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I've an interesting dilemma that will occur in a few years. My wife and I are currently overpaying our mortgage and will be mortgage free by the age of 35. We are also already putting away some money for retirement and have an emergency fund established.

Our plan has always been to continue paying the equivalent of the mortgage payments into an investment account and then use this money to either move to a bigger house later in life, or to retire earlier. This is straightforward and we should be able to retire with modest but decent pensions, plus some cash for travelling and enjoying life.

However, driving home from work I had a second idea. We could rent out our current house (which will have no mortgage) and use this rent money, less an amount to cover expenses, to overpay on a second mortgage. On the one hand, this means that the rent money is helping to pay for a second house, with none of the usual rental risk that the house sits empty whilst still needing mortgage payments. In effect, someone else is helping to pay towards your mortgage. On the other hand, it's a lot more effort than simply investing into a Vanguard LifeStrategy or similar every month and much harder to liquidate a house into cash.

I'd like to think about this now, so we can start putting money towards the deposit on a second house if we decide to go that way.

I know that a definitive answer needs some figures, which I will calculate at some point in the future, but I wondered if anyone had any general advice in this situation, or anything obvious I'm missing?

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    Would you be comfortable with having more than 100% of your net worth tied up in real estate for quite a while? i.e. zero diversification? – Chris W. Rea Feb 5 at 22:58
  • Dave Ramsey made most of his millions (both before his bankruptcy that led to him becoming the debt recovery guru, and after getting back on his feet financially) doing just this. His first advice is to invest only cash (never borrowed money) you can afford to lose, because the odds are that eventually some deal will go sour and if you borrow you are still on the hook for the balance. – pojo-guy Feb 7 at 3:21
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I can't speak for the UK, but renting a house in the US is effectively a part-time job. There are management companies that can take care of most of this burden, but they generally cost about 10-15% of the rent, plus you'll need to pay for any maintenance or other expenses (meaning the 10% just covers their time dealing with hassles). Those fees eat into your returns.

But yes, renting real estate can be a good source of income. My suggestion, though, would be to NOT use this income to pay your current mortgage, but instead keep it aside and either invest it separately or save up for a second rental once you have enough to buy one for cash (assuming you like being a landlord :-) ). If you use the returns from the rental, your returns do not compound, since they are "eaten" by your living expenses, and you add the risk that if your house goes unrented for a long period, you won't be able to pay your current mortgage. If you simply set it aside, you can let the house go unrented until you find a good renter, and the only thing you lose is that portion of your returns. A bad renter can cost much more than a few months of lost rent.

  • Thanks for the advice. I have to admit the compounding effect had slipped my mind, so while it may be better early on to have someone else pay your mortgage, in later years the returns from investments would outstrip this. I'm definitely leaning towards passive investing, especially given that it is much less hassle – Jon Feb 6 at 7:56
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    @Jon It's not a terrible idea, but it's not an apples-to-apples comparison with equity investing (unless you also pay your mortgage out of the passive investment) – D Stanley Feb 6 at 14:09
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Robert Allen has written volumes on exactly this subject - developing a business of real estate rentals. You can actually retire early doing this.

It's difficult to advise further, for a couple of reasons. First, markets are so localized. Bubble cities like New York or San Francisco are very dangerous places to get into this sort of thing. However, many other places with an intersection of "sane housing prices" and "decent people often rent" are great places to get into that.

Second, I believe we are in the middle of a housing bubble, and you definitely, definitely, definitely want to time the market. Buy when there are 10 for sale signs on every block and tradesmen will deep discount for lack of work.

Speaking of that, if you are planning to rent your current home, get it absolutely tip-top in terms of the work you are able to do. Once it becomes a rental unit, you are required to hire licensed tradesmen to do many jobs.

  • Thank you for the advice. Good point regarding working on the house, I'd not considered this. – Jon Feb 6 at 7:56
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    I don't think the comment about licensed tradesmen applies to the UK, though you do have to get certain safety certifications renewed regularly (but that's prudent even if you're an owner-occupier, if you value your safety!) – Ganesh Sittampalam Feb 7 at 10:57
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This is a good idea on paper, and can lead to a good investment, as long as you are willing to work on the house and dealing with tenants.

  1. get rent guarantee insurance
  2. Make sure you have a good contract (AST are the norm)

Also in recent years the UK government have changed quite a few of the tax rules around rental income for non company landlords.

  1. Larger Stamp Duty - 3% on second house purchase, this adds an additional cost to entry.
  2. Finance costs are not counted as an expense, they do offer relief but only to a maximum of 20%, I assume since you are nearly mortgage free you are a 40% tax rate payer.

Let me explain number 2 in a simplified way. Old way:

10000 rent 4000 interest 6000 - profit

Tax is due on the 6000 profit from the house. so for a 40% tax payer that would be 2400.

New way

10000 - rent 4000 - interest

Tax is due on the 10000 income, so for 40% tax payer would be 4000.

Finance Relief 1200.

total tax due 2800.

So Tax has increased, this also has a knock on effect to the total income in a year. Pre changes it would be +6000 to income, after the changes it would be +10000 per year, this can affect a multitude of other benefits, that you might be entitled to.

Child Benefit, this tapers out between 50000 and 60000, you can claim but have to repay it. Personal Allowance, this is removed gradually at 100000, the income from property is counted on this, also income from other non ISA wrapped investments.

  1. Capital gains tax, The UK government reduced the headline rate of capital gains tax to 20%, however of sales of residential property there is a 8% surcharge, so it did not change, this is something to also consider.
  • Thanks for the comment on tax. And my wife and I are both 20% tax payers (albeit at the higher end), we've just budgeted as much as possible to get rid of the mortgage early. – Jon Feb 7 at 12:35
  • @Jon So if you each earned an extra 5K this might push you into that threashold. depending on how you split the income, you also might be able to avoid the 3% by putting one house in each persons name. Then you need to consider the extra fees of a buy to let mortgage as they are rarely as competitive as residential mortgages, unless you own it out right that is. – JamesD Feb 7 at 14:52
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It depends on how risk-averse you are really.

Renting out a property is risky for a number of reasons, the house could be empty, the tenant could damage the house, not pay the rent etc. You can insure against this but obviously this reduces your income. Some tenants are easy to manage, some difficult.

I don't know your specific circumstances but I would suggest looking around and doing some research into maximising your yield from the rental property(s).

Let's say, for arguments sake, that your house is worth £300,000 and the rental income is £1,200 a month, that works out at a yield of 4.8%

You will easily beat that if you buy a property in an area that has cheap housing, for example it's possible to buy a perfectly serviceable house in the North of England for around £40k, rental is likely to be around £400 a month and that is a yield of over 10%.

Other risks are mortgage rates increasing, negative equity, house prices falling etc.

If you don't like risk, don't do it, your investment may be less risky.

My gut feeling is you will do better if you go down the buy to let route but there is more work involved (not necessarily a lot of work) especially if you are looking at a long-term investment.

I am not a financial advisor but I do own a rental property myself.

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