Your Guide to Landlord Insurance

Are you a small-scale property manager or “accidental landlord,” trying to learn the ropes of renting out property so you can develop a more professional business model?

Many people who fit this description are not familiar with landlord insurance, and may be relying on homeowner’s insurance to protect them against property damage or liability.

Perhaps you own a vacation home and plan to rent it out for four years to help cover your child’s college expenses.

Maybe you have an aging relative who has moved into long term care, and your family is not quite ready to sell the house.

Or, you might be a real estate broker with a few vacant properties that could be bringing in income.

Whatever circumstances have led you to becoming a landlord, buying landlord insurance should probably go on your short list of tasks.

This guide will introduce you to everything you need to know about landlord insurance: whether you need it, what it covers, how to buy it, and a handful of other crucial considerations.

Do you need landlord insurance?
The answer is: Probably.

It’s not legally required, but carrying the right insurance is a basic element of protecting your investment.

Landlord insurance covers areas of risk that regular homeowners don’t have to worry about, such as legal costs in case your tenant sues you.

Landlord insurance also offers special options like rental income replacement and emergency appliance repair cost coverage.

Landlord insurance is most likely not necessary if your rental situation resembles one of the following scenarios:

  • You leave your home and rent it out for one weekend each year when a big local festival happens.
  • You rent out the basement of your home to a local college student.
  • You have a vacation cabin that you let your friends use for three weeks each summer.

In these examples, you’re either renting out property for a very short term (less than 4 weeks) or a tenant is sharing the home you live in.

Homeowner’s policies assume you’re living in the dwelling that you’re insuring — although they do offer additional coverage or a second policy to cover vacation homes.

While your homeowner’s insurance is probably sufficient in the situations listed above, it’s necessary to talk to your insurance agent and make sure.

Insurance companies may legally refuse to pay claims if they discover the existence of a landlord-tenant relationship that they didn’t know about.

Differences between homeowner’s insurance and landlord insurance:

  • Different pricing structure: Landlord insurance will probably cost you 12 percent to 25 percent more than homeowner’s insurance, but it provides wider coverage.
  • Different risks: Landlord insurance takes into account the extra risks you face from everything that can happen at a property that’s not your own home. These risks may include your tenants vandalizing or accidentally breaking your property, suing you for some rental policy they disagree with, or not reporting a problem to you until it becomes a crisis. For example, even the nicest tenants can be confused about what’s going on with the washing machine, and they may ignore all the warning signs of a blocked outlet pipe until the machine overflows and floods half the downstairs.
  • Rental income: Landlord insurance may pay you the rental income you were counting on if the dwelling is rendered uninhabitable during repairs (only if those repairs are covered, though).

What landlord insurance covers
The main coverage areas of landlord insurance are property, liability, and rental income replacement, in addition to extra options.

Each of these coverage types is discussed below:

Property Coverage
Landlord property coverage is offered in three different tiers: DP-1, DP-2 and DP-3 (DP stands for Dwelling Protection).

  • DP-1: The lowest coverage level, this tier only covers basics like fire and vandalism. If the dwelling is a complete loss, DP-1 policies pay the depreciated cash value of the home at the time it was lost, rather than the actual cost of replacement.
  • DP-2: This tier adds more coverage with a list of specific covered events. These typically include such things as tenant damage, windstorm, hail, and even collision (if a car crashes into your property and damages it). If a damaging event is not named on the DP-2 list, it is not covered.
  • DP-3: Called an “open-peril” policy, this tier covers all instances of damage unless they are specifically excluded. Also, DP-3 policies pay actual replacement cost if a dwelling is lost. This type of policy is usually the best choice, unless you’re already partially covered for losses by a condo association.

Insurance policies generally don’t cover flood damage.

Flood insurance is sold by the federal National Flood Insurance Program (NFIP).

Your agent should be able to sell you one of these policies, but the amounts and premiums are set by the government.

The insurance company may offer its own excess flood insurance if the NFIP amount available to you isn’t sufficient.

Landlord insurance can be written to include any items you own that are kept on the premises, including appliances, tools you keep on site and other structures (e.g. sheds) on the property.

Liability
Landlord insurance takes into account the additional risks you acquire when you put property into a tenant’s hands:

  • Personal injury coverage: Tenants or their visitors may file a liability claim against you for their medical costs if they get hurt due to an unsafe condition they feel is your fault. Additionally, if they suffer property damage as a result of something you did not repair, they may sue you for replacement costs. Finally, you are also legally liable for issues entirely unrelated to the physical state of the dwelling. For example, your tenant may make a legal claim against you for wrongful entry, illegal eviction, invasion of privacy, or disputes over deposits.
  • Legal counsel: As you can see, the numerous kinds of liabilities you encounter as a landlord make access to legal counsel an essential part of your financial security.

Loss of Rental Income
This category of insurance protects you against losing rental income if the unit becomes uninhabitable.

It is important to be aware that this insurance does not cover you if you simply lose rent because of eviction or vacancy; you must have actual physical damage that is covered by your insurance and be losing rent while it’s being repaired.

