Rent and Lease Housing’s Blog

Step 1: Renting vs Selling - Analyze Your Situation

So you’re at the point where you are not sure what to do with your house.  You are in a scenario where you either cannot afford the monthly mortgage payment or where you have to move, but your house is now worth less than your mortgage balance. What do you do?  Let’s take a look to see if renting out your property would be a smart move.

First, let’s answer these few questions:

1.    What kind of mortgage do you have? (30 year fixed, 5 year ARM, Interest only, etc.)

2.    What is your monthly mortgage payment including real estate taxes, insurance and anything else?

3.    What is your house worth? - www.zillow.com

4.    What do you owe?

5.    What is it going to cost to sell your house now?

6.    How much rent can you charge? - www.rentometer.com

For example:

1.    FHA 30 Year Fixed Mortgage@ 6.25%
2.    $1,900 PITI (Principal, Interest, Taxes and Insurance)
3.    $300,000
4.    $340,000
5.    5% realtor commissions, $2,500 in closing costs
6.    $2,000 in monthly rent

Once you have gathered all this information, open up the following rent vs sell excel sheet to do a simple analysis of your situation.  After plugging the numbers in the excel sheet, find the scenario that meets your situation.  The first three scenarios put you in a good position to get out of this real estate market ahead of the game.  The fourth scenario is a little tricky, and unfortunately, I think a lot of people fall into it.

Scenario #1 - If the annual cash flow is positive and the equity is negative, it is a good idea to rent out the property.

Scenario #2 - If the annual cash flow is negative and the equity is positive, it is a good idea to sell the house.

Scenario #3 - If the annual cash flow is positive and the equity is positive, it is a good idea to rent out the property.

Scenario #4 - If the annual cash flow is negative and the equity is negative, you have to weigh the negative cash flow against the loss on the sale of the house.

The 4th scenario definitely deserves a closer look.  Our excel sheet is telling us that you owe more than what the house is worth and you cannot get enough rent to cover the mortgage payment.  Obviously, this is not an ideal situation to be in, but let’s look further on how to handle it.

First, you have to identify how much extra money you are going to put out each month to cover the difference between the rent and mortgage payment.  Second, you have to determine how much of a loss you will take on the house if you sold it today.  Third, you have to determine how long of a time period it will take before the monthly rental losses become greater than the loss on the house today.  The two examples below illustrate how you can handle the situation.

Example 1- Small Rental Loss, Large Loss on Sale

If you are putting up a small amount of cash each month, and you would take a large loss on the property today, it might be worth it to ride out this real estate market and settle for the small monthly loss of cash.

For example, if your monthly mortgage payment is $1,500 and you can get monthly rent of $1,400; however, you owe $350,000 when your property is worth $300,000.  It is probably a good idea to take the small monthly loss.

Rent:            $1,400 x 12 = $16,800
Mortgage:    $1,500 x 12 = $18,000
Annual Loss:                       ($1,200)

Sale of the Property (Not including Realtor commissions or closing costs)

Sale Price:    $300,000
Mortgage:    $350,000
Gain (Loss): ($50,000)

Even if you kept the house for 5 years and incurred the $1,200 loss each year, you would be still $44,000 ahead.  It would be wise to rent the property.

Example 2 - Large Rental Loss, Small Loss on Sale

If you would lose a large amount of cash each month and/or you have a rising adjustable rate mortgage and you would only incur a small loss on the sale of the house, it might be in your best interest to sell the property.

For example, if your monthly mortgage payment is $2,200 and you can get monthly rent of $1,400; however, you owe $320,000 when your property is worth $300,000.  It is probably a good idea to sell the house and take the small loss.

Rent:          $1,400 x 12 = $16,800
Mortgage:  $2,200 x 12 = $26,400
Annual Gain (Loss):           ($9,600)

Sale of Property (Not including Realtor commissions or closing costs)

Sale Price:       $300,000
Mortgage:       $320,000
Gain (Loss):     ($20,000)

If you were to keep the house for over 5 years, you would have come up with an extra $48,000.  Selling the house today would save you $28,000 in the long run. In this situation it might be a good idea to sell the house and take the loss today.  Or if you are in a financial pickle, call your lender and arrange a short-sale.

To wrap this article up, if you are in a scenario 4 situation, you need to weigh three items:

1.    How much cash do I have to put up if the rent doesn’t cover the mortgage payment?
2.    How much would I lose today if I sold the house?
3.    How long would I rent out the property before I would sell it?

So if you are in a situation where renting your property is the best option, please stay tuned for Step 2…

Introduction: Do Not Sell Your House, Rent It

Step 1: Renting vs Selling - Analyze Your Situation

Step 2: Renting Your House - Create a Plan

Step 3: Signing a Lease - coming soon!

Overview of Process - coming soon!