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Filing Lawsuit for Tenants’ Withholding Last Month’s Rent- Property Code § 92.108

austin_small_claims_courtFor the first time, I sued a tenant in small claims court for not paying last month’s rent and was awarded triple damages. Tenant failed to give proper written notice, breached lease by vacating early, and did not pay last month’s rent. We had previously filed an eviction lawsuit and received an eviction judgment for rents in arrears. We filed a second small claims lawsuit for damages, reletting fee, lost rents, and triple damages for not paying last month’s rent.

When filing an eviction lawsuit, a judge will only award a judgment for past due rents. Late fees, reletting fees, future rents, and damages will not be considered in eviction court. A landlord must file a small claims lawsuit to pursue rents from breach of contract, damages, and late fees.

Texas is a very friendly landlord state and has property codes to protect landlord. Under no circumstances are tenants allowed to pay the last month’s rent using security deposit. Texas property code § 92.108 states:

Notices About Security Deposits:
(1)Property code § 92.108 provides that a tenant may not withhold payment of any portion of the last month’s rent on grounds that the security deposit is security deposit for unpaid rent.

(2)Bath faith violations of § 92.108 may subject tenant to liability up to 3 times the rent wrongfully withheld and the landlord’s reasonable attorney’s fees.

We use a TAR lease (Texas Association of Realtors). This language is included on page 3 and 4 of the lease agreement. See a sample copy on our forms page.

If a tenant loses a job or has a financial burden, we always try and work things out. We only file an eviction lawsuit if tenant is not able to pay rent and has no income. We normally don’t proceed with filing a second small claims lawsuit. However, this tenant was dishonest and promised to pay rent. Instead, monthly rent funds were used to pay security deposit for another property. For more details on the eviction process, see our blog article regarding eviction process.

We also recommend filing an abstract of judgment if you receive a judgment in court. The JP court will issue a judgment in eviction court or small claims court. It is only a few dollars more for judge to provide you an abstract of judgment, and we recommend filing the abstract judgment in county court house of subject property. Filing the abstract judgment at county court house gives you an additional layer of protection if tenant(s) ever purchase or sell a home.

Most lenders require a new title policy before approving a mortgage. A title policy is issued by a title company and protects the buyer from any previous clouds or liens on title. This insures buyer will have a clear title when they purchase property. Title company will do a title search for any liens or judgments. A recorded abstract judgment will be discovered in the title search for that county. All liens and judgments must be satisfied before a title policy is issued. The buyer’s lender will not approve a mortgage unless a title company issues title policy and all liens are satisfied.

Filing an abstract judgment or having two judgments does not guarantee payment. Most Justice of the Peace courts will report judgments to credit bureaus. Many tenants are judgment proof because they have no assets, don’t own a home, and most likely will never purchase a home. However, a judgment will lower the tenant’s fico score and hopefully notify a future property manager, apartment, or owner of eviction or judgment when screening tenant(s).

Many times, professional Austin property managers can discover a breach of lease or eviction when screening tenants. Many Austin property managers and apartments subscribe to tenant performance services which have a database for eviction files, names screened by previous landlords, and rental history. For rent by owners face the greatest risk of not being able to adequately screen a tenant. Many times, the tenants with multiple evictions or poor rental history will seek homes being leased by owners for this very reason. For more information about filing an eviction, click here to read my eviction article.

If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Tips For Getting Home Ready For Lease

Getting a property ready for lease does not require as much work as getting a home ready for sale. Prospective tenants are not as concerned about curb appeal, condition of yard, or extensive upgrades. However, tenants are looking for homes in good subdivisions that are priced competitively and show nicely.

Tenants are looking for a home with clean walls and carpet. These are probably the most important features. Like home buyers, tenants have choices in looking for homes. However, most will submit an application once they see a home that meets their needs and is priced competitively. Tenants usually don’t preview additional properties once they find one in good condition, because there are fewer homes for lease than for sale. Homes with clean walls and carpet will lease quickly and sometimes receive multiple applications.

We recommend using a flat paint premixed at factory plant to paint interior walls. We use Monarch/Pittsburgh paints, and they are premixed at the plant and shipped to paint stores in five gallon tubs. The paint store does not mix these paints according to a formula. Premixed Monarch paints will touch up better and ensure consistent blending when touching up walls. This saves time and money when turning the property and getting home ready for lease.