Optional Coverage
Creative insurance underwriters have come up with a whole toolkit of optional extras that they feel will benefit landlords.

You don’t have to purchase all of them:

  • Emergency lock replacement
  • Emergency repair service: for furnaces, hot water heaters, air conditioners, and other crucial appliances. This is generally accompanied by a network of preferred contractors whom you can contact for repairs.
  • Personal property (contents) coverage: This expands your property coverage to include all furnishings within the dwelling that belong to you, including carpets, curtains, and contents of outbuildings. Contents coverage is essential if you’re renting a furnished home, but you may also want to consider it if you have high-value appliances or personal tools at the rented dwelling. Your policy will not cover the possessions of your tenants, so it’s advisable to ask that they carry their own renters insurance.
  • Mold coverage: Juries have awarded substantial damages to tenants who have been exposed to toxic mold, because it’s not always visible and it can cause serious health problems. For this reason, some landlord insurance companies specifically exclude mold coverage. To guard against future mold problems, it’s important that you impress upon your tenants their responsibility to report any type of leak to you immediately.
  • Online policy management
  • Coverage for specific acts of nature: you will certainly want some of these, but the needs vary from region to region. It’s helpful to discuss coverage specifics with your insurance agent in order to make appropriate choices. For example, hurricane insurance in Florida can be so expensive that rebuilding your dwelling may cost less than insuring it against hurricanes.

What to look for in a landlord insurance policy

  • Customization: The policy you end up with should be tailored to your specific needs, because each landlord’s situation is very different. For example, if your rental units come with a swimming pool, you will probably want to increase your liability coverage.
  • Flood insurance: The federal government offers flood insurance through a designated set of insurance agencies. If you live in a flood-prone region, you should make sure your insurer participates in this program. The price for flood insurance is set by the government, and its cost depends on the level of risk in your region. (Flood insurance refers only to weather-related flooding. Water damage due to burst pipes or other accidental causes is already covered in your regular policy.)
  • Guaranteed replacement costs: Some low-cost landlord insurance policies pay you the “cash value” of covered items. While this phrase may sound good, it’s actually something to avoid. “Cash value” refers to depreciated cost: If a storm damages your ten-year-old roof, for example, a cash value policy will be based on how much you paid for that roof ten years ago, and will then decrease that value for each year you’ve had the roof. Your insurance company may end up paying you only a fraction of what it costs you to replace the roof in today’s marketplace. Better-quality policies guarantee that payouts will cover your actual replacement costs.
  • Inflation protection: The cost of professional home repair continues to rise, so it’s helpful to have a policy that automatically adjusts its coverage level to keep pace with inflation.

How to keep rates low
Make your coverage decisions carefully, depending on your particular situation.

Don’t buy every possible type of coverage automatically, just because it’s available; there’s a certain point at which additional insurance simply becomes an unnecessary expense.

For example, if you purchased a condo unit to rent out, the condo association may already cover certain building-related costs.

If you happen to have your own personal homeowner or auto insurance through a company that also sells landlord insurance, you are likely to qualify for a discount through that company.

Like any insurance policy, you’ll pay lower premiums if you are willing to bear the risk of a higher deductible.

Take all your tax deductions
Being a landlord means running your own business, and landlord insurance premiums can be deducted as a business expense.

Also, if you experience financial loss due to property damage that’s not fully covered by your insurance, you can often count that “casualty loss” as a tax deduction as well. (While you’re thinking about taxes, don’t forget all the other deductions you can take as a landlord. These include depreciation on the cost of your rental property as well as repair costs, accountant fees, mortgage interest and more.)

Lower your risk
Insurance agents will offer you better rates on your landlord policy if you have certain safety measures in place.

All of the following can potentially lower the cost of your policy by decreasing your risk:

  • Sprinkler system
  • Burglar alarms
  • Gated or locked access
  • Absence of known risks in the area
  • Current electrical inspection
  • Mold inspection
  • Requirement that tenants be non-smokers
  • Requirement that tenants purchase renters insurance
  • A clean bill of health on the dwelling’s CLUE report. CLUE stands for Comprehensive Loss Underwriting Exchange, and it is a report on any insurance claims made on a property for the past seven years. This report is generated by LexisNexis, a consumer reporting agency. If the dwelling’s CLUE report shows previous claims, the insurer will charge more to cover it. Only owners and insurance companies can request these reports, but the Fair Credit Act made these reports free to the owner.

The importance of maintenance
A well-maintained property will result in fewer headaches overall, and will also contribute to lowering your landlord insurance premiums.

Over time, the CLUE report on a well-maintained property will reflect fewer insurance claims, because you’re less likely to experience damage related to faulty household systems.

When you maintain your property well, it’s much easier to track how well your tenants are performing the upkeep that you require of them.

You will also be in a position to effectively defend yourself against any claims by your tenant that they suffered damage due to your neglect.

Renters insurance
Renters insurance is not required by law, but you can write your lease to require tenants to carry their own insurance.

