Help a Reader: Buying a Live-In Rental Property

Here's an email I recently received from a reader:

I'm 50 yrs old, divorced 5 years, struggling to get back on my feet.  Credit in so-so shape, score somewhere in the upper 600's; want to purchase my first home by myself - currently renting an apartment.  Due to the banks understandably tightening the purse, loans at my score probably close to nil. 
 
Couple of ideas, what if I could purchase a 4-unit or 2-family property, either live in part and rent out the other saving for downpayment on a single family home? or what if I could manage to get a rental property and continue to live where I am, using all of the profit (less expenses) for the purchase of my own home?

This email confused me a bit and I responded:

I think I need more details -- or at least one big question filled in. How do you plan to buy a property of you can't get a loan?

And she replied:

Thanks for replying.  Perhaps I made my situaion sound more dire than intended trying to keep it short.  I can qualify for a loan - just not enough to qualify for the type of home that I would really like to purchase - but I'm flexible in my wish list.
 
Here's the nutshell of it.  Here the city and county have 1st time home buyers downpayment assistance programs that aid with both the downpayment and closing costs.  The program allows for the purchase of single and two family properties.  If you are purchasing a two family the income - whether currently occupied or anticipated market rent is considered income - thus allowing me to qualify for more than I would qualify for a single family. I figure if I occupy a unit the extra income from a tenant would allow me to cover the mortgage thereby free up money to save towards purchasing the type of house that I want to settle into. Or I could stay where I am - relatively low overhead and get more income - figuring the rent would most likely be more than I'm paying in rent now because I'm looking at better areas - market rent-wise?
 
The four-family option was something I tossed out there because of some exposure to understanding current workable short sale strategies someone offered to mentor me on.  I'm actually really feeling comfortable about the 2-family.
 
My concern was if I become a landlord or if I become an owner occupant which is better tax wise. And does it make sense to anybody seasoned in real estate investment?

What's your advice for her?

Comments

[jim]

I would say if you are "struggling to get back on [your] feet" then I would NOT jump into real estate investing and instead stay in your apartment.

If you're "struggling" then what happens if your renter can't or doesn't pay the rent for a month or two? Can you afford the entire mortgage out of pocket without it being a financial burden?

Rental properties are an investment that comes with risks and work. If your renter gets a month behind then moves out in the middle of the night you're out a months rent. If your renter simply stops paying and squats there forcing you to hire a lawyer to evict them then you're probably out a couple months rent plus a legal bill. If the furnace in your rental breaks down in the middle of Christmas then you're out the cost of a new furnace and your Christmas is disrupted.

My wife and I own rentals and my father has owned a few units for many years. I think rentals can be a great investment but you have to WANT to be a landlord and you really should have an emergency reserve of cash to handle the inevitable problems that arise.

[JimL]

Not enough information. Does this person have any debt? If so, it should be paid off before taking out a mortgage. Further, does this person have an adequate emergency fund that also inclues extra funds in case repairs are needed for the rental unit(s) or can cover rent for an extended period if the rental goes vacant or a tenant skips out on the rent?

[robert]

Sorry You sound like a foreclosure in a few years.
When struggling to get on your feet, MORE DEBT is not sharp.
With a 600 Fico, you have debt issues.
A house, 2 family 4 family have cash flow problem that you will not have the money to survive.
Stay in your appartment. Get cash fat , Debt skinny.
University of Hard Knocks and large debts.
Don't buy in a property now. Rentals are hassles next door.

[Cheapskate Sandy]

Agreed with the above posters. Raise your FICO by lowering your debt first. You are not if you are struggling then you are not the best candidate for a a house because the costs are far more than just the mortgage.

I subscribe to purchasing investment properties with cash or as much cash as possible since there is ALWAYS something that pops up.

I suggest that you save as much money as you can while you are renting the apartment. Then shop for the cheapest home that you can pay comfortably afford.

[Robert M]

I was going to say more, but the previous posters already covered what I was going to say.

Keep renting and perhaps even look for a less expensive place or a good roommate. Save as much money as you can as fast as possible with the goal of paying all your rent from the proceeds of your investments.

If you have any debt, then by all means, get out of it!

[Easychange]

Lots of people throw around percentages when lookig to rent. For me it was something like 28% of my net paycheck was quoted. That would have been ok but it really only works if you have a steady employment with a high (read 85% chance) that you will see raises.

At 50 in most cases you are at the top of your earning potential besides possible cost of living adjustment. So you don't have much upward room for growth. Settle your debts and save.