Paint is the most cost effective upgrade, and these premixed paints will blend in nicely. We use are Crisp Kahki and Summertime colors. Crisp Khaki is very popular and used in brand new homes. This paint really makes a home look updated and looks great against white trim. We can usually touch up between tenants or roll a wall without having to cut in by ceilings, corners, and trim areas. This saves time and money, and we usually leave leftover paint for tenants to touch up before they vacate the property at end of lease.

Contrary to many articles I have seen for rental property, we do not recommend using a semi-gloss paint. Semi gloss paints will not touch up and will show a new sheen. We also do not recommend having multiple colors in home. Most custom colors will not blend in. Even if you have the original formula, the walls will spot anytime you touch up walls. The most cost effective solution is to have a single premixed color for entire home.

The second most important item tenants look for is clean carpet and flooring. Many times, professional steam cleaning will remove stains make carpets look nice. For do it yourself landlords, I don’t recommend renting a steam cleaner. Invest in having the carpets professionally cleaned. However, worn out carpets will not look better after being professionally cleaned. Carpets will usually last 3-5 years for rental properties. If you lease home multiple times within five years, you will be lucky to get five years of carpet usage. We recommend using a light to dark tan color FHA quality carpet. Many new homes have a white or very light color. Light colored carpets will show more dirt. We don’t recommend installing expensive carpet. We frequently replace carpets from damage and stains. Pet urine will damage expensive carpets just as easy as inexpensive carpets.

Installing extra ceramic tile can lower your cost of ownership long term. If you own a smaller home, it can really payoff installing extra ceramic tile in high traffic areas. Most flooring wear and tear occurs in entry ways, hallways, and living rooms. Ceramic tile never wears out and is resilient to water penetration. We don’t recommend installing wood laminate flooring, especially in wet areas such as kitchen or bath. On more than one occasion, we have had toilets overflow, hot water heaters leak, and dish washer pumps leak. You cannot extract water from any type of wood flooring.

Many landlords inquire about investing in landscaping or sprinkler systems. Most tenants will not take care of the yard like a home owner. Many tenants will shut off sprinkler systems entirely. Tenants frequently program sprinkler controller incorrectly and have large water bills. Others are concerned about high water bills and just turn system off. Sprinkler valves also break, and tenants damage sprinkler heads. We recommend limiting landscaping to small drought resistant bushes in front and mulch. Investing in a sprinkler system will be handy during vacant period in summer months, but till not generate more rent.

Most tenants renting a home also have their own refrigerator, washer and dryer. So, we don’t recommend investing in additional appliances. If you own a multifamily property such as a duplex or 4plex, you should provide a refrigerator. Most tenants will expect landlord to provide a refrigerator. If blinds need replacing in a home, consider spending a little extra for faux wood blinds. Faux wood blinds usually are only $25-$35 more per window and will hold up better than metal blinds and make home show better.

In summary, keep things simple when getting a rental property ready for lease. Paint interior walls using a premixed factory flat paint. Replace carpet if worn. Choose upgrade improvements carefully. And, most importantly, make sure you price home competitively. We recommend being the price leader. Tenants want a good clean home, in a good neighborhood at the very best price. Follow these guidelines, and you will lower you overall cost of ownership and lease your home quickly.

If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Will A Swimming Pool Increase My Home’s Value?

Adding a swimming pool can increase the value of your home and make home for saleable. However, like most upgrades, sellers most likely won’t capture the entire cost of adding a swimming pool.

In my experience, there are usually three profiles of buyers looking at homes with swimming pools. Some buyers specifically want a home with a swimming pool and make this an important factor in their home search. Other buyers will not consider a home with a pool due to cost of maintenance and or fear of liability if they have small children. The most common buyer may not be looking for a home with a pool in a home search but end up choosing a home because it has a swimming pool. So, the swimming pool can be a feature that sells the home. In this scenario, a buyer chooses the home with a pool because it stood out from other properties.

Higher priced homes have a better chance in recovering the cost of adding a swimming pool. In fact, if many homes in a subdivision have a swimming pool, it can be a real advantage for the seller. Homes in these neighborhoods without a pool may actually be at a disadvantage when competing with other listings that have swimming pools.

