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My wife and I are looking to purchase a home in the near future. With this in mind I am curious about how we should now look at our emergency fund situation. The general guideline you will see is for 6 to 12 months in liquid assets to cover living expenses.

We intend to keep our first home for rental purposes. We just found out from lenders that we have talked to, that we must meet the following criteria for a mortgage:

  1. We MUST put 20% down
  2. We MUST have 6 months of payments for our current residence AND the new residence (including taxes, insurance, and mortgage)

With that in mind we will have to replenish our emergency fund -- luckily due to the loan requirements we will be covered as far as housing costs go. What new expenses should we take into account since we will have a rental property? Do we simply follow the same guideline, and dip into the fund if a repair is needed or do we need to add in things like the refrigerator or dishwasher dying?

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Don't forget most retirement accounts allow you to take a 'loan' out of them to pay for things you need. One of the most common reasons for doing so is to get that down payment, which can be paid back (to yourself) over a long period of time. This would keep your emergency fund intact, and be using pre-tax dollars to put down on your house instead. –  Neal Tibrewala Feb 6 '12 at 4:35
    
A lot of good answers here. Luckily the unit we will not need to worry about the roof or any outdoor maintenance of the unit as it is the responsibility of the HoA, but those are good things to consider for others who may need similar advice. –  Scott Feb 7 '12 at 14:09

3 Answers 3

up vote 8 down vote accepted

Yes you will need an emergency fund for the rental. Besides appliances, or a roof, that might need to be replaced, you will also have to protect against being unable to rent the unit.

Another risk is that you may have a tenant damage the unit. While you can get the money through the courts it may take months or longer. You can't wait for the money before you repair the unit.

Keeping the rental unit funds separate from the rest of your funds will allow you to make sure you are adequately protecting yourself.

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"you will also have to protect against being unable to rent the unit". Exactly what I was about to post. This is a huge danger area for the budgeting these folks are doing and must be accounted for. –  gef05 Feb 4 '12 at 18:08

This comment is too long to put in comments. Sorry.

I suggest you also do a dry run of your taxes with the rental as part of it. When you rent a house, you take depreciation each year. This means that even if you are breaking even, the rent paying the mortgage, property tax, etc, you may still show a "tax loss." In which case, planning and knowing this, might suggest you adjust your withholding so instead of a large refund, you get better cash flow each month.

Also, pull a copy of Schedule E and the Instructions. You'll be wiser for having read them.

Last. If you have decent equity in the existing house, it may pay to refinance to save a bit there, or even pull some cash out. When you buy the new one, you want to be in the best position you can be, and not risk cutting it too close.

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A few things you might run into:

  • Keep an eye on the roof and plan accordingly.
  • It is always a good idea to plan for at least a 10% vacancy rate. ie. one month per year per unit.
  • General maintenance, upkeep (yard maintenance, painting, leave raking, etc).
  • Destructive tenants (Be sure to take your time screening potential tenants to avoid this).
  • Keep an eye on appliances, if one seems like it's on its way out be ready to replace it when the time comes.
  • Check your insurance to see how that will be affected.
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RDL, I've never heard of using a flat figure like 10% before (for vacancy rate). Real vacancy rates and average time on market (ie. official stats) would be preferable, wouldn't they? –  gef05 Feb 5 '12 at 3:07
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@gef05, yes, official stats would be preferable, especially depending on your area. 10% is just an average rule of thumb. I will add 'at least' in there to account for that. –  RDL Feb 5 '12 at 4:36

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