost of the interest rates available, to the loan products available, and the minimum required size of your downpayment. The existence of a second mortgage, home equity line, etc. may affect refinancing in the future especially if the liens are with a different lender (resubordination can quickly complicate refinancing). This list goes on an on which is why it's so important to consult with your loan officer and attorney very early in the process before making any plans. [/UPDATE]

Can turning your existing property into a rental be a great way to transition into your next home, and potentially generate some additional income? Absolutely! So long as you prepare yourself, put together an experienced support team (loan officer, attorney, real estate agent, etc), identify any potential issues early on, swiftly address the issues and think ahead, but never get ahead of yourself.

As always, I wish you all the very best.