This reduces your liability in cases where a tenant’s possessions are stolen or someone is injured due to the tenants not maintaining the property in a safe condition.

While renters insurance certainly offers you some protections, it doesn’t substitute for your own landlord insurance.

Specifically, renters insurance won’t cover damage to tenant’s possessions that results from your lack of maintenance.

For example, if tenants lose expensive musical instruments to a fire that started from faulty house wiring, renters insurance won’t cover their loss.

Likewise, if a tenant’s visitor slips and falls on icy steps because the tenant neglected to clear the snow away, renters insurance will cover the claim.

However, if the visitor falls because one of the steps isn’t nailed down properly, then you’ll be liable for the cost of the claim.

Umbrella policies: sometimes a good option
If you’re renting multiple units, your potential liability may be high enough that your insurance agent will recommend an umbrella policy.

This protects your personal assets in case your liability exceeds the levels of your landlord insurance policy.

It also ensures that you’ll be able to recover your investment in the case of catastrophic damage, and may be required by your mortgage lender.

What to do if your insurer drops you

  • Check your CLUE report: You’re entitled to a new copy every time you are turned down for insurance coverage.
  • Contact other insurance companies: If they turn you down, find out why. See if it’s something you have control over.
  • Get in touch with your state’s insurance commissioner: Their office may have a pool of insurers who cover higher-risk insurance needs.
  • File a complaint: If you feel you were unfairly denied insurance, you can complain to your state’s insurance commissioner, the FTC, or the insurance company itself.

How to Buy Landlord Insurance
The first step is always to speak with an agent in person and see if you feel comfortable talking with them.

In addition to your sense of personal trust, consider the following points before agreeing to buy:

  • Check the quality rating the company has been given by the rating agencies (Moody’s, Standard & Poor’s, A.M. Best, and Fitch). The Insurance Information Institute provides some background on how these agencies work, as well as extensive unbiased information on all insurance-related topics.
  • Check for any unpaid claims or complaints against the company with your state’s insurance commissioner.
  • Does the company (or your agent) specialize in landlord insurance?
  • Do they offer adequate coverage?
  • Are their premium and deductible amounts competitive?
  • Do they offer discounts for bundling several insurance products together?
  • Is their office nearby and/or easy to access by phone?
  • What is their claims paying process?

When you become a landlord, there’s suddenly a lot you have to learn.

You’re responsible for the welfare of people whom you can’t directly supervise, and this makes you subject to a whole new set of legal liabilities.

Purchasing a good landlord insurance policy will protect your real estate investment, give you peace of mind, and help you conduct your rental business in a professional and profitable manner.

 

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What do you do when your tenants expect you to mediate their problems?

In an ideal world, your tenants get along without any problems.

In reality, minor and major problems occur as a result of differing lifestyles, lack of communication, or inconsiderate behavior.

Your tenants should handle most minor disputes among themselves, without requiring your input, as solving every issue that comes up between tenants could take a significant amount of your time.

Some of your tenants may expect meditation with all of their disputes, though, and some situations require your direct attention.

Setting Mediation Expectations
Let your tenants know mediation expectations upfront so they know when you will step in and when you will allow tenants to figure it out for themselves.

Write these expectations into the lease or include it in the tenant’s resources.

Give examples of appropriate landlord mediation situations, the process for involving you in the dispute and the resolution methods available.

You also want to make it clear that tenants are expected to work out minor disputes among themselves, if possible, to cut down on the hands-on time you spend engaged in mediation.

Lease Clause Complaints
Tenant disputes related to lease clauses are the type of situation most likely to require your attention.

These complaints revolve around tenants who are breaking a lease clause of some sort, such as denying another tenant’s quiet enjoyment of her home, keeping animals in a pet-free house, or conducting a business out of the home.

Remind tenants about their legal responsibility to follow the terms of the lease contract if they want to remain in your property.

In the event of noise complaints, find out when the noise problems are and how loud the noise level actually is.

Use a decibel recorder, if necessary. Some tenants are more sensitive and complain even when sound levels are reasonable.

Additional soundproofing measures or even a white noise machine may quell this issue before it becomes a major problem.

Minor Complaints
Tenants may have minor complaints about where another tenant parked or perhaps what items are left on the tenant’s patio or strewn across a common area.

Encourage tenants to work out these minor issues by directly communicating with each other.

Try to avoid stepping in before the tenants have time to work the situation out themselves.

Don’t let a lot of minor annoyances pile up without being addressed, though, as you don’t want high tenant turnover due to passive-aggressive behavior.

In the event of an ongoing issue, request that tenants document the situation and the steps taken to resolve the complaint before involving you.

Criminal Complaints
Step in as soon as possible if a tenant has concerns of a criminal nature.

These concerns may be about direct threats or violence from another tenant, allegations of drug use or production, or other concerns best addressed by the appropriate authorities.

If you suspect a potentially dangerous situation with a tenant, contact the police for assistance while finding out more about the situation.

If criminal activity is occurring on your property, most states have landlord-tenant laws facilitating eviction within a few days to minimize the potential for harm.