Resale values will also be higher for pools in subdivisions where there are many pools. When appraising a home, the appraiser will search sold comps for homes with swimming pools in the subdivision. If there are multiple sold comps with pools, seller most likely will capture most of the cost of adding a pool. It becomes more difficult to capture the cost of adding a pool in neighborhoods where there are few or no homes that have sold with swimming pools. Most appraisers will use sold comps within 90 days and no more than 180 days. If there are no sold comps with swimming pools, Fannie Mae will only credit seller about 25% of the pool cost. So, if the seller paid $40,000 for a new swimming pool, the appraiser most likely will add a $10,000 adjustment to each sold comp.

In summary, adding a swimming pool should not be considered an investment. Adding a pool will make the property more saleable and most likely will help owner sell property quickly. However, only higher end homes will capture a large percentage of the cost of adding a pool assuming there are sold comps in the neighborhood with pools. More importantly, a swimming pool will provide many years of entertainment, relaxation, and an enhanced lifestyle. These benefits are more important than recovering the cost of adding a swimming pool.

If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Tenants Behind on Rent? Consider A Lease Modification

It can be challenging working with tenants and collecting rent. Many times an unexpected car repair or medical bill will come up. Or, a tenant may lose his or her job and lose income for a month. This can make is extra difficult for tenants to get caught up in paying rent. Most tenants will have a hard time paying the next month’s rent plus a month in arrears. In these situations, we have considered a lease modification for qualified tenants.

There are a couple of modifications we consider for tenants who had a temporary loss of income. The first option is to draft a new lease and modify the monthly rent. If tenants have a $1,200 balance, we may increase the rent by $100 for a 12 month lease or $66.67 an 18 month lease. These are just sample examples. The lease modification will allow the tenants to pay the balance off over the term of the new lease. This is a much better alternative than evicting a tenant. Assuming the loss of income was a one-time occurrence, this can really be good solution for a tenant who has paid rent in the past. The tenant is also more likely to remain in the property and become a long term tenant. If the tenant is constantly late, this would not be a good solution. Instead, we would only allow the balance to be paid over a few months to avoid eviction proceedings.

We also run into situations where the tenants have a hard time paying rent the beginning of the month. The monthly rent may be a large portion of a single pay check, and this leaves little room for unexpected expenses. Many tenants don’t have a credit card to pay for these expenses and have little choice but to use a portion of rent funds. We have offered bi-weekly rent payment options, and we charge tenants every two weeks, or 26 payments per year. If the monthly rent is $1,000 per month, we charge the tenants $500 ever two weeks on a corresponding payroll date.

You would be surprised how many tenants will opt for paying rent bi-weekly. It can be a win-win scenario for both landlord and tenant. The landlord receives more rent than a monthly lease payment (26 payments per year), and the tenants are better able to manage their finances by paying rent when they are actually paid. It may be more costly, but it is a better solution for their family.

There are other options such as processing rents by credit card, check by phone, and bank draft. These are services we offer our tenants. Many times family members will call our office and pay by credit card or check by phone. This is one of the advantages of using a professional Austin Property Management company to manage your property. Offering a wide variety of payment services helps us collect rents in a timely manner and many times avoid loss of rent and eviction process.

If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Profitable Tenants

austinprofitpuzzleThe screening process is a very important in considering a prospective tenant application. We do pull credit reports for all applicants. However, a credit report is just one metric we use when screening a tenant application. We obtain recent paystubs, pull a criminal background check, and verify rental history. A low fico score does not tell me if a tenant will take care of a property or lose his or her job in the future. So, what is the most desirable or profitable tenant?

The most profitable tenants have good jobs, work hard to provide for their families, take care of the property, and stay in the property a long time. One of the advantages of a single family residence property versus a multi-family unit is many tenants stay in a home much longer. Because it is cheaper to rent than purchase in most situations, tenants can live in an expensive neighborhood that they otherwise could not afford. Renting in a nicer neighborhood provides a high quality of life for their family. Hence, many tenants will stay in a home for years.

