To Rent or To Sell
Many people are faced with a difficult decision in today’s real estate market: sell your home and lose a significant amount of money invested or have to bring cash to close, or rent it out to cover the mortgage and sell at a future date. There is a simple formula to help you decide which is better for you financially.
Current Mortgage Payment – (Estimated Monthly Rent – Expenses) = Monthly Loss or Gain
What should you estimate for expenses? You can go through your actual taxes, insurance, maintenance expenses, add property management fees, and estimate vacancy loss, or you can use a rough estimate of 20% of gross rent. This amount should be higher than your actual expenses, but is a safe number for this calculation.
Example:
$1500 Mortgage Payment – ($1600 Monthly Rent – $240 Expenses) = -$420
If you calculate a monthly gain, then this decision should be a no-brainer. But many people will calculate a net loss. Here’s the next formula:
Yearly Loss X Number of Years Estimated for Equity Recovery = Total “Loss”
What should you estimate for the number of years for equity recovery? Your area is important to consider. More stable areas around the University will recover quicker than outlying areas, but you can estimate anywhere from 5 to 10 years.
Example:
$5,040 X 10 years = $50,400
That may seem like a high number, but also remember that in this amount of time, your tenants will be helping you pay down the principal balance of your loan. On a $250,000 loan amount at 6% interest, you will have paid $36,380 towards principal, assuming the loan term started the same day you began renting it. If you’re a few years into your loan, this amount will be even higher.
To account for the amount paid down in principal:
Total “Loss” – Principal Paid = Actual Loss
Example:
$50,400 – $36,380 = $14,020
And of course this is not accounting for the tax deductions you may be able to take during this 10 year time period. (Talk to your favorite tax person for more info on this.)
So, in this example, the market would need to recover enough in a 10 year time period to cover your initial investment in the property plus $14,020. In most markets, this is a very realistic expectation.
What you must decide is A) can you afford to continue making payments even at a loss and even if the property is unrented for a period of time? and B) is the time and effort of renting the property worth the potential long-term gain? If you can answer yes to these questions, renting is probably a better decision than selling now and losing any potential to recover your initial investment.
Smart Tip! If you are able to refinance to a lower interest rate, do so before you move out. It is much easier to refinance a primary residence than it is to refinance a second or investment property.
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