Knowing the appropriate time to step in to solve tenant problems helps you promote a healthy environment at your properties.

Some situations, such as criminal complaints, need your direct intervention, while others benefit from some tenant-to-tenant time.

DIY Accounting Options for Your Rental Business

As your rental or property management business is expanding, it’s easy to get bogged down in paperwork.

If you’re dealing with just a small property, though, you may not handle enough transactions to want to hire a full-time accountant yet.

Get your paperwork on track as soon as possible with some of these DIY accounting solutions.

Some are general accounting programs, while others are specifically designed to tackle the needs of property managers, rental businesses and real estate companies.

GnuCash
GnuCash runs on most modern operating systems and even has a mobile app, if you need it.

GnuCash is free software, so there’s no cost to you to try it out.

While GnuCash works fine for most businesses, be aware that it has no specific options for rental companies or property management.

You may need to manually set up accounts within the system to reflect your business’ unique needs.

While GnuCash is free and versatile, be aware that it uses what’s called a double entry accounting system, which many novices find confusing.

Double entry bookkeeping means that all transactions are recorded as being a deficit to one account and a credit to another account.

While GnuCash’s documentation helps smooth the transition for new accountants, you may find the adjustment period difficult.

Unfortunately, GnuCash offers no options for the single entry accounting systems that most novices find more intuitive.

Wave
Wave is a free, online accounting system.

Because it’s online, you can use it anywhere. All the data is saved on the cloud, and all you need to do is log in.

Its online and mobile options extend to an invoice-creation app, which also tracks payments based on when they’re due.

This may not be useful for rental payments, but this system works well to track rental deposits.

Wave can even take credit and debit card payments, if you allow your tenants to pay their rent that way.

Quicken
Quicken offers a specific Rental Property Management program that handles specific needs like tracking rent and security deposits.

One of Quicken Rental Property Management’s more unusual features is that it makes it easy for property managers to find tax deductible expenses.

The program also integrates cleanly with your bank accounts and comes with mobile options.

The program is not free, and due to its features that deal with taxes, you would need to buy a new version each year to have the right updates.

FreshBooks
FreshBooks is a cloud-based program, and its primary selling point is its ease of use.

It boasts a clean, simple interface that many users describe as intuitive.

FreshBooks also provides rapid customer support for users who need help with the program (or with accounting in general).

In addition to accounting features, the program also offers online billing and invoicing, along with importing of expenses, ability to accept online payments, and tracking timesheets.

FreshBooks is a subscription-based service, but offers a free trial.

Intuit QuickBooks
QuickBooks is a software program designed to handle accounts for many kinds of businesses, including property management companies.

In addition to all vital accounting functions, it allows easy synchronization with banks, online invoicing, and bill payment, and so forth.

If you need extra help, you can hire an accountant or financial adviser from their site directly.

QuickBooks is a subscription service, although there is a free trial for the program.

However, many professional accountants use QuickBooks, so if you choose in the future to hire an accountant to handle your finances, you’ll be able to simply hand them your QuickBooks files with no need to convert.

Sage 50
Formerly known as Peachtree, Sage 50 is an accounting program specifically designed for small businesses.

While a lot of the program’s functions are for retail businesses, there’s plenty for property management companies as well.

Unlike many of the programs listed here, Sage 50 is a subscription purchase that’s paid for by the year.

That yearly fee is in the hundreds of dollars, so if you have the luxury of time and are looking to convert to Sage 50 you may want to wait for them to hold a sale.

Sage 50 offers multiple tiers of their software for different purposes.

The higher tiers allow more individuals within your company access to the software, and provide more sophisticated options.

For instance, the Premium version handles audits and automation, while the Quantum version is specifically designed to handle large amounts of data, and offers plenty of options that are specific to various industries. Sage 50 offers free trials for its software, so you can test your desired version and explore its options before paying.

There’s a wide range of accounting programs available to property managers.

The simpler ones are generally less expensive and focus purely on general accounting.

More complicated programs are usually subscription-based and offer options tailored specifically to the needs of individual businesses, including property management companies.

Many of these services offer free trials, so you can decide if you like their product.

Take advantage of this period to decide if they’re useful to your business before making a choice, and you’ll walk away happy.

Avoiding Liens and Legal Issues When Buying a New Property

If you invest in rental properties, you know that purchasing a property can be lucrative when the price and location are right.

However, it’s easy to get caught up in deals that seem too good to be true.

When buying any property, it’s important to conduct a check to determine whether there are any strings attached.

Tax liens against a property, for example, could cost you thousands of dollars, so you need to know how to do your homework before you make a purchase.

Tracing Lien Information
Property investors may flock to foreclosure auctions to try to make the most of their investment by purchasing a property at a great price.

The problem with foreclosure auctions, short sales, and other property sales that involve a below-market selling price is that the properties in question often come with liens attached.

Tax liens may be levied against the property, but liens can also be placed in relation to delinquent credit card or loan debt, unpaid bills from contractors and even child support back payments.

