Tom Garrity of iLoan Home Mortgage reporting from St. Paul, Minnesota
Minnesota Home Shopper,
You may not be familiar with the term “buy and bail” but lenders are. And if you’re not familiar you may be very surprised when a lender denies your loan when you try to convert your primary, current residence into a second home or rental. That is, unless you stumbled upon this blog. First let’s talk about conventional loans (those backed by Fannie Mae and Freddie Mac.)
If you are applying for a conventional loan, the guidelines are as follows:
Borrowers who currently own their own home typically have three (3) options when they decide to purchase a new Primary residence. They can …
- sell the current residence and payoff the outstanding mortgage,
- convert the property to a second home assuming the borrower can qualify with both the existing and new mortgage payments, or
- convert the property to an investment property and provide documentation that they will rent the property and use the income to offset the mortgage payment.
In order to ensure that borrowers have sufficient equity and/or reserves to support both the existing financing and the new mortgage being originated, the following guidelines are required for qualifying borrowers purchasing a new Primary residence when the current Primary residence is pending sale or they are converting their existing Primary residence to a second home or investment property.
Current Primary Residence is pending sale but will not be sold (closed) prior to the new transaction:
- Both the current and the proposed mortgage payments must be used to qualify the borrower for the new transaction.
- Six (6) months of PITI for both properties is required to be in reserves. Reduced reserves may be considered of no less than 2 months for both properties if there is documented equity of at least 30 % in the existing property. Valuation can be derived from an appraisal, automated valuation model (AVM), or Broker Price Opinion (BPO) minus outstanding liens. Valuation is subject to underwriter approval. Reserve requirements for loans submitted are dictated by the automated underwriting findings and will replace the requirement listed above.
- The current principal residence’s PITI will not be required to qualify the borrower as long as the reserve requirements above are met and an executed sales contract for the current residence is provided and confirmation that any financing contingencies have been cleared.
Conversion of Primary Residence to a Second Home
- Both the current and the proposed mortgage payments must be used to qualify the borrower for the new transaction; and
- Six (6) months of PITI for both properties is required to be in reserves. Reduced reserves may be considered of no less than 2 months for both properties if there is documented equity of at least 30 percent in the existing property. Valuation can be derived from an appraisal, automated valuation model (AVM), or Broker Price Opinion (BPO) minus outstanding liens. Valuation is subject to underwriter approval.
Conversion of Primary Residence to an Investment Property
- Both the current and the proposed mortgage payments must be used to qualify the borrower for the new transaction: and
- Six (6) months of PITI for both properties is required to be in reserves unless otherwise dictated by automated underwriting findings.
Up to 75% of the rental income may to be used to offset the mortgage payment in qualifying if there is documented equity of at least 30 percent in the existing property. Valuation can be derived from an appraisal, AVM, or BPO minus outstanding liens. Valuation is subject to underwriter approval. If the 30 percent equity in the property cannot be documented, rental income may not be used to offset the mortgage payment.
- a copy of the fully executed lease agreement; and
- the receipt of a security deposit from the tenant and deposit into the borrower’s account.
If you are applying for an FHA loan however, the guidelines are similar but slightly different in significant ways. Also, keep in mind, there are few exceptions to using FHA financing when you already have an FHA loan. Here are the guidelines:
The main difference with FHA is that they don’t have specific cash reserve requirements in the same way as conventional loans. In this way, FHA is more lenient. Rental income on the property being vacated, reduced by the appropriate vacancy factor as determined by the jurisdictional FHA Homeownership Center (see http://www.hud.gov/offices/hsg/sfh/ref/sfh2-21u.cfm) may be considered in the underwriting analysis under the following circumstances:
- Relocations: The homebuyer is relocating with a new employer, or being transferred by the current employer to an area not within reasonable and locally recognized commuting distance. A properly executed lease agreement (i.e., a lease signed by the homebuyer and the lessee) of at least one year’s duration after the loan is closed is required. FHA recommends that underwriters also obtain evidence of the security deposit and/or evidence the first month’s rent was paid to the homeowner.
- Sufficient Equity in Vacated Property: The homebuyer has a loan-to-value ratio of 75 percent or less, as determined by either a current (no more than six months old) residential appraisal or by comparing the unpaid principal balance to the original sales price of the property. The appraisal, in addition to using forms Fannie Mae1004/Freddie Mac 70, may be an exterior-only appraisal using form Fannie Mae/Freddie Mac 2055, and for condominium units, form Fannie Mae1075/Freddie Mac 466.
Here is a link to FHA’s Mortgagee Letter 08-25 that originally outlined these requirements:http://portal.hud.gov/hudportal/documents/huddoc?id=08-25ml.doc.
I’m providing these guidelines as reference. They are by no means a replacement for a good loan officer who can help structure a loan that is right for you without hours of internet research!
Tom Garrity, iLoan Home Mortgage
[Ed. Note: Tom has been in the mortgage industry for almost 10 years. He is currently licensed in Minnesota and Wisconsin. Tom provides the highest level of customer service and brings abundant technical knowhow to the lending process.]