Should you buy your own home before you buy a rental property?
Although the idea of owning a rental property is appealing to many people we highly recommend that you buy your own home before you buy an investment property. Below we review the many reasons why it makes more sense to buy your primary residence before you start building your rental property empire.
Easier to Qualify. It is easier to qualify for a mortgage on your primary residence than on an investment property mortgage. This is because when you apply for a loan on your own home the lender only includes the monthly housing expense -- your mortgage payment, property taxes and homeowners insurance -- for one home in your debt-to-income ratio.
When you apply for a mortgage on a rental property the lender includes the total monthly housing expense for that property plus the housing expense for your primary residence -- for example your monthly rent -- in your debt-to-income ratio. Including the housing expense for two properties instead of only one makes it more challenging to qualify for the mortgage on a rental property.
Use ourHOW MUCH HOME CAN I AFFORD CALCULATORto determine what price home you can buy
Also, if you buy a rental property first and the property is cash flow negative, then the loss is included as debt in your debt-to-income ratio when you apply for the mortgage on your primary residence. This can make it difficult to get approved for a mortgage on your own home.
Finally, the down payment requirement for a rental property is higher than for your primary residence. Plus, in many cases you are required to have landlord experience to get full credit for rental income from an investment property. For all of these reasons, it is easier to qualify for a mortgage and buy a home you live in than to buy a rental property, especially if it is your first one.
Lower Mortgage Rate. The interest rate for the mortgage on your own home is typically 0.250% to 0.500% lower than the mortgage rate for an investment property. A lower mortgage rate enables you to qualify for a higher loan amount or reduce your monthly payment.
If you are looking to maximize your home buying budget then you want to buy your own home before you purchase a rental property. Paying a lower mortgage rate also reduces your total interest expense which saves you money in the long run.
The table below shows mortgage rates and closing costs for leading lenders near you. We recommend that you contact multiple lenders to find the best mortgage terms when you buy your home.
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Eligible for Low Down Payment Mortgage Programs. Most low down payment mortgage programs only apply to owner occupied properties so rental properties are not permitted. You can use these programs to buy a home with a down payment of 3% or lower depending on the program. In comparison, the minimum down payment required for a single unit rental property is 15% and you need to put down 25% of the purchase price for a two-to-four unit property.
Coming up with the necessary funds to pay for a down payment is one of the biggest obstacles to home ownership, so this is another reason to buy your own home before you buy a rental property.
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We should also highlight that many low down payment mortgage programs allow you to buy a property with up to four units as long as you live in one of the units. For example, you can buy a duplex and rent out the second unit which effectively enables you to buy your own home and a rental property at the same time.
No Eviction Risk and Greater Financial Certainty. One of the benefits of owning your own home is that you eliminate the risk of eviction or a significant increase in your rent. If you use a fixed rate mortgage to buy your home, your monthly payment never changes which provides more certainty compared to renting.
Additionally, you do not have to worry about tenants not paying rent or the cost of upkeep or unexpected repairs to a rental property. In short, owning your primary residence usually provides greater financial security as compared to buying a rental property.
You Can Rent Your Home Later. Just because a property is your primary residence when you buy it does not mean you cannot rent it out it the future. After you have lived in your home for at least a year you can move out and use it as an investment property.
If the property produces positive cash flow it may help you qualify for the mortgage on the next home you buy, be it your primary residence or an investment property. Plus, you develop landlord experience which can help you qualify for a rental property mortgage.
To summarize, buying your own home before you buy an investment property offers multiple advantages. Not only does this approach provide financial benefits but it can be the first step to owning multiple rental properties in the future.
Sources
"Standard Eligibility Requirements: Investment Property." Eligibility Matrix. Fannie Mae, October 2 2019. Web.
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