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Historically, when a person wanted to buy a new home, they would sell their existing home, take the equity from that, and apply it to purchasing a new home. This would create the “move up” buyer from their starter home since their families were growing and they were in a better position with their career to move up to a bigger home, and this would open their starter home for a younger home buyer that was in a different season of life. Then, as time progressed and their children aged, they would sell that home, take the equity they gained from that, and downsize to a home, often in a different location of the country or style of home, and a person from a starter home would then move into that home, and the cycle repeated itself for years.
With the recent rollercoaster of events with interest rates, a lot of homeowners are starting to rethink this position. During the post covid era, interest rates fell to historic lows, and a lot of homeowners that purchased a home or decided to refinance their existing home locked in a long-term mortgage that was around 3%, some even less than that, and then with the Federal Reserve’s aggressive stance to fight inflation interest rates soared to as high as 8% for some borrowers. When that is compounded with a lack of inventory in the market, a lot of homeowners realize that they have a lot of value with the cheap money they have borrowed and are choosing to capitalize on that by keeping their existing home as a rental and purchasing a new one to move into, especially since rates are starting to come down some for borrowing, not to the levels as mentioned before, but low enough that with the additional income spread they are earning on their rental home there is enough to cover the difference and then some, all while continuing to build equity in the rental property that can one day be liquidated.
Now you may be thinking, how would the numbers work out for that, and who would take care of it? Using an example from a house in my area, Northern Kentucky, I’ll walk through some high-level numbers with you. Let’s say you have a home worth $350,000 (the median price in our area is just shy of $300,000). It’s the standard 4-bedroom, two full-bathroom cookie-cutter subdivision house. You have a loan on it for $280,000 (which is 80% of the appraised value), but you secured a loan during the interest rates bottoming out at 3.5% on a 30-year mortgage. The principal and interest payment on that mortgage would be $1,257 per month (to calculate different amounts, I like to use this free mortgage calculator online: https://mortgagesolutions.net/mortgage-calculator/.)
In our area, the average property tax rate is close to 1.7% of the assessed value, so in this case of our example, that would put the annual tax bill at 1.7% of $350,000, otherwise stated at $5,950 per year or $496 per month. Insurance for this home will probably cost you about $1,700 per year or $141 per month. The total cost of taxes, insurance, principal, and interest comes to about $1,894 per month.
This home, in a typical area, would rent for about $2,500 a month. Take out some expenses for hiring a property manager and a little bit of put back for other expenses you are looking at a net income from your rent, say $2,200 per month, and then you back out your hard cost of ownership that leaves you with approximately $300 a month cash flow.
At this point, you are thinking, “Yeah, that sounds great, but is it worth it?” and in the words of the great salesman Billy Mays, “But wait, there’s more.” When paying the rent and the mortgage, you must look at a few things. One of the biggest, and often overlooked, is the principle you recognize (or gain) each year. I suggest running a loan amortization schedule with the loan, and you can do that here: https://www.calculator.net/amortization-calculator.html or use your own. You start off gaining over $5,300 a year in principle pay down, which when you put it monthly is an additional $441 a month, then you start getting upwards of $8,000 - $10,000 per month once you hit years 10 and beyond. So now your $300 a month cash flow is closer to $740 a month with the principle paydown.
In addition to the principal pay down, the interest on your loan may be tax deductible as a business expense. That analysis is different for each property owner and outside the scope of this article, so I suggest you consult your tax professional. The same goes for property taxes as well as insurance, all items that could help reduce your tax liability.
Before you decide to sell your home, I suggest you look at your overall financial goals as well as your current means. If you can hold onto your property and still purchase the new home you want, then it may make sense to take this course of action. Remember that real estate has created more millionaires than anything else in this country and continues to be a haven for those trying to build and preserve their wealth. Over time, that second home can add a substantial amount of cash to your retirement picture, so don’t be too hasty to unload it today to save a few hundred dollars a month on a new mortgage when you may be able to keep it, make up that same money (and more) in cash flow and equity gains plus gaining market appreciation and potential tax benefits against your current working income.