Converting Existing Homes into Rental Income

Fannie Mae, Freddie Mac and the FHA have all instituted policy's for current home owners who cannot sell their current primary residence but would like to buy a different home in which to reside.

According to reports, some home buyers who have chosen to vacate their existing principal residence and purchase a new residence have provided misleading information regarding the rental income of the property being vacated to qualify for the new mortgage. In affect they will have two mortgages and need to show rental income from the vacated home to offset the expense of the new mortgage and assure they can afford the two mortgages.

The guidelines state that no rental income from a single family home currently occupied by the owner can be used except under two situations which will be explained below.

FROM HUD

"This guidance is directed to prevent the practice known as "buy and bail" where the home buyer purchases, for example, a more affordable dwelling with the intention to cease making payments on the previous mortgage." This will obviously end up in a foreclosure situation.

There are two exceptions in which the rental income can be considered in the underwriting analysis:

1. RELOCATIONS:

The home buyer is relocating with a new employer, or being transferred by the current employer to an area not within reasonable distance. A properly executed lease of at least one year's duration after the loan is closed is required and evidence of a security deposit and first month's rent is paid.

2. SUFFICIENT EQUITY IN VACATED PROPERTY:

The home buyer has a loan-to-value ratio of 75% (70% for a Fannie Mae/Freddie Mac loan) or less as determined by an appraisal no more than 6 months old or, by comparing the unpaid balance with the original sales price of the property.

If the home being vacated had an FHA mortgage and the new home is also going to be financed through the FHA there are additional guidelines.

MULTI FAMILY DWELLINGS

There is more leniency with 2-4 unit owner occupied properties.

If you own and live in a 2-4 family dwelling you may be able to utilize the rental income to qualify under the following conditions for an FHA mortgage.

You can use the income from the tenant units as long as you can provide tax returns that show a history of rental income from those units.

To use rental income from the unit that the owner is planning on vacating you will need to provide a copy of the following:

1. Cancelled Check for one month's security deposit
2. Cancelled check for one month's rent
3. A 12 month lease by signed by the owner and the new tenant.

In summary, if you own a home, particulary a single family home, you need to check if you can use rental income from the current home to offset the fact that you will have two mortgages and still qualify to buy another home.

Latest Interest Rate News

Wednesday the Fed announced they were going to help stimulate the credit markets and increase liquidity by purchasing over $700 billion in mortgage backed securities (MBS), double what they originally stated. This announcement resulted in a very large run up in Mortgage Backed Securities as well as a steep drop in the treasuries. The combination of these two factors are very favorable to a decrease in mortgage rates. Wednesday MBS increased by 132 basis points. A normal day would see a movement in the range of 10-20 basis points so the increase was substantial. We received numerous emails from our rate services forecasting very large decreases in mortgage rates. Thursday rates did drop between 1/4% to 1/2% with different lenders to a low of 4.875%, but we were actually expecting even bigger decreases. Today (Friday the 20th of March) as I write this post at 10 AM, rates are INCREASING and giving back some of the gains made on Thursday.

The most likely reason for this is due to the lack of manpower at the various wholesale lenders. Over the last two and a half years over 300 lenders and brokers have ceased doing business. At the same time those who remained in business were cutting their workforce drastically. Therefore, you have fewer lenders with fewer workers and fewer investors buying loans. When any sudden and significant drop in interest rates occurs, these lenders become overwhelmed with new loans and cannot cope with the volume in new business. Today the average loan can take 45-60 days to close. And if you are dealing with a foreclosure or short sale it can easily take 3-4 months. Lenders will raise rates back up to slow the market down until they can get a handle on things.
And let's not discount the potential for profit. If all the other factors remain the same, by increasing wholesale rates and not passing on the the lower rates to consumers, the lenders make more money.

The feeling is that rates will gradually decline over the next 6 months with temporary increases from time to time so the lenders can keep up with the demand. If you are looking to apply for a mortgage any time soon and your loan officer contacts you about declining rates it might be wise to take the bird in the hand. Trying to get the absolute lowest rate is no different than trying to time the stock market, it's nearly impossible. Rates could well drop into the low to middle fours this year. But they could just as easily go higher. There is no guarantee either way.
The affects of a global economy make the financial markets unpredictable.
I don't know about you, but I'm not a gambler.
Just my 2 cents.

Foreclosure or Bankruptcy

This post is a further review of credit issues and dealing with a bankruptcy (BK) or foreclosure when looking to purchase or refinance a home.

The best program available dealing with these two issues is currently the FHA and here are their guidelines. You will still be required to qualify based on the usual standards of income, assets, employment etc.

1. Chapter 13- If you have had a chapter 13 BK and have made your payments on time for one year from the date of the filing, you will qualify for a purchase mortgage. You must also have re-established good credit.

2. Chapter 7- The BK must be at least 2 years ago and re-established good credit. Unlike the Chap 13 this is based on the DISCHARGE date not the filing date. The discharge is typically a few months after the filing date.

3. Foreclosure or Deed in Lieu of Foreclosure- After 3 years borrower can be approved. If the foreclosure was the borrower's primary residence AND the foreclosure was due to extenuating circumstances (medical, or spouse died etc) AND the borrower has since re-established good credit, exceptions can be made. Poor money management is not a qualifying factor for the exception.

Credit letters will usually be required explaining the reason the BK or foreclosure and what plan will avoid a similar result.

Most lenders now are requiring a minimum Credit Score of 620 for FHA loans. On a "hard" pull credit report or tri merge which is required by the lenders, a borrower receives a credit score from the three credit repositories, Transunion, Equifax and Experian.
They each have their own software that calculates your score. The high and low scores are throw out and your middle credit score will be the determining factor. Often I will have a customer who has had a credit report from some free site on the Internet. These usually only provide one score and it is almost always higher than a tri-merge report. I would not put a lot of weight on these free reports as they cannot be used in a mortgage application.

If you find there are inaccuracies on your report and you have supporting documentation I may be able to increase your credit score with letters to the credit agencies.

For more serious issues there are legitimate credit repair companies out there who can raise your score in several months and they can be a useful tool. I can put you in contact with such a company.

Follow up to Last Post

I need clarify the new FHA loan limits I addressed in the last post. The maximum limits of $475,000 in RI is the FHA Jumbo limit. FHA Jumbo loans have a 3/8% to 1/2% higher rate. To stay under the Jumbo guidelines the loan cannot exceed $417,000, this is the limit for non-jumbo loans. This is similar to the conventional guidelines of $417,000.