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Should you rent out your basement?

Mother-in-law apartments can be a great source of income or household help if done right. Here are questions to ask before installing that separate entry.

1. Do I really want to be a landlord?
Even if you rent out a unit in exchange for services, you are now a business owner with complex legal responsibilities.

"You have to keep tenants safe from everything from rickety stairs to criminal intrusions," Portman says. "It's a huge responsibility that you can quickly get into trouble with if you don't know the rules."

You can hire a property manager to help, but even then you may be called on for emergencies, particularly as you're the one on-site.

"What's your energy level in general?" Hare asks. "It's not a situation you want to get into if you never want to be bothered by anyone."

In addition to tending to the tenant's needs, you'll also have to appease the IRS with extra forms, the insurance company, the town and any other entities governing rentals, such as the homeowners association or the rental control board.

2. Is my property really up for the job?
Read through the zoning requirements yourself. Did you plan on renting out the larger portion of the house? This might not be allowed. Want to rent it out as two apartments while you're in Florida for the winter? This also could be a no-no.

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Would a planned addition be too close to the property line? Would any extra required parking spot extend beyond bounds? Would the tenant's door need to be added to the front of the house? These are often not permitted.

What about the house itself? Can the septic system handle another bathroom? Do the ceilings and walls have good sound barriers? Look around — would you be able to live with a little less privacy?

3. If I build it, will they pay?
If income is the only reason for a rental, this is obviously crucial. Check the apartment listings, visit units and talk to other landlords.

"Call (apartment-building) owners. Say, 'We're thinking of doing this. Can we come talk to you about this?'" Hare advises.

Some areas, such as high-rent cities or college towns, will keep a strong rental market for attached units. Others, such as those with heavy job losses, could experience high vacancy rates.

Compare prices to other attached apartments, which tend to be discounted 10% or more below the rent for traditional apartments, Hare says. Keep in mind, too, that homeowners typically don't raise the rent for good tenants in these types of close living situations.

4. What would it cost to build, really?
Builders say asking what a renovation might cost is like asking, "How much is a house?" There are too many possible answers. But they will cough up some very broad ranges.

The most expensive: an exterior addition needing a foundation. That's similar to adding a small house and could run $150,000 or more.

Renovating an attic and adding a new roof: Expect $100,000 or more.

Carving out living quarters from a daylight basement or above a garage is less intensive, but the costs can still climb. Requirements vary by location, but in general a separate unit must have its own kitchen or kitchenette, its own bathroom, a separate exit and only connections to the main quarters that are protected by fire-safe doors.

The kitchen and bathroom easily could cost $20,000 apiece, at the least, Hydeck says.

One thing that's consistent about costs: "It's always more than you think it's going to be," he says. "I've never had anyone say, 'Oh, that's a lot less than I thought it was going to be.' In 25 years of doing this, I've never heard anyone say that."

You'll also have to boost your insurance coverage, cover any city permitting fees and pay taxes on the income, although you can deduct the expenses, as well.

5. How could I pay for it?
Now the good news.

"It typically pays off right away, because most of the people finance the installation," Hare says, and areas with high remodeling costs typically also bring high rents.

A $60,000 loan repaid at 6% over 20 years would cost $430 a month. An $800 rental would leave you with $370 a month to cover added insurance costs and taxes.

If you're buying a home, finding one with a rental might allow you to qualify for a larger mortgage. Some banks have treated such loans as a sound investment, Hare says, and might count 75% of a property's rental income toward your mortgage payment.

However, last year Fannie Mae and Freddie Mac also increased lending fees for multifamily homes, seeing risk in relying on multiple sources of income. In short, shop around for a supportive lender.

Potential costs of illegal apartments
Clearly, many homeowners today are jumping into the “accessory dwelling unit” market. The American Apartment Owners Association reports a spike in calls recently from homeowners requesting information on their new, often unofficial (illegal) rentals: attics, basements, outbuildings and even as-is garages.

They're renting out anything "that's got a roof," says AAOA board member Jeff Cronrod. "We're in an economy where the need for cash flow is going to drive people to do some things that they wouldn't ordinarily do."

It may be tempting to skip the paperwork and hassle of getting approval on your addition, but illegal apartments can be far costlier than the income they'll generate. "It's amazing what we're aware of, what we've seen," Cronrod says. "And the litigation that can result can wipe out the property owner faster than foreclosure."

Here are some of the ways you could end up paying for trying to fly under the radar:

Fines: It's not hard to irritate the neighbors. Maybe a parking spot is taken, or a tenant comes home late and makes noise, or a neighbor just has a personal grudge against you. One phone call and the city building inspector can fine you for not having the appropriate permits or possibly violating building or zoning codes. Next, you're closed for business.
"You've got a problem there because the neighbor says, 'I don't like you and I'm going to report this,'" says Portman, the housing lawyer. "You are starting down a road that could become very uncomfortable, if not costly, later on."

Lost rent: Some pretty responsible-looking tenants can do some pretty serious damage, or simply neglect to pay the bills. (See “Landlords’ tales of nightmare tenants.”) You can evict them, sure, but if the apartment is not aboveboard, then the judge is more likely to dismantle the unit than award you any back pay.
"When you have an illegal contract, you simply can't enforce it, and that means the judge can't honor the landlord's right to receive rent," Portman says. "Even if you're completely right, you are risking the shutdown of your entire business. And a tenant who knows this can just have his way with you."

Canceled insurance: Fail to upgrade your homeowner's insurance from a single-family to a multifamily residence and you're arguably voiding your contract, giving the insurance company grounds to deny a claim. That could include costly damage to your own part of the house caused by a tenant.
"Insurance companies more and more are denying claims," says Robert Solberg, president of Campbell Solberg Associates, a New York City insurance brokerage firm. "If they can find a way to not pay for it, they will."

A second kitchen and additional residents increase risk, which costs more to insure. "You don't want to misrepresent the property," Solberg says.

Inability to screen tenants: Experienced landlords know how important it is to run a thorough background check on prospective tenants. But such checks involve sensitive personal information, and by law screening companies are supposed to provide this private data only to landlords who can prove that they are renting a unit that has been legally registered in the municipality. If you can't prove this, you may not get a thorough background check from a top-rated company.
Trouble with your current mortgage: Is your mortgage restricted to a single-family unit? "Lenders have lent on the premise that it's a home and not a rental. So you could be subject to foreclosure, which ironically is what people are trying to avoid in the first place," Cronrod says. While actual foreclosures for such violations may be rare, you could face difficulty paying your mortgage should your rental be shuttered by the city for violating city code.
Less opportunity for financing the remodel: Loans are available for renovations to create rental units, but the bank obviously needs assurance that it is legal and will generate income.
Costs at resale: If you sell the property and fail to disclose that it has an illegal unit, you could be sued and required to bring the unit up to code. The sale could even be voided, Portman says. "If I were a buyer in a situation like this and I discovered that this place is not legal, I would sue for the value of the property without this unit, which is essentially what I've got now," Portman says.