When a person purchases a property that has liens attached to it, he or she becomes responsible for settling the liens.

Liens have the potential to cost buyers thousands of dollars, and a purchase price that seems like a good investment can end up taking hard-earned money out of your pocket.

Follow these steps to ensure there are no liens on the properties that you are considering adding to your portfolio:

  • Obtain the parcel ID number from the seller.
  • Access the local county clerk office’s website.
  • Navigate the website to find where a lien search can be completed. If you are having trouble locating this search option, contact the county clerk’s office for help.
  • Be sure that you are selecting “liens” during the parcel ID search. After you search for liens, do a search for all records related to the parcel ID to ensure that financial liabilities attached to the property are not listed under another category.

If you are worried that the results of a parcel ID search are not sufficient, you can visit the county clerk’s office to ensure that a professional is conducting the search for you.

If you would prefer not to do the search on your own, it is also possible to hire someone who is knowledgeable about searching for liens to do it for you.

Title search companies are responsible for ensuring that the property title is clean.

While you will have to pay to hire a title search professional, it’s often worth it to ensure that properties do not have hidden costs.

Finding Out About Legal Issues
Even if the property does not have a lien on it, there are other legal issues that could make it a bad investment for you.

To avoid dealing with the headache of a property that is tied up in legal issues, you can start by asking the seller if they have a legal representative who you could talk to.

However, sellers who are highly motivated to sell or who are selling due to legal issues may be inclined to hide these issues from potential buyers.

Legal issues that may be encountered in relation to a property you are purchasing include:

  • Unlawful additions: If the previous owner added rooms or changed the layout of the house, these additions may not have been completed with the proper permits in hand. Once you purchase the property, you are responsible for ensuring that any additions comply with zoning and building safety requirements. You could end up having to do a large-scale renovation to get the property in compliance with regulations.
  • Lead-based paint, mold, and asbestos. If you are purchasing an older home, there is a chance that lead-based paint or asbestos were used when it was constructed. Even in a newer home, mold can grow if the previous owners were not proactive about managing moisture levels. When you’re purchasing an investment property that you plan to rent out, the presence of these dangerous building materials could open you up to liability.
  • How do you protect yourself against these issues? Here are some options that will help you invest wisely.
  • Hire a lawyer: Lawyers who specialize in real estate transactions are able to navigate through the legal issues that may be attached to a property you are purchasing. In fact, legal professionals are also often able to help with your lien search to ensure that you are not liable for expenses that you did not incur.
  • Have a home inspection completed: Home inspectors are knowledgeable about building safety regulations and will look over the structure of the building, as well as the electrical and plumbing structures, to ensure that everything complies with legal requirements. In addition, home inspectors are able to determine whether wear or damage could require costly repairs in the future.

When you purchase a property without doing your homework, you stand to lose money on your investment.

You’re not in property investment to suffer financial losses, so it’s important that you take a proactive role in determining whether a property will yield positive financial results.

Liens and legal issues threaten to eat up your profits, but you can protect yourself by taking a few precautionary steps.

 

Mortgages as They Relate to Landlords

Getting a loan for a rental property is not the same as getting a mortgage for a residence.

While the two situations have some similarities, they also have important differences.

Landlords who are considering applying for a loan to purchase a new rental property should look at the requirements carefully.

Credit Scores
You can do a few things before you apply or put in an offer to make getting a mortgage and closing on the loan easier. First, make sure your credit score is where it should be.

Fannie Mae allows up to 10 loans for investment properties at a given time, but the credit score requirements vary; more loans mean higher risks.

  • The first four loans require a minimum credit score of 630.
  • The remaining six loans require a minimum credit score of 720.

Cash Reserves
You also need cash reserves.

Many lenders require six months of loan payments in savings to ensure you can make the payments even if your property remains unrented for a period of time.

Cash reserves may include the mortgage payment for the rental property and any other loans or expenses you have.

Down Payment and Income
Another requirement is a higher down payment.

You may be required to put down 25 or 30 percent, but the minimum is usually 20 percent.

Many investment mortgages have stringent limits on loan to value. Unlike personal home mortgages that allow up to 97 percent LTV, investment loans may limit the LTV to 70 or 80 percent.

You must show stable income on your W-2s or tax returns.

Your rental income may be considered if you have a history as a landlord.

If you are a first-time landlord purchasing an initial rental property, your regular income must be sufficient.

You need to have higher income to qualify, especially if you already have a personal mortgage.

Find the Right Lender
Not all lenders are experienced with investment properties. Make sure the lender you choose has handled loans for landlords and investors in the past. Otherwise, you may end up in a nightmare with delays and even the loss of a property you want.
Ask your lenders about their experience.

Even better, work with lenders who have purchased investment properties. They will understand where you’re coming from.

Find out how many loans they allow for investment properties.

Just because Fannie Mae increased its allowance from four to 10 doesn’t mean every lender has relaxed their standards.

Rent Loss Insurance
Another requirement you can expect for many investment loans is the need to purchase rent loss insurance.

