My husband and I started thinking about purchasing a rental property when the house across the street from us took forever to sell. The price was something we could afford, and the interest rates are very low right now, so becoming landlords seemed like a great way to invest some of our savings.
Though that particular house ended up selling to another family, we are still keeping our eyes peeled for a nice little property as an investment. Unfortunately, there have definitely been some surprises in this journey. We have discovered that several of the associated costs of buying an investment property are higher than the costs of buying an owner-occupied home. Those unexpected rental property expenses can turn an otherwise profitable investment into a break-even situation, or worse.
If you, like us, are tempted to invest in real estate while interest rates are at historic lows, then you should be aware of some additional costs you may face:
My husband and I looked up current interest rates prior to meeting with a loan officer at our bank. Imagine our surprise when she quoted a rate that was a full point higher than the ones we had researched online.
Apparently, banks consider non-owner occupied home loans to be riskier than owner-occupied ones. If you live in the home that you have financed, you are clearly going to do everything in your power to make sure you don’t lose it. Landlords, on the other hand, have much less of an emotional and physical stake in the property. Because of that, banks offer higher rates as a means to protect themselves.
In addition to the higher rate, lenders also tend to be more stringent about the down payment for landlords. While all mortgages these days require a decent-sized down payment, a potential landlord will likely have to pony up at least 20% in order to get a bank interested in financing the loan—and many lenders will want to see a 25% down payment.
And all of this does not include the six months of cash reserves that banks require from their non-owner occupied borrowers. This is necessary to be sure that the would-be landlord doesn’t lose his shirt if he can’t find a tenant right away.
Where we live in Indiana, homeowners are eligible for something called a homestead exemption, which means that up to 60% of the value of the home is exempt from property tax. This is a major tax break offered by several states that is only available to homeowners living in owner-occupied homes. Landlords have no such exemption.
As a landlord, in addition to the general insurance worries that all homeowners face, you also have additional potential pitfalls, such as vandalism. Because of this, insurers view non-owner occupied homes as a greater risk, and the price of the premiums reflect that. Generally, potential landlords can expect to spend about 25% more on their landlord insurance than they do on their general homeowner’s insurance. That price may go up if the house remains untenanted for a long period of time, as insurers do not like empty houses.
On the other hand, if you can prove that you will have a tenant for a full year, you may be able to negotiate a lower price on your premium, although it will still give you a little sticker shock compared to your homeowner’s insurance.
The Bottom Line
Even if you are an old pro at buying a home for yourself, you should not assume that purchasing a rental property is exactly the same. Because of the greater risk, there is a greater cost, which you must factor into your calculations as you make your investment plans.