High fico score tenants can actually cost owners the most. Most high fico score tenants pay their rent on time but are not immune from job losses and layoffs. We rarely have a 680 plus fico score tenant occupy a property for more than 1-2 years. This results in frequent turnover costs. Anytime we turn a property, most landlords will lose a month of rent just in paying leasing, rekey, and make ready costs. This assumes there is no extended vacancy period or damages. Vacancy and turnover costs are usually the most costly expenses in leasing and managing rental properties. It is cheaper to replace carpet and paint interior walls for a property occupied by a tenant for four years than to turn property yearly and pay turnover and vacancy costs.

We have some tenants who have occupied and rented the same homes for six or more years. They have no plans to purchase a home, have poor credit, and cannot qualify for a mortgage. Sometimes we do have a problem if their car breaks down or they have a medical bill, but most of the time we are able to work things out.

The current housing crisis is a reminder that home ownership is not for everyone. Millions of owners are upside down because they put little money down, lost their job, or could qualify only with an interest only or adjustable rate mortgage. It is much easier and less costly for a tenant to pay a reletting fee and breach a lease than sell a home with negative equity in a poor market. Home ownership resulting in foreclosure has damaged many home owners’ credit. Renting may have been a better alternative for these homeowners.

The good news is that the current housing crisis could be very profitable for long term professional landlords. Interest rates most likely will likely increase in near future, and inflation may also increase as our government increases its debt and deficit. Rental property could be a great hedge against inflation. I am hoping rents increase as the pool of renters increase and the percentage of home owners decrease. Maybe the mortgage crisis will result in higher rents and profits for landlords.

In summary, I advise landlords to look more closely at each application. A 550 fico score tenant with long term steady employment and good rental history may be less costly than a high fico score tenant. A landlord can also ask for a higher security deposit for tenants with a low credit score. We manage over 300 properties and have a very low percentage eviction rate. Less than 2% of our leases agreements resulted in eviction proceedings last year, and most of the tenants lost their job and income stream.

If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Should I Payoff Credit Cards Before Buying a Home?

payoff_credit_cardsSometimes sound financial strategies can be counter-productive to borrowers in qualifying for a mortgage. I often have future home buyers ask me if they should payoff credit cards before purchasing a home. In many cases, this can actually disqualify the borrower(s) from qualifying for a mortgage.

Lenders qualify borrowers based on gross income and monthly debt obligations. Lenders consider two debt ratios. A house ratio is calculated by taking the actual mortgage payment and dividing by gross income. Total debt ratio adds other minimum debt payments to the mortgage payment and divides by gross income. As a general guideline, a mortgage payment should not exceed 28% of gross income, and total monthly debts including mortgage payment should not exceed 36% of gross income.

What counts as debt and income? Lenders consider guaranteed income or monthly gross income for W2 employee wage earners. A weekly salary and 40 hour work week are examples of income. Overtime, bonuses, and commission can be added as income, but only if applicant has a two year history. Self employed borrowers must provide two years of tax returns, and the net profit average will be considered as income. Lenders count monthly installment and revolving debt payments on a credit report including car payments, student loans, minimum credit card payments, and child support. For revolving debt, lenders count only the minimum monthly payment. Insurance payments, utility payments, living expenses, and voluntary 401K deductions are not deducted or considered in calculating debt ratios.

Let’s look at a sample scenario for a married couple. One spouse has a $35,000 yearly salary, and the other spouse makes $40,000. Total income is $75,000 per year, or $6,250 per month. Based on this scenario, the couple can afford a mortgage payment up to $1,750 per month (28%), and other monthly debt payments should not exceed $500 per month (36%).

Below is summary:

Gross Income-                $6,250 X 28% = $1,750
Gross Income-                $6,250 X 8% = $ 500
Total Debt Ratios-          36% = $2,250

In this situation, the lender allows $500 of monthly debt to be added to the mortgage payment. Let’s assume borrowers have a car payment of $300 and several credit cards with minimum payments adding up to $200. Allocating thousands of dollars to payoff the credit cards will not help the borrowers in this situation. In fact, it may exhaust the borrowers’ down payment and disqualify them from buying a home. If the borrowers purchase a home with a $1,500 mortgage payment, they can have up to $750 in other monthly debt payments. The total debt including mortgage should not exceed 36% of gross income, or $2,250 per month. If the borrowers have zero debt, they still are limited to the 28% house ratio or $1,750 per month. Paying off all debt does not increase the house ratio allowance.

