Are you looking to buy a house? Or maybe you would like to buy a house but you worry that it will set you back financially.
Have you considered renting out part of your house to help cover the mortgage? Of course being a landlord requires some work, but doing so can help you accelerate your savings and or afford a nicer home than you otherwise would feel comfortable with.
In 2015, I was looking to buy a house, I knew I wanted to find one that would serve as a long-term home, with the ability to rent out the basement. For two years we had been renting basement apartments ourselves because we found them to be a better deal than traditional apartments.
We nearly made a major mistake along the way, we were under contract for an affordable home that we liked and thought we should be able to rent out. But it was not ideal, it didn’t even have a separate entrance and later in the due diligence process we found out that we wouldn’t be able to rent out the house legally because the city ordinances didn’t permit the renting out of owner occupied single family homes. Regardless we almost settled because we weren’t finding much else in our price range that seemed ideal for renting. Luckily the inspection we had done revealed enough issues that we started to have second thoughts and backed out of the property completely. Soon after that we found an opportunity to purchase a new fourplex which we pursued for months and ultimately weren’t able to secure satisfactory financing but that’s a different story.
After the fourplex fell through I again started searching for houses that would be suitable basement rentals, drawing on my experience and lessons learned in my prior search. It took me two months to get to the point where I felt confident in the search for these ideal properties, here are some tips I learned along the way.
- Review city ordinances
Make sure that your target city allows you to rent out a single family home. It wasn’t until after looking at multiple properties that we found out that our target cities didn’t allow for renting out single family homes. After doing some research we found three other nearby cities that allowed for this practice, provided the house meet certain criteria. We changed our focus to these three cities. Note: In the cities which didn’t allow for renting, you could find ads for basement rentals in single family units online, so people were still renting. Sometimes the city ordinances aren’t strictly enforced until someone starts complaining. We didn’t want to take a chance with such a big investment, it’s best to play by the rules. - Find good resources for locating homes
At first, we had our real estate agent send us hot sheets for homes with two kitchens in our target cities, it wasn’t long before we wanted to expand our search and had to go back to our agent to update our criteria. We became dependent on our real estate agent to locate these properties and felt a little crippled in the process. Eventually, after doing some searching I found a website that listed all two kitchen homes for sale in various counties throughout the state with daily if not hourly updates. This was a huge resource, we started finding more homes to look at making our search much more efficient. - Expand your price range
Initially, we were only looking at houses within what we considered to be a very affordable price range. Because we wanted to be able to have a great savings rate regardless if we were renting out the basement or not. The problem was that we weren’t finding very many two kitchen homes to look at. After a while, we started to increase our price range to include properties where the payments would still be affordable, where we could handle the payment on our own if we had to, that helped us increase our finding pool significannly helping us find serviceable properties. The rationale here is that while the properties are more expensive your cash flow doesn’t have to take a big hit because on average the more expensive the house the higher the rental income potential. - Be patient, and don’t be afraid to walk away
The first house we made on offer on in this price range had a lot going for it. A beautiful house in our favorite area and it already had great renters in the basement who wanted to stay there for the foreseeable future. We had an idea of the max we wanted to pay for the house and so we put in an offer, a counter offer came back the next day that was slightly higher than what we wanted to pay so we countered again. Before we knew it another party was involved in the bidding and the price shot way up. We were kicking ourselves for not taking the initial counter and almost succumbed to a bidding war. Luckily my wife talked some reason into me and we backed off. We kept looking and it wasn’t long before we found another place we were interested in at a great deal and everything fell into place.
The home we were initially under contract for and almost bought was in our very affordable range and would have cost us $1,275-$1,375 a month (starting at $345 towards principal a month). While it had a mother in law apartment, it didn’t have a separate entrance and we would not have been able to rent it out legally because of the city ordinances. It was also a 40-year-old home and had 2,966 square/ft.
The home we ended up with costs us $2,180.35 a month with Private Mortgage Insurance (starting at $572 towards principal), 8 months later we were able to refinance and drop our interest rate and PMI getting our payment down to $2,001.01. We are able to legally rent out our basement and are currently getting $1,175 a month (1,200 sq/ft, about half of our basement). The home is a step above the initial home in amenities and quality. It has nice high ceilings, granite counter tops etc… It’s 4,781 square/ft so we have plenty of room to grow into. The home was all set to rent, with a bolt lock door in the basement to seperate our basement from the rental and it had a second entrance and met all the city requirements. All we had to was submit our application to the city, it cost us like $70 for the review. And a few days later we had approval to start renting.
Besides the fact that we are living in a much nicer and roomier home, as long as we are renting we are coming out ahead financially by purchasing the more expensive home. Consider the following, going with the PMI included monthly cost of the new home at $2,180.35 and $1,175 rental income. Let’s say that $175 goes to utilities (Our Electric and Gas combined are usually less than that). And $1,000 goes on the mortgage, that would leave us responsible for $1,180.35 a month on our mortgage and that’s around $100 less a month then we would have been paying on the other home. Did I mention that with the mortgage payment we are also gaining over 200$ more in additional equity each month!
In short, you can leverage a basement rental to help you afford a nicer home and save money at the same time! Think big!
Things to consider:
- Taxable Income
You are responsible for paying taxes on your rental income, however, you can offset the tax burden by deducting a percentage of your mortgage costs, equal to the percentage of the house you are renting out. You can also lower your tax burden by depreciating the same percentage of your house minus the land value. Any repairs you make or additional costs you take on such as city garbage can fees can be deducted. Don’t forget to include extra costs to utilities as a business expense as well. (Consult with a tax professional if needed) By taking advantage of all these tax deductions we pay very little if any tax on the rental at the end of the year. - Watch your furnishings
Just because you’re moving into a bigger house doesn’t mean you need to go crazy with furnishings. During the first year in our house, we only spent around $1,000 dollars on furnishings. We didn’t go out and buy new furniture to match the house, we kept our old furniture and bought a few things over the first year like a new bed, our old bed got moved to our guest room. We bought a desk for the office room and a new armchair. Resist the temptation to impress guests and friends with a fully furnished house, this can get very expensive! - Financial Security
When looking to offset costs by buying and renting out part of the home make sure that you are not depending on the rent to get by. A good rule of thumb would be to make sure that you could get by paying for the house on your own. That way if something did happen and for some reason you couldn’t rent out your home for a few months, you won’t find yourself in a dire situation. - Side benefits
Along with being able to rent out the home, we are also in a position where family could move into the house. I would love to have my parents come live with us for a while. (they are currently renting out of state) Because I enjoy the company of family and you can’t beat built in babysitters. Plus if the economy ever took a dive and things got rough we could work together to make the mortgage payment so we don’t lose the house. - Be Aware
Most city ordinances that allow you to rent out your home have stipulations, like you can only rent the home while it’s owner occupied. That means if you were to move and decided you wanted to keep the home as an investment, it would be against city ordinances to rent out the home as two units. Following the ordinances you would be renting out the home as one unit which would bring in less. For that reason this strategy works best if you intend to stay in the home for the long haul. In our case we have no intention of moving anytime soon, the house has plenty of room to grow into while renting out the basement. If your’re planning to move right away then you won’t see as much benefit and will have added risk following this strategy.
Let me know if you have any questions or if there are any other topics you would like me to address.