I read this really interesting article a few days ago that can be found here. We didn’t write it, but we have heard it before: the housing market crash in and around 2009 left many people with very few options.
The truth is that we never really know how the housing and job markets are going to go. With that knowledge we should all have a backup plan that is attainable before we sign that dotted line!
So many things can happen that make a mortgage unmanageable. This leaves homeowners with very few options, one being to rent their house out and find another dwelling that more meets their needs. Putting the house on the market to try and get out from under the mortgage is, I think, the first choice when you realize you just can’t do it anymore. Sometimes that is not a viable option depending on how much you owe, repairs needed, and the time it will take to sell it.
There are some things to consider before you, too, become a landlord by accident.
Look at what your mortgage payment is, and figure out if you can charge any dollars over that for rent? You will need those extra dollars for repairs, taxes, and insurance. Anything that you charge over your mortgage payment cannot really be considered profit either. You will have additional expenses. Because of this, renting your house out will not immediately earn a very good living for you 99% of the time.
Let’s look at some fictitious numbers (because I can’t remember the real ones honestly, but I will get close) to help explain why renting may seem like a great idea, but may not be worth it in the end.
I’m going to use a scenario where someone was left a house that had a mortgage on it. Before they got the best advice, they went ahead and signed to assume the mortgage and take on the additional house payment. They had the credit to do it, and the mortgage company was happy to oblige rather than foreclose and put it on the market themselves. This is a typical situation that can make someone an unintentional landlord.
Sweetheart came to me and said, “Mandi! I’m going to rent out Mom and Dad’s old house! I can ask for and get $1500 per month in rent! Do you know what I could do with that kind of EXTRA money!? I want to ask your advice and show you my plan. I want you to be honest and give me any advice you may have.”
“Well Sweetheart, I want the best for you. I will be honest with you if that is truly what you want.” I reluctantly said.
The Real Truth
Here is how it went (in summary):
Mom and Dad refinanced the house for remodeling they wanted to do. They took a $50,000 mortgage out for the renovations. Only a few of the planned renovations actually happened. They used the rest of the money for other needs.
So, we are looking at a house that the market value on is about $25,000 as it is. Mom and Dad’s good credit got them that loan, because the appraisal I saw sure said it wasn’t worth that much. And:
- No appliances were left in the home, lots of ruined furniture and old clothes were.
- No HVAC.
- The bathtub and faucets had leaked for several years into the walls which led to a mold problem.
- The house smelled of mold and mildew.
- The roof was also in bad shape which caused a hole in one ceiling (and of course more mold).
- The back porch had separated from the house years ago because of a bad foundation problem.
- Several electrical outlets did not work and had been out of code since probably the early 80’s.
- The floors all throughout had some very soft places in them from water damage.
- Bad carpet. BAD CARPET!!! I’m talking – I didn’t want to walk on the carpet with boots on, BAD CARPET!!
- Something bigger than a large rat was living in there as evidenced by the excrement we found everywhere.
- I just took a guess at the plumbing and electric being in bad shape. I was right.
Sweetheart had a contractor over to bid on renovating the house just to livable standards, not counting the foundation work. Her estimate came in at around $25,000. She got a break in labor cost because she knew him and he was trying to help her out.
That estimate, combined with what was left owed on the mortgage, would put her into the house for $45,000. Considering other rents in the area, the size of the house, and what the rental market for it actually was, she would be able to ask $550 per month in rent after it was made livable (maybe $650 if she pushed and left it vacant a while).
The mortgage payment on the house, plus another loan payment to fix it up would come to about $800 per month, with none of this counting any repairs, taxes, or insurance. The taxes were pretty reasonable, I remember them running about $500/year. Insurance was extremely high and did not cover much until proof of renovations were done, and ran about $2500/year.
This means that the house now needs to bring in $1051 in rent just to cover the loans, taxes, and insurance. Add another $300 (bottom dollar) for regular maintenance and repairs per year, and you sit at $1076. Remember the average rent for that area at the time in a large home that was nice and livable was $550 – $650/month.
The conclusion was that Sweetheart was already upside down by $426/month, if she was able to get the $650.
How That Went Over with the Homeowner
This was not the news she wanted to hear. She was not interested in selling to a redeveloper like us because she needed at least the mortgage to be paid off, and she wanted to get some money out of the house as well. So now she is in a situation where she is stuck. Her only options as I saw it were:
- She can of course walk away from the mortgage that she has on the place, but that will affect her own credit score.
- She can rent it out for what she can get and just lose the $426/month until the mortgage is paid.
- She can consider owner financing it as is, and hope that someone will buy it for the money owed on it.
None of these options were very good at all. What to do in this situation… She thought outside the box! And she…