This policy protects you if you should lose out on rent income for various reasons that result in damage to the property.

This can include fire, water damage, or other natural disasters.

It doesn’t cover you if your property is vacant because you can’t find a tenant.

This policy is usually included in your property insurance once you let the insurance provider know what kind of property it is.

It is purchased at an additional cost based on cost of property, mortgage payments and vacancy rate in the area.

FHA
You may be surprised to learn you can get an FHA loan for a rental property.

Most people assume these loans are limited to people who plan to occupy the residence. In essence, this is true because you are required to live in the property for 12 months.

After that time, you can rent it out.
An FHA loan is a viable option for someone who wants to get started in real estate investment with limited cash.

Only one loan is allowed from FHA, so you have to find other options for your second and future rental properties.

Types of Loans
If you plan to rent out your property immediately, you have to choose between a residential and a commercial property loan.

The residential loan is usually designed for properties with four or fewer units and is most similar to traditional mortgages.

You still have more stringent requirements, but not as complex as for commercial investment loans.

The benefit of this type of loan is that previous experience as a landlord isn’t generally required, and the interest rates are only slightly higher than for traditional home mortgages.

Commercial loans aren’t just for rental properties, but for any type of business.

They require much of the same information as residential investment loans, but the details may be different.

For instance, lenders look closer at the amount of cash flow that is expected over just verifying income. They also check your background and experience in managing the properties.

These loans include DSCR or Debt Service Coverage Ratio.

This means the lender is checking the cash flow as compared to the income and expenses.

The formula is DSCR=(Net Operating Income)/(Debt Service).

It’s possible to get a loan to purchase new rental properties, but be prepared for things to work differently than with a traditional home loan.

Know what is expected and find a lender who can guide you and support you through the process.

 

How Can You Make Sure You’re Financially Ready to Invest in Your Next Rental Property

If you’ve had a good experience with your first rental property, you may be thinking about purchasing another.

But while a successful stint as a landlord is definitely a good sign that you’re prepared to take on another property, it’s important to remember that all the same financial risks that came with your first purchase still apply.

Consider these important factors to make sure you’re truly financially ready to buy your next rental.

Cash Flow
From a month-to-month standpoint, the most important thing to consider is whether your cash flow can support a new investment, even above and beyond saving for the initial down payment.

Ideally, you’ll have enough free cash flow saved up to pay for both (or all) of your rental properties entirely on your own for at least three months.

That kind of buffer ensures that you won’t be caught off guard if you have difficulty securing quality tenants for the new property, or even if you lose your existing tenants at the same time.

In short, you need to make sure you can cover catastrophic scenarios for all apartments simultaneously, or risk falling into debt.

Additional Costs
It’s crucial to remember that you’ll incur most of the same additional costs during a second property purchase that you did for the first property.

Of course you’ll need to calculate the “always expected” costs of things like property and income tax for a new property, but you also need to include all the incidental and one-time costs that might arise.

Use your experience with your first rental property to estimate a broad window for how much you’ll require in repair and renovation costs when purchasing an additional property.

You’ll also want to keep in mind any advertising or brokerage costs that might be required to find quality tenants in your area.

In general, it’s a good idea to sit down and make a list detailing every penny you spent on your initial property during its first one to three years, then make sure your cash flow or savings can accommodate at least that amount for an additional property.

If you had an especially easy time of things the first time around, you’ll want to be more pessimistic in your calculations, and assume for safety’s sake that you’d need to spend more with a new property.

Assessing the Market
Beyond your own finances, one of the biggest factors to consider is whether your local market is a good choice for renting at all.

Nearly every city has a very active rental market, but you need to confirm what the exact state of that market is, and how it may have changed since your first purchase.

Accordingly, you need to do all the research you did the first time around.

Look at how many active vacancies exist, what the going rental rate is, and how long the average apartment stays vacant.

If any of those factors have soured since your first purchase, you’ll need to adjust your plans for cash flow accordingly, and may need to delay the new purchase entirely.

Once you’ve ensured that you can support not only the purchase price and mortgage, but also all additional expenses and worst case vacancy scenarios, you should be well on your way to expanding your rental property portfolio.

 

What You Need to Know About Refinancing a Rental Home

Refinancing a rental home is usually a bit more complicated than refinancing your primary residence.

Before you start sending applications to lenders, here are a few things that might help you navigate the process.

You’ll Need Plenty of Equity in the Rental Home

Most lenders want you to have 20 percent equity in your own home to refinance your mortgage, but when it comes to refinancing a rental home, you need at least 25 percent equity.

Few reputable lenders will go below the 25 percent mark. Since the property isn’t your primary residence, lenders see it as a bigger risk.

If you have at least 25 percent of the home’s value invested in the property, lenders know that you are committed to maintaining the house and paying your mortgage on time.

The Lender May Not Care About Rental Income

Today’s mortgage lenders are all about lowering risk.

That means they are unlikely to consider your rental income when deciding whether they will refinance your mortgage. If the current tenant moves out, then that money disappears.

