Many Americans with low-interest-rate mortgages are facing a crucial decision when it comes time to move: should they sell or rent out their existing property? This choice becomes particularly tricky for those looking to buy another home, as they navigate the complexities of managing multiple properties and securing new financing.

The Mortgage Landscape

According to the latest figures from the Federal Housing Finance Agency, approximately 6 in 10 existing fixed-rate U.S. mortgage holders had an interest rate below 4% during the fourth quarter of 2023. In stark contrast, the average 30-year fixed-rate mortgage hovered around 7% in May. This significant difference in interest rates presents both an opportunity and a challenge for homeowners.

Renting Out Your Property: Complexities and Considerations

Renting out your old home while purchasing another property "gets very, very complicated, which is why most people don’t do it,” said Keith Gumbinger, vice president of mortgage website HSH. This complexity arises from several factors, including the difficulties in qualifying for a second mortgage and the responsibilities associated with becoming a landlord.

Qualifying for a Second Mortgage

Homeownership has become increasingly unaffordable due to higher interest rates and soaring home values, making it harder to qualify for a second mortgage. Without tapping into the equity of your original property, securing financing for a new home can be challenging. According to a survey from the National Association of Realtors, the typical down payment for first-time homebuyers was 8% in 2023, compared to 19% for repeat buyers, based on transactions from July 2022 to June 2023.

Using Rental Income for Mortgage Qualification

If you plan to use rental income to qualify for the second mortgage, lenders typically consider only 75% of your rental proceeds. This adjustment accounts for potential vacancies and maintenance costs, thereby reducing the income considered by lenders for mortgage qualification purposes.

The Realities of Being a Landlord

Certified financial planner Kashif Ahmed, president of American Private Wealth in Bedford, Massachusetts, cautions against the allure of easy rental income. "Be careful about wanting to be a landlord," he said. "It’s not the panacea you think it is." Ahmed, who owns rental property in Austin, Texas, highlights that first-time landlords often underestimate the costs of ongoing maintenance, potential vacancies, and lower-than-expected rental income.

Additionally, landlord insurance typically costs about 25% more than a standard homeowners policy, according to the Insurance Information Institute. These added expenses and the stress of managing a rental property can significantly diminish the perceived financial benefits.

Capital Gains Tax Implications

Another crucial factor to consider is the capital gains tax exemption for primary residences. Married couples filing together can exclude up to $500,000 in gains from capital gains taxes, while single filers can exclude up to $250,000. However, there are strict IRS rules to qualify for this exemption.

Renting out your home starts the clock on the "residence test," which requires that the home must be your primary residence for 24 months out of the five years before the sale. These 24 months do not need to be consecutive. “It’s a huge factor,” said CFP David Flores Wilson, managing partner at Sincerus Advisory in New York. “Those numbers go into projections.”

Strategic Financial Planning

Ultimately, the decision to sell your first home or rent it out hinges on your overall financial plan. Changes in cash flow from rental income can impact retirement and other long-term financial goals. Homeowners must carefully weigh the benefits of potential rental income against the costs and responsibilities of being a landlord and the implications for their broader financial strategy.

In conclusion, while renting out your property might seem like a viable option to take advantage of low-interest rates, it involves significant complexities and considerations. From qualifying for a second mortgage to managing rental properties and understanding tax implications, homeowners need to carefully evaluate their options and align their decisions with their long-term financial goals.