Why you should turn your starter home into a rental property when you move instead of selling it

Only about 62% of Americans own a home today in 2017.  Although this is low in comparison to where it was 10-15 years ago (and is still declining each year), 62% is still a majority.  This is good news, because it means that chances are, for those of you reading this right now, most of you own your home. 

This article will be directed mostly towards these homeowner readers, however if you are currently renting stick around.  You can still get a lot from reading this article because hopefully someday soon you will also own a home and you can use this same wealth building strategy.  To follow this strategy, you don’t have to be an entrepreneur.  You don’t even have to know a single thing about investing or business.  All you do is let nature take its course and NEVER sell your home(s). 

Most homeowners start out with a smaller or moderate sized starter home.  This is probably because newer families are smaller, earn less in the early years, and just don’t need a big 3,500 square foot 5 bedroom home in the beginning. 

My starter home was a 1,248 square foot, 3 bedroom 2 bathroom home.  That is all we needed because it was just my wife and I.  Our thought was that we could have 1, 2 or maybe even 3 children and still live in this inexpensive small home for quite some time before we needed more space. 

Now for most Americans, when they begin to outgrow their starter home they plan to sell their home and use the equity from the sale as a down payment for a larger home.  This is what my parents did.  I grew up in a home under 2,000 square feet.  Just as I was finishing the 7th grade, my parents sold that house (at the high point of the real estate boom in 2005- good for them!) and bought a monster house that was over 4,000 square feet. 

While this plan works for a lot of people, I want to share an alternative wealth building strategy that can be more powerful than rolling profits from a sale into a bigger, more expensive home. 

Imagine this scenario.  You finally buy your first home.  Because it was your first home, you qualified for an FHA backed loan, meaning you got a preferred interest rate and you only had to put down 3.5% of the purchase price.  For this example we will assume it only cost you about $12,000 to buy this home (including the down payment, loan fees and all other closing costs). 

You are now living in your starter home with a relatively low mortgage payment.  The home is smaller, but plenty of space for now.  While you are living in this home, you are saving money from each paycheck you receive at your job (paying yourself first).  Over the course of a few years, you start to build a substantial amount of equity in your home from market appreciation and debt pay down through months and months of paying your mortgage. 

You begin to consider the idea selling your home, but then you start to think about your option of keeping it and renting it out instead.  Besides, you have been saving (paying yourself first) for a few years and you have enough to buy another home without having to sell your current home. 

Then you also discover that although you may not qualify for a second FHA loan, you will still qualify for a conventional 5% down loan with a competitive interest rate.  Now you really start to consider the fact that you can afford to purchase a second house since you will only need 5% down. 

After some thinking, you make the decision not to sell but instead to purchase another home and make your current home a rental property.  Now you have two smaller-moderate sized houses and you are living in one and renting out the other.  Fast forward another couple years.  You are once again in the same situation: You have a decent sized savings set aside and you start thinking about buying a 3rd home and renting out the one you are currently living in.

Your brain starts to explore the idea of owning 3 homes.  You were recently surfing the internet and while on Zillow.com you noticed that both of your homes have appreciated substantially.  You also see that there has also been a lot of rent growth in your market and both of the houses would command a rental rate of a couple hundred dollars more than the mortgage payments.

You make a plan that every 2 years you are going to buy an additional house to live in and turn your current home into a rental property.  You realize that by doing this over a period of 20 years, you will accumulate a portfolio of 10 houses, 9 of them being rental properties.  Now imagine what these homes will be worth at the end of the 20 years.  Your first 5 properties may very well be worth double or even triple what you originally bought them for.  Not to mention that on a couple of them you may be starting to see the light at the end of the tunnel on paying them off completely. 

In fact, if you were smart, several of them are already completely paid off!  You took the monthly cash flow from the rental properties and paid down the mortgages one house at a time.  You have 5 rental houses that are completely free and clear.  Now you are really making a good cash flow!  Over the next few years you use this large income to really ramp up your payments towards the other mortgages.  From here it does not take long to get the remaining homes paid off. 

By now you are in your mid to late 40’s, and you have (plus or minus) 10 rental properties that are completely free and clear.  The majority of the rental income that comes in is profit (of course you still will be paying annual property taxes and hazard insurance) and you can sit back and collect rent checks for the rest of your life. 

Now for most people, owning 10 homes free and clear that are each brining in a solid $1,500 per month in passive income would be a dream!  How can someone set themselves up so good for retirement?  They must have started out with a lot of money!  Not at all!

Instead they started out with a moderate home, only requiring a small down payment.  All they did was repeat this process over and over again and refusing to sell!  Instead of selling their first home and going big on a second home, they were smart and built up a portfolio of dependable rental properties that would generate a stream of life long passive income.  They did this with no business or investing experience, and they never considered themselves entrepreneurs.  They just bought homes and refused to sell.  That’s it. 

Now you can go out and buy a bigger home.  You have $15,000 per month coming in every month.  Imagine what kind of home you could live in for $5,000 per month?  Your buddy’s 401(k) sure can’t afford a home like that!  You now deserve it.

FINAL SIDE NOTE:  So why are most Americans still banking on their 401(k) as a great retirement plan?  I have no F’ing idea.  I guess they just don’t know how money works.  Get educated and make a decision not to follow the crowd.  The crowd always gets slaughtered.   

 

 

 

 

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