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Buy a home and rent it out

Chris Farrell Oct 12, 2010

Question: I own my own house. I am divorced with money from settlement I have in American funds and Genworth accounts. I have an inheritance of 80000.00. I was thinking of using my house to buy a house to rent to my son, as the money from the inheritance is not earning anything in saving, but I do need ready cash. I am still working but not earning very much about 17000.00 a year. I have no credit debt. Is buying a house a good investment at this time? Irene, AL

Answer: It’s possible that buying a house is a good investment at this time. After all, fixed rate 30-year mortgages are at a low 4.32% and home prices are down sharply from their 2006-2007 peak. Problem is, prices could go lower considering the trauma still hammering the housing market, from the foreclosure moratoriums to a dearth of buyers.

The real issue is whether it makes sense for you to leverage up your current home and take on the risk of owning another home and renting it out. Right now, you’re debt free. The $80,000 is a good safety net. Yet you don’t earn much and you need ready cash.

The strategy you’re considering is risky.

The way I like to think about investment risk and reward was shaped by the late Peter Bernstein, a brilliant philosopher of money and risk. He once defined his approach to investing this way: “In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches,” he said to Jason Zweig, the veteran journalist. “You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.” (I aired some thoughts and my appreciation for Bernstein on Marketplace Money after he died.)

In other words, the key investment question is this: “What is the downside? What could go wrong?” And if the unthinkable happens–like a credit crunch, a recession, a further decline in home prices–can you weather the storm? It’s a simple approach, but profound.

I’d carefully think through the downside as well as the upside before acting on this investment. As you can tell I’m concerned that it’s too much risk for you.

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