Given its capricious nature, many lenders simply don’t care how much you can potentially make by renting the property.

Some factors may make a lender more or less likely to consider rental income.

For example, if the tenant has been living in the home for several years, the lender is more likely to look at the income. Long-term tenants come with less risk than new tenants.

Having a new tenant isn’t the only reason that lenders may disregard rental income.

If, for instance, you are renting the property to a relative, the lender will want to see proof that person is paying an appropriate amount each month.

Lenders may think that relatives can get away with more than other tenants, so they represent a higher risk. If you have bank statements proving the relative has been paying for several years, the lender may take a different position.

You’ll Probably Pay a Higher Interest Rate

Between November 2015 and February 2016, rates for 30-year mortgages bounced between 3.88 and 4.15 percent.

Rates for a 15-year mortgage fell as low as 3.15 percent during the same period.

Not surprisingly, higher risk associated with income properties means you will pay higher interest when you refinance.

In most cases, lenders will add about 0.5 percent to the going rate.

It’s not a substantial amount, but it’s worth thinking about because the higher rate will increase your overall costs.

You Can Deduct Associated Fees at Tax Time

Refinancing a rental property is often more difficult than refinancing your personal residence, but the rental gives you more tax advantages.

In fact, you can deduct every expense associated with the new mortgage, including

  • Fees for credit reports
  • Application fees
  • The cost of appraising the property
  • Insurance premiums
  • Points

Most of these deductions are spread over the life of the mortgage, so you can expect to save a little money each year.

Even if you only save $100 each year on your taxes, it’s still more than you would get from refinancing your home, and it will help make your rental property more profitable.

Refinancing the mortgage on a rental property could help you lower your expenses and free up cash that you need to repair the home or invest in other properties.

Getting a lender to refinance the mortgage, however, takes some work.

That doesn’t mean it’s impossible, but you should expect to face closer scrutiny and higher costs.

What Fees Should You Expect When Financing a Rental?

Interest rates remain low, making this a great time to finance an investment property.

However, it is important to be prepared for the extra fees you will face when taking a mortgage for a rental home.

These fees must be paid along with your down payment at the time of closing, if not before, and planning ahead will help prevent any bumps in the road.

Fees Charged by Your Lender and Service Providers

Many of the fees you will pay to finance your rental property are paid directly to the lender.

The figures below are approximate.

For detailed information on specific costs charged by your mortgage company, check your Truth in Lending disclosure.

  • Processing Fee: Your lender receives this amount, which is intended to cover costs associated with processing your mortgage application. These fees do not usually exceed $1,000.
  • Underwriting Fee: This charge is assessed by your lender to cover costs associated with decisioning your loan application. Underwriting fees are often as high as $795.
  • Miscellaneous Fees: Your lender is likely to charge you for any fees incurred in processing your application — for example: courier fees, postage fees, and credit report fees. All of these fees are fairly small, but they can add up to several hundred dollars.
  • Appraisal Fee: Though the cost of getting an appraisal is paid to the appraisal company, it is typically paid to the lender, who then hires the appraiser.
  • Loan Discount Points: If you wish to bring your insurance rate down, lenders may offer you the option of prepaying interest in the form of loan discount points. At closing, you pay one percent of the total loan amount, which will reduce your payments going forward.
  • Flood Determination: Lenders want to know whether your property is at risk for flood damage, so an assessment of whether the area is in a flood zone is required. Fortunately, the charge for this service is fairly low.
  • Title Fee: You want to be sure that no one but the seller has claim to the property you want to buy. Your title company will conduct a thorough search on the deed to ensure you don’t run into future issues. Costs for this service vary widely.
  • Survey Fee: Some states require a survey company to ensure that property lines are accurately recorded. Costs for this service vary, but they do not usually exceed $450.
  • Closing and Escrow Fees: The individuals who conduct your closing (for example, the title company or real estate attorney) charge a fee for their service. The costs are typically calculated at two dollars for every thousand dollars of the home’s purchase price, plus an additional amount of approximately $250.
  • Recording Fee: This is a charge assessed by the city or county recording office responsible for documenting real estate records.
  • Buyer’s and Lender’s Attorney Fees: When buyer’s and lender’s attorney fees are required, they can add a significant amount to the bottom line payment due at closing.
  • General Inspection and Pest Inspection: Whether or not your lender requires a general inspection or an inspection for wood-destroying pests, the cost is well worth the peace of mind of knowing you won’t face thousands in repair costs down the road.

The upfront costs of financing a rental property can rapidly climb into the thousands.

Preparing for these fees ahead of time will prevent unpleasant surprises when you finally get to closing.

Additional Resources

Truth in Lending Fee Disclosures

What Are You Legally Required to Disclose When Selling a Property?

If you’re currently a landlord thinking about selling a house, you may have to fill out a disclosure statement first.

Even if your state doesn’t require this form, it’s recommended that you provide it, since it can protect sellers in the long run.

Here’s how it works and what kind of information you need to provide.

