When someone buys a home before selling their current home, they may have a problem: if they have a mortgage on the old home, that debt is included in their debt-to-income ratio.
In the old days (pre-2008), home buyers who did not sell their home first had at least a couple of ways to offset their mortgage debt.
Some lenders would accept the income reported on a rent survey prepared by a licensed appraiser. Other lenders would accept a rental agreement.
The lender would subtract 25% of the income obtained by either of these methods off the top to account for expenses and vacancy. They would then subtract out the PITI (principal, interest, taxes, and insurance). If there was a positive balance left after this calculation, it was added to the homebuyer's income. If there was a negative balance, it was added to their debts.
Most lenders still use this method to calculate the positive income or negative debt. Now, however, there is a twist. You need to be concerned with the amount of equity in the old property. In addition, more documentation is required for rental income to be included.
Fannie Mae now requires the following documentation to use rental income from a primary residence converted into a rental property:
- An executed lease agreement
- receipt from the tenant of a security deposit
- supporting documentation of deposit of the security deposit into the homebuyer's account
Do you need help structuring a loan, or getting a rate quote? Call me at (650) 222-0386, or e-mail me.
This is not an offer for extension of credit or a commitment to lend. All loans must satisfy company underwriting guidelines. Information and pricing are subject to change without notice. This is not an offer to enter into a rate lock agreement under any state law.
Great post about one of the many reasons why even today having a great credit score does not mean you qualify for a new mortgage.
Phil -
Thanks for the info. I just learned of the equity requirement yesterday. But your post went more in-depth.
I just want to be sure I understand. Are you saying the client I spoke to today, who has a home he would like to sell in California, may have difficulty purchasing in Maryland, even if he has rented the California home, even more so if he has no equity? Margaret C.
Its a complicated mortgage and loan world these days -- thanks for the post.
"It's tough out there for a pimp broker!" LOL!
By the way, thanks for the update on Fannie. I didnt know they were lowering the debt ratio.
thanks
-Nelson
Phil * I routinely scan signed leases and e-mail them to mortgage lenders when my clients refinance * I'll e-mail a copy of the fixed-term lease to a specific person (I no longer fax for security reasons)...I've never had to provide copies of the security deposit (which is LEGALLY NOT the property owner's by most state laws) and the rent check and when the mortgage co is informed the property is professionally managed, there is no issue with income verification.
They have never asked for a copy of a tenant application as that is a violation of several federal credit laws.
Does anyone see anything wrong with this picture?? I do understand having someone qualify for the loan, but some of the tighter guidelines seem to be over reaction on the part of lenders.
I ran in to this last year (guidelines just starting to tighten up) and now it is even more critical that the consumer be educated about the 2nd home buying process and what is / isn't allowed.
Phil - Good information. Consumers should be aware of the requirements if trhey decide they want to rent out their current home and buy another. I reblogged it.
Phil, I was told you also had to have a rental history on the home. This did not use to be that way, but now if you can't sell and need to move, the only way to count that as a rental was to have a history of renting that home.
Was I told right?
Excellent post.
most folks have not thought about this. All due to buy and bail.
Have a great day
Tony
Phil,
Congrats on the featured post!! I agree these rules are making more difficult for many otherwise strong borrowers to buy another home. Where applicable the buyers can use the FHA loan which isn't nearly so burdensome.
All the best,
Mike
Hi Phil-
Great feature! Nothing is a simple as it used to be and although that may be inconvenient, we need the right information in order to assist our clients with their decisions. Personally, I wouldn't be a fan of renting out a home to buy another if the client has less than about 50% equity (conservatively), as it just increases the risk factor to them. Of course, it's their decision.
--Sara in San Antonio
Phil-FHA lenders are now requiring that the borrower have at least a 25% equity stake in the property they will now be renting. I sympathize with this tightened requirement because too many lendrs have been burned by the buy and bail strategy you described.
Now borrowers will need tp pay for two appraisals. One for the property they are buying and another on their current property to prove they have the equity.
Jon and Joel - thanks for the comments.
Margaret - If he is going to rent his current home, he must have 30% equity in that home to use that rental income to offset the PITI.
Bob & Carolin - thanks for the comment.
Nelson - yes, the lower debt ratio is now in effect. Credit is tightening, not good news for homeowners and homebuyers, especially in the economy we have now.
Wallace - I'm not quite sure what your point is - can you expand?
Barbara - I have had the exact same thoughts. I think there is a lack of cohesion in the different departments of the government, and this paradox is the result.
Kris - I agree. I wrote this post because I have a transaction I am involved in right now with this issue. I don't think many in our industry (real estate agents and lenders) are aware of this until they run into it. I admit, I didn't until I got involved in this transaction.
Lew - thanks for the re-blog.
Missy - I have heard something similar - I am going to check on this.
Tony - thanks for the comment.
Mike - Good to hear your voice yesterday - thanks for the comment.
Sara - In this market I think it's especially important for real estate agents to be aware of new underwriting guidelines. Knowing these guidelines can save a lot of time and headaches.
Paul - I wonder if we have to wait three days after application to order the current home appraisal because of HVCC?