[Old Limey]

Renters can be a major headache for the following reasons.
1) Non payment of rent which ultimately requires the services of an eviction attorney - not cheap.
2) Renters can inflict serious damage to your property - expensive water damage - pet damage - ruined carpets - abused appliances etc. There are a lot of slobs out there.
3) Renters can become delinquent with their utility bills and then quietly move out leaving you holding the bag.
4) When a tenant decides to move there's usually a lot more work than you think required before you can rent it again.
There's a lot to learn about screening tenants and becoming a successful landlord. It also sounds like you are probably not a "handyman" and able to do repairs, maintenance and trash hauling yourself.

From what you have described becoming a landlord would not be a good decision.
You probably have no choice but to remain a renter at this time. A compatible roommate that would enable you to reduce your debts is not a bad idea.

[Travis]

Positive cash flow is unlikely without a large down payment for the property. It is true you'll get some tax benefits but doing it for those alone make no sense. Heck I'll give you 0.25 if you give me a dollar :) Seriously though if you can cover the mortgage payment in it's entirety or at the very least have 6-12 months in savings to cover a non-paying renter then you really shouldn't be considering this.

Take some time and save a down payment, improve your credit score, bulk up savings and then look at the rental. Owner-occupied is a good thing cash flow wise but remember that your tenants will essentially have 24/7 access to you to fix even the smallest of things. Best of luck!

[Chris]

In addition to all the cautionary advice above, I just want to point out that getting financing for an owner-occupied 2 unit house is not as easy as for a single family house. Banks will require an extra point paid at closing in addition to any points paid to buy down the interest rate.

[Stephan]

i would continue to rent and save as much money as possible each month. The ideal situation would be to raise your score over the next 12-18 months and build up a large enough cash stockpile so you can have a downpayment of at least 20% of your future homes price. I dont think real estate is something that should be invested in until your personal finances are all set, and it seems they are not at that level YET. good luck!

Preferred Financial Services

[CPA Abroad]

@ Travis - great comment about $0.25 for a dollar. You would be amazed at how many people feel the need to get the biggest mortgage possible to lower their tax bill. Never makes sense to pay $1.00 for $0.25 in value.

I have an unintentional rental (moved abroad and couldn't sell due to the market), although I have a friend manage it. Last week I got back from a relaxing long weekend to an e-mail saying the A/C broke. Talk about feeling a pit in your stomach. Thankfully, it only cost $155 to fix, but the unit is from the late 60's so it is living on borrowed time. The reason I bring this up is luckily my wife and I have plenty to cover a new A/C, but if a new A/C or new roof makes you wonder how you are going to pay the bills, being a landlord is not something you should be doing.

I agree with almost all of what is written above. Another point I would like to make is you may be overly ambitious to think that the tenant will cover the entire mortgage (assuming you live in the other side). My guess is you will need to use a few hundred of your own money per month to cover the mortgage. Still better than footing the entire mortgage though.

For the taxes, there can be a few curent benefits, but those current benefits can lead to long term unfavorable tax consequences, like depreciation recapture when you sell. If you are doing it merely for the tax benefits you are doing it for the wrong reasons.

Obviously there are many aspects to your financial situation that we are unaware of, so take the 2 cents for what it is worth and good luck.

[Khaleef @ KNS Financial]

I agree with all of the previous comments! This was the mentality of many people in 2004-2007 and look where that got them! You should be patient and stay where you are until you can get out of debt (if you have any), save up enough for a 20% down-payment AND closing costs (even if you receive assistance) and maintenance for the first year or so (estimated at 2% of the value of the home per year).

Also if you insist on a multi-family dwelling, be sure that you can comfortably afford the mortgage on your own. You are not guaranteed to have a great tenant, or even have a tenant at all - it's all speculation at this point!

[Budgeting in the Fun Stuff]

I'm going with the pack on this one. My husband and I were broke out of college but had a reasonable cash flow within a year. We still chose to wait to have a considerable emergency fund and minimal debt (one car loan) before buying our house. I'd wait and build up your credit score and cash reserves.

[Valerie]

My husband and I purchased our first home two years ago using an FHA loan program, 3% down. This program is still available, but you do need to have decent credit (closer to 700) and enough cash on hand to cover three months' mortgage payments in case your renter stops paying. Rental property that isn't owner-occupied is much more expensive in terms of interest rates, insurance, and down payment requirements (usually at least 10%), so the two family owner-occupied is probably your best option.

I would suggest to wait a year and save as much as you can, and also work on building up your credit score. If you can find a local nonprofit housing agency they have a lot of good information and can help you to organize your finances. Also you can take some time and look around at properties that are currently for sale, and get to know what neighborhood you want to buy in. It is exciting to buy your first home, but it's very important to stay grounded and think rationally when you are buying investment property. Try not to get caught up in a sense of urgency that you have to buy right away. There might be some enticing bargains right now, but prices will be low across the board for at least a few more years, so there is no sense in rushing into anything.