How to Upgrade to a New Home & Become a Real Estate Investor
If you’re a homeowner who has reached the stage where you’ve outgrown your current house or you’re ready to downsize, you’ll likely be looking to buy a more suitable property based on your current situation. Traditionally, buying a new home meant selling the old. With today’s low cost of borrowing, however, keeping your existing home and renting it out represents a practical way to earn money through rental income as well as property appreciation.
Investing in real estate can be a lucrative undertaking but requires careful planning and commitment. The upfront costs of purchasing a second home without selling the first can seem daunting but, with tenants covering the costs of the rental, you can reduce the possible risks and reap the potential rewards.
Start by gauging the vacancy rate in your neighbourhood. If you’re like most people, your primary goal of renting your existing home is to make a profit so, if the rental market is stale, you may want to reconsider. If it’s healthy and you want to move ahead, you’ll need to calculate the carrying costs associated with the rental property such as mortgage, insurance, property taxes and utilities, and determine how much you can realistically charge in rent. Be sure to have a cash reserve in place for maintenance and repair costs, and to cover periods when you may not be generating income due to vacancy lulls. After crunching the numbers, educating yourself about what’s entailed and performing an honest assessment of your risk tolerance, you'll be ready to finance your new purchase.
Financing Options
Refinancing
Refinancing your first home is a viable and cost-effective way to help secure the purchase of the second. A mortgage refinance means you’re essentially paying off your existing mortgage and replacing it with a new one. This allows you to take advantage of the home’s equity (the difference between the home's value and your mortgage balance) as a source of extra capital and use it towards your second property purchase. You may also be able to obtain a lower interest rate for the new mortgage. Keep in mind that the amount of your refinance can’t exceed 80% of the home’s value.
Your lender will arrange for the current home to be re-appraised and the new property value minus the current outstanding mortgage balance will be used to determine the amount you’re eligible to refinance. With today’s hot real estate market, home values have increased substantially and, theoretically, so too will the amount of equity you have available.
Refinancing also means a new qualification process, similar to when you applied for your first mortgage. Your lender will also want to assess the feasibility and sustainability of your planned rental income. For example, they’ll want to know whether there’s a demand for the property and whether your rental income will cover the mortgage payment and carrying costs or if you’ll be required to dole out extra cash each month.
Just like any real estate transaction, there are costs associated with a refinance, including pre-payment penalties, mortgage discharge fees, legal fees and closing costs. You may want to enquire about a blended interest rate, which represents the combination of your current rate and the rate being offered by your lender. The blended rate will fall somewhere between the two (not necessarily the average) and may be used in lieu of pre-payment penalties.
Home Equity Loan
The equity in your existing home can also be leveraged to help purchase your second through a home equity loan or a home equity line of credit (HELOC). The two options are similar, with the main difference being how the loans are paid.
A home equity loan acts like a second mortgage that’s secured against your existing property and is paid as a one-time lump sum amount, whereas a HELOC is used as revolving credit, similar to a credit card whereby you have the flexibility to withdraw as much or as little as you need (useful for maintenance and repair costs). As you pay down the balance, the credit revolves for you to use again.
Home equity loans have fixed interest rates so you know the exact amount of each repayment HELOCs have variable interest rates, which may or may not be favourable depending on the interest rate environment. You’re only required to pay interest on the HELOC amount that you use. The qualification and approval process for either option is similar to that of a refinance and presents less of a risk than a first mortgage as the debt is secured by the home’s equity.
Whichever route you feel is best, it’s always advisable to get help from an experienced mortgage broker, as I’ll offer advice and expertise to ensure the process runs smoothly.
Renting your current home also allows deductions and write-offs that can potentially reduce your income tax, so you’ll want to speak with your accountant, tax lawyer or financial advisor to learn more. You may also want to engage a team of professionals to help prepare rental documents and associated paperwork.
Have questions about renting out your current home and buying another? Answers are a call or email away.