Becoming a landlord on rental property is not for everyone. What's the motive for doing a rental on a homeowner's current home? Unless you really want the current property to become a long-term rental I would not recommend it. I've heard many sellers say if I can't sell it for xxx amount of dollars I'll just rent it til the market value goes back up. That could be years and being a landlord has it's own set of potential problems.
Linda Metallo, Re/max Impact, Lockport, Il.
Phil,
This is some powerful stuff - I kind of new this but did not have a full understanding.
What I did not know is the reduction of debt - this will really hurt, won't it?
I think I am going to go ahead and reblog this.
Merry Christmas,
John
Hi Phil -- I think it's just a plain bad deal fraught with risk and consumers need to take a hard look at the risks, there are so many risks already inherent in today's market, adding another self-induced one doesn't make sense in this case, unless the new home is like no other. That hardly ever happens.
Referring to pre-2008 as 'the old days' - just goes to show how fast things are changing. Thanks for helping us keep up!
Great information! Thanks! :)
Phil, Great information. I handle a lot of executive leasing in Atlanta. I pretty much tell folks outright, please sell your first home before you buy a second home, unless you are buying with all cash or own the current home for all cash. I do think if you are in great financial position, there is a decent opportunity to buy a new home, lease the old one and sell that when the market improves. There is no guarantee about this, so it's only if you are in great financial shape. On the flip side, I've help a number of folks and companies lease homes out that weren't selling, so they didn't lose a whole year of cash flow in a market that was difficult to sell. Thanks for the good info about mortgages. All the best, Michelle
Thanks for keeping us up to date on these changes, everything happens so quick. By the time I learn about one change it's different again!
This is good information to have with so many sellers thinking they can just rent their home. There's always a new twist with lending requirements. It's incumbent on agents to keep clients as informed as possible about how these types of things can impact their transactions.
All the more reason to get your client's home under agreement right away if they intend to repurchase using the $6,500 home buyer credit by April 30.
Phil,
thanks for the update. As agents, we do not always follow this as close as you are, and it is great to learn it.
So, Fannie Mae would require 30% equity, ad FHA -25% (Paul's comment)? Not easy in this market.
Congratulations on well deseved feature
Thanks for this post. Many of my clients are folks who buy second homes. This is great info!
Thanks for this post. Many of my clients are folks who buy second homes. This is great info!
This is really good information. I've seen people do the very thing that the banks are fearing - the buyers who buy and then walk away from the first home. Thanks for the post.
Hi Phil, your image with tightening the screws with that 30% equity number and the max debt ratio changing is very appropriate for the discussion in this post. It doesn't seem to be getting easier to do a real estate transaction does it? Buy and bail is so shifty!!
Thanks, Phil, I am affected by this issue now so appreciate the post with the review on rentals.
I have a client who bought a new home while they planned to rent out the condo. they were living in. The rental market didn't support the rent they needed and had gotten the previous year. They can't afford to run an $800/month negative cash flow, and now live in their new home with this condo threatening to throw them into a "short sale" situation and destroy everything they worked so hard for...through no fault of their own!
Great,,,,they should have not got as lack as they have.
Good post today, I've re-blogged it.....Thank you!
Patricia
It's going to get harder and harder for people to qualify for loans which will also effect the sellers of houses those move up buyers might have purchased. I understand the lenders are trying to limit their losses, but 30% equity when we've lost 40% of median value?
Thanks for the post Phil. You have made it easier for me to explain.
I believe that this is true even if your not selling your current home.
Phil, the lending market continues to change. And, what changes! Several years back, more than I thought, now that I think about it, I converted my then primary residence into a rental, and bought a new home in the community to which my then employer moved me. I didn't have any trouble getting a loan.
Reading your information, it sounds as though I would not have been able to do that, if these current guidellines were in place. I would have had to sell my home, or rent in the new location. Neither option would have been desirable. In fact, the renting option might not have been possible, with one dog and four cats. And, I wanted to keep my home long-term, even if it meant it would be a rental for several years.
This new change is penny-wise and pound-foolish.
Great timing! I've got a client right now considering this very scenario...
Phil,
Nice post...
What are next months changes?
Congrats on the feature, Phil...it was definitely well-deserved! I'm also going to re-blog this. :)
Leilani
Great post and Thanks for informing us about such an important point during buying new home.
Thanks,
Portable Storage,
http://www.moveablecubicle.com
Phil, Once again, you've proven you're on top of it! I've been out sick and just got back into originating loans when I came across this just last week! It looked like a good subject to post about,but you've beat me to the punch! LOL! Thanks for saving me some time with the reblog! Have a great holiday.
Great info Phil, I hope you don't mind, but I've re-blogged this post.
To everyone - thanks for the compliments and re-blogs. I had a busy week and fell behind on responding to comments.
Thanks for writing this article. Unfortunately it was not what I wanted to hear as we are in a situation where we are needing to relocate for work but are stuck with major negative equity in our current home. We were hoping to rent it out as the rental market is strong enough to support around $600 profit per month and then buy a new primary residence in our new city. Looks like we will have to rent out and rent a new home which is not a great scenario. Not many options unfortunately!
Jeff
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