Borrowers must put down a minimum of 3.5% when applying for an FHA mortgage and 5% for a conventional mortgage. Some loans also require borrowers to have 3-6 months reserves in addition to down payment, closing costs, and prepaid expenses. See my blog article regarding gifts and seller concessions.

As you can see, it is important to do your homework. It may be necessary to pay down debt to qualify for a mortgage. However, you must balance paying off debt and maintaining adequate funds for down payment, closing costs, and monthly reserves. In most circumstances, the seller can provide an allowance towards your closing costs and lenders will considered an IRA or 401K for monthly reserves, but only 60% of vested balance.

Make sure you don’t spend your down payment and reserves. If you have any questions, please call us at 512-257-9836. Our office provides sales, leasing, property management, and mortgage services.

Understanding Depreciation Expense for Investment Properties

The IRS allows generous tax deductions for business owners and landlords. Unlike an employee, a business owner generates revenue and pays income taxes AFTER deducting business expenses. Business owners pay income taxes on net income, while employees have income taxes deducted from gross income. Employees receive remaining funds after taxes are deducted. Landlords are similar to businesses. They collect rent and pay income taxes after expenses. One of the best deductions for investors is depreciation expense. Depreciation is a very powerful tool for lowering taxes and building wealth.

Depreciation expense is a very unique deduction for investors and landlords. Real estate is the only type of asset that can be depreciated, but is an APPRECIATING asset. Most businesses depreciate capital equipment over the life of the asset. For example, a company truck may be depreciated over five years. If the vehicle costs $50,000, the business expenses $10,000 deduction yearly for five years. After five years, the truck is fully expensed and has a remaining salvage value. The value is substantially less than what the owner paid for the asset. However, real estate in most situations is an appreciating long term asset.

Landlords can depreciate the improvement portion of the property over 27.5 years for a residential rental property and 39 years for commercial property. Improvement is the total value of the property minus the cost of land. For example, if an investor purchases a rental property for $150,000, and the land has a value of $25,000, the amount allowed for depreciation is $125,000 ($150,000 – $25,000 = $125,000). The yearly depreciation expense in the above scenario is $4,545 per year ($125,000 / 27.5 = $4,545.45).

Landlords can deduct interest, property taxes, maintenance and repairs, property taxes, hazard insurance, mortgage insurance (if applicable), management fees, leasing fees and depreciation expense. The only expense a landlord cannot write off against rental income is monthly principle payment. The depreciation expense is added to the other expenses incurred by landlord. However, you don’t actually cut a check for the depreciation expense. It is known as a phantom expense. The $4,545 expense is added to interest, property taxes, insurance, repairs, etc.

Below is a year one scenario assuming a purchase price of $150,000, 80LTV, interest rate of 6.25%, tax rate of 2.5%, and $1,000 in repairs and maintenance, and $1,100 in monthly rent.

 Monthly                                Yearly Deduction

Principle Pmt                 $117.18                                   NA
Interest Pmt                   $621.68                                   $7,460.16
Hazard Insurance           $50                                         $600
Property Taxes               $312.50                                  $3,750
Repairs                           $83.33                                    $1,000
Totals                             $1,184.69                               $12,810.16
Rent                                $1,100                                    $13,200

Yearly Gain/Loss                                  $389.84
Depreciation Expense                         <$4,545.45>
Loss after Depreciation                      <$4,155.61>

As you can see, the landlord actually realized a gain of $389.84 before using the depreciation expense. Again this is a phantom expense. The investor did not write a check for the depreciation expense. It was simply added to all other rental expenses. Now the property will show a loss of $4,155.61 and can be deducted from ordinary income assuming investor’s adjusted gross income does not exceed $100,000.

The IRS allows individuals to deduct up to $25,000 in real estate losses (not from sales transaction) against ordinary income. If an investor owned six properties with similar deductions, they could write off $24,933.69 against ordinary income. Once the adjusted gross income exceeds $100,000, the IRS reduces the amount over $100,000 by 50% and deducts this amount from the loss. For example, if an investor has an adjusted gross income of $110,000, he or she would only be allowed to incur a maximum $5,000 loss against ordinary income ($110K – $100K = $10K x 50% = $5,000). After $150,000, the deduction is completely phased out. Any losses not incurred can be rolled over to the following year(s).

