Should I Rent or Sell My House?

When it comes time to move, some homeowners may wonder whether it's better to sell their house or keep it and rent it out to earn passive income. This decision isn't always easy, as there are a lot of responsibilities involved with renting. Therefore, the biggest question to ask yourself when faced with this decision is how much cash flow your home would generate as a rental property.

In order to make a profit by renting, the amount you charge for rent will not only need to be higher than your mortgage payments, but also leave you with enough money in the bank to cover any potential repairs. Making a profit after all expenses are taken into account tends to be difficult. Still, it can be highly rewarding for those who manage to make it work.

Read on to learn more about what owning a rental property entails to determine if it makes sense for your situation.

You may need to sell your home to purchase a new one.

Most buyers finance their new home using the equity they have in their current one. But that may not be possible if you hold onto your property to rent it out. The only viable way to rent out your property and still use the equity for your down payment is to do a cash-out refinance prior to selling. But that method only works if the mortgage on your current home after doing so is affordable enough that your tenants' rent will pay it off.

Even if affording your new home isn't an issue, you'll still have to meet your lender's criteria to qualify for a new home loan. Most mortgage companies require borrowers to have sufficient “reserves” to qualify for a loan. In most cases, you'll need enough income and savings to cover not only your down payment, but also 6 months of mortgage payments on your new home, plus 2 months of mortgage payments on any rental properties.

Requirements are even stricter for first-time landlords. Because your investment property isn't yet established as a reliable source of income, most lenders will only credit you 75% of the rental income you'll be receiving as “income” towards qualifying for the mortgage. For example, suppose you charge $1000 a month for rent. In that case, a lender may only count this as $750 a month when determining your eligibility.

Your monthly PITI costs will increase if you rent.

Each monthly mortgage payment you make consists of 4 main parts: Principal, Interest, Taxes, and Insurance, abbreviated as PITI. While a home's principal is the same regardless of whether or not you live in it, renting out a property will generally lead to an increase in the other components of PITI.

Generally, a homeowner will usually take better care of a house than a renter will. As such, insurance companies charge more for landlord insurance than homeowners insurance to account for the increased risk rentals pose. You can typically expect to pay 15%–25% more on insurance once you start renting out your home.

Mortgage lenders also view investment properties as a bigger risk since borrowers are more likely to default on a loan that isn't for their primary residence. As such, interest rates on rented homes will typically be about 0.50–0.75% higher.

Renting out a house also means you won't be able to enjoy any of the tax benefits reserved for primary residences. Most homeowners qualify for various tax breaks, like homestead exemptions, capital gains exemptions, and mortgage interest deductions. Additionally, most states place a limit on yearly property tax increases for primary residences. As a landlord, you won't qualify for any of these exemptions, meaning your property taxes will likely go up by at least 10%–20%. On top of that, you'll also need to pay income taxes on the income generated from the rental.

These increased PITI payments—on top of HOA fees, if applicable—often make it challenging to break even on an investment property, let alone make a profit.

Your cash flow needs to be sufficient to cover any potential repairs.

A couple hundred dollars a month of supplemental income may seem enough to make renting worthwhile. Still, chances are, you won't be keeping all the money your investment property brings in. Home repairs can be extremely costly, and if something goes wrong with the HVAC system or water heater, you may need months of rent payments in reserve to fix the problem.

Whether or not a house is worth renting out often depends on the building itself. Older homes, in particular, are likely to have damaged foundations, poor plumbing, faulty electricity, or a variety of other issues. Even a property that is fine for the time being may be days away from disaster if items like the water heater or furnace are past their lifespan. If you're not confident that your home is in good condition, converting it to a rental property poses a significant financial risk.

Be prepared for potential vacancies between tenants.

Success as a landlord partly depends on luck. In an ideal world, you'd either rent out your property to a long-term tenant or always have a new tenant lined up after the previous one's lease ends. This reality is this isn't always the case.

