Can I Break the 20% Down Rule on My Second Home If I Do THIS?

May 19, 2023

When is it okay to break the 20% down payment rule? In this highlight, we discuss what you should be aware of if you are going to break the 20% down payment rule.

For more information, check out our free resources here.


Next up, we’ve got a question from Chad. He asks if he needs to put 20% down on his second home or upgrade home if he plans to keep his current home as a rental. It’s a juicy question.

If Chad wants to upgrade homes while keeping his current home as a rental, does the rule of putting 20% down still apply? Let’s talk through a few things first because this is a compound question. You know how they always save it for the end of the test, those word problems with multiple components? Well, that’s what this is.

The first question is about the primary residence. Should Chad sell it or turn it into a rental property? As a former tax preparer, I feel obligated to give you something to think about. There’s nothing wrong with the house hack strategy, where you live in a property and then move out, especially if it’s a duplex or quadplex. However, if it’s a traditional house, you should consider the tax implications.

One interesting aspect of the tax code is that if you live in a house for at least two out of the past five years and it’s your primary residence, the government allows you to exclude up to $250,000 for a single person or $500,000 for a married couple from capital gains when you sell it. It’s like a magic wand wiping away that amount of money tax-free. This can be a significant benefit.

Now, let’s talk about my own experience. When I moved from Georgia to Tennessee, I couldn’t sell my primary residence at the time due to the market conditions. Instead, I turned it into a rental property. However, I was aware that there’s a time limit on this strategy. If you can still meet the requirement of living in the house for two out of the last five years, there may be a balance. But if you plan to immediately buy a property to rent it out, you should consider the unique tax opportunity and weigh your options.

Now, let’s get to the core of Chad’s question. If he buys a second house, does he need to put 20% down? Well, it’s an upgrade, and I agree with that. Whenever you upgrade by moving to a new house while keeping the previous one as a rental, it’s a decision, not a necessity. And when we upgrade, we do need to adhere to the 20% down payment rule. It’s important to have equity, especially if you still have a mortgage on your primary house. You don’t want to be overly leveraged with debt.

The flexibility of putting down 3% or 5% on the first house is there to help you get started in real estate. However, if you continue using this approach for each subsequent property, you’re essentially becoming a real estate investor without establishing a solid financial foundation. Real estate investing can be great, but there’s a catch. When the market changes and you lack deep pockets, you can end up in financial trouble. So, it’s crucial to have a strong financial foundation in place.

If Chad wants to follow this strategy of turning primary residences into rental properties, he can take advantage of the 3% or 5% down payment rule for the first property. But for subsequent properties, he should carefully consider the risk and reward and avoid being overly leveraged. Making money in real estate is possible, but it’s important to understand all the elements and make informed decisions. Building your financial resources before diving into “rich people stuff” is essential. Otherwise, people can tell when you’re faking it, and the banks will notice too.

Want to know what to do with your next dollar, you need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.



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