Lender Requirements for Purchasing Rental Property

It is getting harder and harder to qualify for an investment property mortgage. Mortgage insurance is no longer offered, and borrowers must put a minimum 20%-25% down to purchase a non owner occupied investment property. Lenders add risk factors to mortgage interest rates based on borrower’s fico score, type of property (SFR, duplex, 4plex), down payment percentage, and type of occupancy (primary residence, second home, or non owner occupied investment property). Additional liquid cash reserves are also required for an investment property mortgage, and total debt ratios must not exceed 45% of gross income.

Borrowers must have a minimum 740 fico score to get the best conventional interest rate. The risk factor for a non owner occupied 80LTV single family residence (SFR) mortgage adds three discount points to a par rate. What does this mean? A borrower must pay an additional three discount points in order to have the same rate as a primary residence. A discount point is equal to one percent of the loan amount.

If investor purchases a $125,000 rental property and puts 20% down, the loan amount would be $100,000 ($125K x .80). The borrower would pay three discount points, or $3,000 to get the same rate as if they were purchasing a primary residence property. This translates into an interest rate that is almost 1% higher. So, if the rate for an owner occupied property is 5%, the rate for an 80LTV SFR investment property mortgage would be about 6%.

The risk factor drops to 1.75 discount points if a borrower puts an additional 5% down and obtains a 75LTV SFR investment mortgage. Paying an additional 5% down payment will save about .5% on the mortgage interest rate. An investor would pay a mortgage rate only .5% higher than a primary residence with a 75LTV SFR mortgage. Putting 25% instead of 20% will drop rate .5% and increase the ability for the property to cash flow.

Lenders add a risk factor for the type of property being purchased. The above mentioned risk factors are for single family resident properties. Most lenders will require a minimum 75LTV for a multi-family property such as a duplex or 4plex. Borrowers must put a minimum of 25% down to purchase a duplex or 4plex. Lenders add an additional 1.0 risk factor for a multifamily property. In a 75LTV scenario for purchasing a 4plex, the borrower will pay a 1.75 risk factor (same as SFR) plus a 1.00 risk factor for a multi-family property. In this scenario, the total discount points add to 2.75%, similar to an 80LTV SFR property which adds 3.00 discount points.

Current landlords looking to refinance their current investment property can apply for a 75LTV rate/term mortgage. Landlords will need close to 30% equity in property to roll in closing costs. Closing costs can be added to new mortgage, assuming appraisal supports a 75LTV scenario. For example, if borrower owes $100,000, and closing costs are $4,000, the appraisal must come in at $138,667 ($104,000 / .75 = $138,667). Any appraisal shortage must be paid by borrower at closing. So, if appraisal comes in at $136,000, borrower must pay the difference of $2,677 at closing. For landlords who have 1-2 years experience owning rental property, the lender will count 75% of the rental income, but total debt ratios must not exceed 45%.

In addition to type of property and type of occupancy, lenders add a risk factor for borrower’s FICO credit score. The credit risk factor is added to the type of occupancy and type of property risk factors. For example, a fico score of 680-700 adds a risk factor or 1.00, and a fico score in the 660-679 range adds a risk factor of 2.0. As you can see, a borrower with a lower fico score can pay 1.75-4.00 discount points to purchase an investment property.

Six months of liquid reserves are required for investment properties. Six months reserves equal 6 times the monthly mortgage payment (PITI- principle/interest, property taxes, and insurance). If the mortgage payment is $1,200 per month, borrower must have and additional $7,200 in checking or savings account (liquid). An IRA or 401K may not be considered as reserves for investment property.

We are a full service real estate company offering sales, leasing, property management, and mortgage services. If you have any questions about debt ratios, fico score, refinance scenarios, or market value, please call our office at 512-257-9836.

Converting Your Primary Residence To An Investment Property

Lenders have continued to require stricter guidelines to obtain a mortgage. Gone are stated income products. Most lenders require income to be fully documented via pay stubs for employees or tax returns for self- employed applicants. Fico score requirements have increased. Now lenders have changed the guidelines for converting your primary residence into an investment property.