There's no way to guarantee that there won't ever be gaps in receiving your rental income, so it's essential to be prepared for a worst-case scenario. You'll need enough on-hand money to cover all of your monthly payments—both for your rental property and your primary residence—even during gaps in tenancy.

Be aware that tenants may damage the property.

While pre-screening tenants may mitigate some of the risks of property damage, there's no way to eliminate the possibility of your home being trashed. Tenants may neglect to take care of the property or even deliberately vandalize it out of spite if they get evicted or have a conflict with you. Even residents who try to keep a house in good shape may still accidentally harm it.

Security deposits won't always be enough to cover the damage tenants can do to a home, which is yet another reason you'll need to have plenty of money saved up for emergencies.

You may need to hire a property management company.

Failure to be assertive with your tenants can result in them taking advantage of you. If you're the type who can't handle interpersonal conflicts with an unshakable will, you'll need a property management company to act as a middleman.

Of course, employing the aid of a property management company adds yet another financial expense on top of your increased PITI payments. Most companies charge a rate of 10% of rent on single-family homes. You'll need to consider this fee when determining how much of a profit you can make from renting.

Consider how capital gains taxes factor in.

When you sell something of significantly high value, like a house, you're legally required to pay capital gains taxes on your profit. Most homeowners can substantially reduce or eliminate these taxes. If you have lived in a home as your primary residence for at least 2 of the past 5 years, you won't be taxed on the first $250,000 you make if you file alone, or the first $500,000 if you file jointly with a spouse.

Investment properties, however, are not subject to this tax exemption. If you rent out your home for more than a year, this is considered a long-term capital gain and will cost you either 0%, 15%, or 20% of your profit, depending on your tax bracket. If you rent out your home for less than a year, it's classified as short-term capital gains, which means it's taxed at the same rate as regular income and could cost you as much as 37% of your profit.

You can rent temporarily if you want to move back in.

If you're only temporarily leaving town, it often makes sense to rent your home out while you're away so you can plan to move back in later. Renting is beneficial if your home is in an appreciating market, since keeping your current home means you won't need to pay inflated prices for a new one when you return.

Be aware that your lender may only agree to this arrangement if you promise to move back in after a set length of time. Continuing to rent out your property for the long term will usually require you to take out a different loan.

Understand your state's eviction processes.

No landlord wants to deal with an eviction, but you may be left with no choice if a tenant doesn't pay their rent.

Evicting a tenant requires lots of paperwork and a strong understanding of the law. What's more, laws regarding eviction vary from one state to another. For example, Texas eviction laws tend to lean in the landlord's favor, while California laws tend to favor the tenant. You'll need to do extensive research to determine your likelihood of winning an eviction suit in your state.

Eviction can also place a heavy financial burden on a landlord. In addition to potentially waiting a long time to receive your tenant's missed rent payments, you'll also need to pay all your legal fees out of pocket, unless a clause in the tenant's lease requires them to pay your legal fees.

Don't rush your decision.

Take your time deciding whether to rent out your house — it's a bigger commitment than you might think.

Suppose you change your mind and decide to sell in the middle of a lease. In that case, that lease will usually survive the sale, meaning the new owner is obligated to keep renting out the home until the lease is up. This can severely limit your pool of buyers — especially if there is a lot of time left on the lease and/or the rent isn't particularly high — and less buyer interest usually means a sacrifice in profit.

At the very least, it's wise to avoid long leases until you know for sure that renting is right for you.

Ultimately, it all comes down to the numbers.

At the end of the day, the most significant factor to consider is what will make you more money — the flat profit from selling your home or the cash flow generated by renting it out.

While there's no accurate way to predict how much repairs, evictions, and vacancies will cost you, this calculator can give you a general idea of how much money you'll make renting vs. selling.

Prefer to sell?

Renting out a home requires many conditions to be met, and it's not a viable option for everybody. If you've concluded that selling makes more sense than renting, consider selling to AMI. We buy homes in all conditions and can provide you with a no-obligation cash offer. Contact us today to learn more.