You can buy a rental home with a 20% down payment, but the mortgage rate is significantly better with a 25% down payment; the difference between the two scenarios is about .25% in rate.
When you buy a rental property, your required monthly payment will be the loan payment plus taxes and insurance, but a prudent owner also accounts for repairs, maintenance and vacancy, at a minimum. To have some numbers to talk about, I’ll assume that you can buy a $250,000 home with a down payment of $62,500 (25%). You can expect a rate of about 5.5% for a 30-year fixed rate mortgage. Your monthly payment will look something like this:
You should consider other expenses apart from the mortgage. Do landlords customarily pay for water and garbage in your area? Should you pay for a gardener to make sure the landscaping doesn’t go to seed because your tenant is not as concerned as you would be as the owner? Let’s assume a total expense load of $200 a month. It might not be that much every month, but there could be months requiring more expenditures. Now your expense picture looks like this:
You suggest “renting it out for the mortgage plus some.” While that is certainly possible, the rental rate is something the market decides, not the landlord. While you might like to get $1,750 a month, houses similar to yours may rent for only $1,400.
Income producing real estate generates profit in two ways: current cash flow, and profit on the sale. Let’s assume for the moment that you can rent your $250,000 house for $1,600, so it breaks even each month. Now you are hoping to sell the property in the future to make your profit. For this illustration, we’ll stipulate that your closing costs (title, escrow, lender fees, etc.) amount to $6,000, so your initial investment was $68,500. We’ll also assume that real estate agents in your area charge a 6% commission to list and sell a property.
Now the determining factor will be the appreciation rate in your area. At some point in the future, you’ll find a buyer for a price high enough to recover your initial investment, pay off the existing loan and real estate commissions, and put some money in your pocket.
Let’s start with an appreciation rate of 4%:
You hit a break-even point just a bit after two years. In three years, with net proceeds of $78,856, you’d recover your initial investment and make a profit of $10,356. That’s a rate of return of 4.80% per year. if you held on for five years, your annualized rate of return would go up to 9.24%
What if the rate of appreciation turned out to be less, like, 2.5% on average? Now it looks like this:
Now you reach break-even in about three years. Your five-year annualized rate of return would be 4.78%. Being a landlord can be a lot of work, and I wouldn’t suggest taking the leap with that low of a Return on Investment. Most professional real estate investors won’t even get out of bed for less than 12%.
One more scenario, so you don’t get all depressed with these realities. What if we enjoyed a sustained appreciation rate of 6% a year? Okay:
Now we’re talking! A tasty profit in two years, and a rate of return after five years of 14.55%!
But here’s the thing: you should not go into any investment—especially rental real estate—expecting things to go your way every time. While a 6% rate of appreciation has certainly happened in the past—and some states like California for example, have seen some mind-bogglingly high rates of appreciation at times—it is not prudent to base an entire investment strategy on a too-rosy projection.
When you consider a real estate investment, be driven by the market data, not your hopes. Include contingencies—like unforeseen vacancies or appliances needing replacement—in your plans. You should have a keen awareness of the market rents for the type of property you are considering.
I realize that I didn’t answer your question directly. It’s not really possible to give you such an answer. But now, hopefully, you have a better idea how to arrive at your own answer, for your own circumstances.