In a soft real estate market, many buyers seeking to purchase a new home were not able to sell their existing home. Many owners did not have enough equity to cover closing costs or commissions, so they opted to lease their home and sell in the future when home prices appreciated. In the past, the homeowners simply provided a signed lease for their home, and the lender would count 75% of the rental income towards total debt ratios of new mortgage and home.

Lenders have changed the rules for converting your primary residence into a rental/investment property. In order to count the rental income of the converted property, the borrower must have documented equity of at least 30% (appraisal value minus outstanding liens) in the existing home based on a full appraisal. The rental income must be documented with a fully executed lease and receipt of the security deposit from tenant and deposit into borrower’s account. Rental income cannot be used if 30% equity cannot be documented or if the LTV on the proposed mortgage is greater than 80%. Borrower must also have 6 months of PITI reserves for both properties.

If borrowers do not meet the qualifications, they will have to fully qualify for both mortgages and won’t be able to count rental income. Lenders just recently lowered the total debt ratio to 45% for conventional mortgages. For example, if a borrower(s) has gross income of $10,000 per month, the total monthly debt payments including mortgage (PITI) for current home, mortgage for new purchase, car payments, student loans, and minimum credit card payments may not exceed $4,500 per month (45% times gross monthly income). This will make it extremely challenging for many borrowers to qualify in purchasing a second home. Many home owners will be forced to sell their home first, because they won’t be able to cover the debt ratios for their current debt and two mortgages.

Home Repair Costs are Rising for Investors and Homeowners

Home repairs have steadily increased the past few years. For properties less than seven years old, I recommend usually use a factor of 5%-7% for normal wear and tear repairs. To calculate yearly costs, simply multiply your monthly rent by 5%-7% and multiply X 12 months. For multi-family units, I would use a factor of 10%, and 7%-10% for homes older than 10 years old. These are average normal wear and tear estimate costs and do not include vacancy periods, damages, water penetration issues, or expensive a/c and plumbing repairs.

The most common normal wear and tear repair items are fence repairs, leaking faucets, faucet and bathtub cartridge replacement, minor plumbing blockages and repairs, minor appliance repairs, garbage disposal replacement, basic a/c services, garage door maintenance, etc. Most of these repairs can be completed for less than $300.

Code changes have made plumbing repairs more expensive. Seven years ago, we could replace a hot water heater for about $400-$500. The City of Austin code requires a permit and drain pan system when installing a new hot water heater (unless system has existing pan). Due to weight, removing and replacing a hot water requires two technicians. The technicians have to drain tank, remove, install, bring hot water heater up to code (install drain pan system), and take to dump and pay dump fee. Now, it costs anywhere from $900-$1,200. The cost of a hot water heater alone is about $400-$500. Units in attic area are the most expensive to replace, because the attic stairs need to be removed to make room for the new hot water heater.

A/C systems have especially been affected by recent green laws. Many homes and multi-family units have less efficient a/c systems with a SEER rating of 10 or less. SEER stands for “Seasonal Energy Efficiency Ratio” and is a measure of the energy efficiency of the air conditioning unit. Units with a 12 SEER rating or below are no longer manufactured. Hence, instead of replacing a 10 SEER a/c condensing unit for $800, it now costs a minimum of $1,200-$1,300 to replace with a new 13 SEER unit. The cost is higher for larger units. The costs of replacing a more efficient coil, furnace, air handler, condensing unit, and replacement parts have increased about 40% to meet new energy efficient requirements.

Water penetration problems are also expensive repairs. If a leaking hot water heater or toilet floods an area of a home, we have to extract the water, setup fans and dehumidifier unit(s) to prevent mold and dry area, remove wet carpet padding and sometimes baseboards. These repairs can range from $400 to over $2,000 if water is extracted in multiple rooms. This does not include the damage to wood flooring, carpet, cabinets, baseboards, or sheetrock repairs.

Non wear and tear repairs include tenant damages, vacancy costs, and make ready costs. Carpet may last five years, and most homes need exterior painting every 5-7 years. I recommend landlords set aside at least 2-3 months of rent in a savings account to pay for unexpected repairs, make ready items, and or vacancy periods.

If you plan on being a long term landlord, please budget and plan for these items. Hot water heaters may last 7-10 years. A/C systems should last 10-12 years or more. However, we have replaced many coils and condensing units less than 10 years old, and most a/c systems only have a five year parts only replacement warranty.

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