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Have you ever met someone that owns multiple houses? Did you assume they were wealthy before they got the properties, or wonder if that’s how they became wealthy?
Do you have to be rich in order to own more than one property? No! In fact, property ownership can help you grow your wealth. It does take some careful planning though, so there are some things to keep in mind if you are considering adding rental properties to your portfolio.
One classic example of strategic property acquisition is when a parent buys a second home near where their child will attend college. This allows the owner to have a trusted renter in the home, and for the child to have a safe place to live while in school.
After the child graduates, the parent can then continue renting to others or sell the home. Sounds great! But what do you need to know before you buy?
Before promising your child a new home-away-from-home, you will want to figure out how much cash you need to put down, and where that money will come from. Depending on the type of loan you can get, you may need to put down anywhere from 3.5 percent to 20 percent of the purchase price.
A large rental home may require a large down payment; where will you get this money from? Ideally, you will want to plan ahead for the purchase by figuring out when you want to buy, and how much you will need to save.
Perhaps this means picking up a second job, or allocating sums of money into a dedicated savings account over several years.
I’ve even heard of some parents saying that the home would be their contribution to the child’s academic future, and that they are on their own for tuition.
Plan carefully, and do what works for you!
You probably needed good credit for your first house, and you’ll need even better credit for your second.
Banks know that this second home will be an investment property or vacation home, so they will likely charge a premium in interest rates.
If you aren’t careful, you could find yourself over-leveraged and with a high rate of interest, leaving you with a much more expensive house than you wanted. And when this happens, you either take a financial hit yourself, or you pass the extra costs on to your renters.
You probably don’t want to be the greedy landlord! You might need to adjust your plan, or even bring in a partner to leverage each other’s credit and share down payment costs.
Whatever you decide, do your planning to make sure your credit and your loan interest rate do not push you over your preferred housing cost. Your child and their roommates will thank you!
More Things to Consider
What happens when the plumbing bursts or the dishwasher breaks? Unless your child or renters are going to plumbing trade school, you will need to make sure you have a solid plan to fix this!
Typically, you will either want to budget to fix issues yourself or hire a property management company to take care of the home for you.
Both solutions cost money and/or time. So, you need to consider what works best for you and your budget.
Taxes on a second home can also be complicated?
Is it an investment property or vacation home? Can you deduct repairs? What if you rent it at a “loss” compared to the monthly mortgage because it’s your child?
There are a lot of tax considerations to plan for. If you aren’t super savvy with your taxes, you may need to consider hiring a CPA to help you in tax season.
Finally, if there were to be an emergency on your rental property that, for example, resulted in your tenant suing you, you want to make ensure that they would not take you for every dollar you own.
If it's your child they probably would understand, but if your child has a party and someone gets hurt, what do you do?
The solution is getting liability insurance, and putting the home under a Limited Liability Company (LLC).
This way, if something terrible were to happen, you could have some insurance coverage, and if needed, only lose assets from the single property, not your entire portfolio. Whew!
With careful planning and preparation, you can buy that college pad for your son or daughter, or think of other properties to start to grow your wealth!
And don't forget to check us out at becomingfinancial.com if you have more questions about your finances!