Major Defects on the Property

In general, you have to disclose anything that would affect property value, which includes defects that you’re aware of.

For example, if you know the faucets leak, the roof needs to be replaced, and there are cracks in the foundation, you need to disclose these problems.

This applies whether you have seen them yourself or your tenants have pointed them out.

Similarly, if there is evidence of a termite infestation on the property, let the buyers know in the disclosure statement.

Even if you’re aware that there are lots of barking dogs nearby or construction noise, you should disclose these issues because they could affect the value of the property.

Inspection Requirements

You don’t have to get a full inspection before you sell the house. You only have to disclose the issues you know about, not look for more.

Of course, the buyers will likely hire a property inspector anyway, so they will probably unearth any problems that weren’t obvious before.

If you hire an inspector yourself, and that inspector discovers problems you didn’t know about, you will have to disclose them.

But on the upside, if your inspector doesn’t find additional problems, you will have the documentation you need if the buyer accuses you of not disclosing defects in the future.

If they’re not in the inspector’s report, it will be clear that the defects are new and, therefore, the responsibility of the new owner.

Federal Disclosure Requirements

No matter where your property is located, you need to disclose whether there is lead paint in the home. That’s because the Lead-Based Paint Hazard Reduction Act of 1992 is a federal law.

However, it only applies if your house was constructed prior to 1978.

If this is the case for your home, let the buyers know that the house might have lead-based paint, and then give them 10 days to test the paint for lead.

You should also make sure they know the dangers of lead-based paint, which can be achieved by giving them a pamphlet by the EPA called “Protect Your Family From Lead in Your Home.”

Then you need to have them sign a statement that they’re aware of whether or not the house contains lead.

Keep this signed document for at least three years as proof that you’re in compliance with this federal law.

Additional Information to Disclose

Once you have disclosed the presence of lead-based paint and general defects in the home, you should find out if there are any other disclosure rules specific to your location. That’s because they vary by state.

For example, most states don’t require you to disclose a death in the home, but the exceptions are California, South Dakota, and Alaska.

In California, you must disclose any death that took place in the home in the last three years, even if it was due to natural causes.

But sellers in South Dakota and Alaska only need to disclose murders or suicides that took place within the last year.

In New Jersey, sellers have to disclose whether the house is fit to live in.

They also have to disclose any hidden defects that they know about.

On the other hand, sellers in Georgia aren’t required to offer a disclosure form at all, but they’re still encouraged to do so.

If you’re not sure what to disclose, you can ask your real estate agent about the rules that apply to your specific situation before you sell the house.

What Are the Requirements for a Mortgage on a Rental Home?

Securing a mortgage for a rental home can be a headache.

Although these mortgages work similarly to conventional mortgages, they often have stricter qualification requirements.

Below are some you may be expected to meet.

Credit Score

Your credit score plays a significant role in determining your eligibility for a mortgage on a rental home.

The biggest influences on your credit score are your payment history and debt load – together, these two components account for 65 percent.

Lesser influences include the length of your credit history and the age and mix of your credit accounts.

Maintaining a credit score of 720 or higher can help you to qualify you for a low interest rate on your rental home mortgage. Below that, lenders may charge you a higher interest rate.

Credit Report

In addition to checking your credit score, lenders examine your credit report to gauge your readiness to repay your mortgage debt.

All lenders use information from at least one of the three national credit reporting bureaus: Equifax, TransUnion, and Experian.

If your credit report reveals that you have liens or judgments against your name, you will need to pay these off in full, or negotiate a payment plan with your creditors, before obtaining a mortgage.

Income

The maximum loan size for a rental home is linked to the income you expect to receive once your rental home is tenanted.

Lenders typically require your potential rental income to be 25-30 percent higher than your mortgage payment.

They may also request proof of your personal income and cash reserves to ensure that you have sufficient funds to cover any void periods – times when your property is untenanted or rent is not paid.

Employment History

Rental home mortgages are a serious financial commitment and lenders rely on a stable employment history to determine your ability to make your repayments on time.

Most lenders require at least two years’ verifiable work history, as well as proof that your employment is likely to continue for a minimum of three years.

Lenders verify your employment history by checking with your current and past employers and/or requesting pay stubs and tax returns.

If you are self-employed or work on commission, lenders may ask for at least two years’ worth of accounts to substantiate your employment history.

Debt to Income Ratio

Most lenders require that your debt be no more than 30 percent of your income. This is your debt-to-income (DTI) ratio. The higher your DTI ratio, the more interest you will pay on your rental home mortgage.

If your DTI ratio is too high to qualify you for a mortgage, consider paying off high interest debts to get below the required limits.

Down Payment

Rental home mortgages often require larger down payments than conventional mortgages to compensate for the risk of void periods.

Most lenders request a down payment of at least 15 percent of the loan amount. A higher down payment may be required if you are a new investor and/or you have a credit score below 620.

Understanding the requirements for a mortgage on a rental home is an important first step in the buying process.

Knowing that you meet the requirements can boost your confidence and make it easier for you to negotiate with lenders.