This is a common question I’m asked these days…mostly because many home owners don’t have as much equity as they would need in order to sell their current residence. With home prices being at their lowest in years, many want to take advantage and buy their next home and simply rent out their current residence.
Here are a few considerations:
With Conventional financing, if the borrower does not have a minimum of 30% equity (70% loan to value or lower) in the property they are converting into a rental they will need 6 months reserves for both properties. For example, if their current residence (to be converted to an investment) has a mortgage payment (PITI) of $1800 and their proposed new home has a mortgage payment (PITI) of $2000; they will need a minimum of $22,800 (3800 x 6) left in reserves after closing.
Without the 30% home equity, the borrower will need to qualify with both mortgage payments (no credit for rent).
Currently FHA does not have the same reserves requirement as conventional financing. I’ve found that after down payment and closing costs on the new home and factoring in the 6 month reserve requirement of both mortgage payments, many home buyers wind up leaning towards FHA loans unless they have plenty of funds saved up or significant home equity in the proposed rental.
FHA will allow rent to be considered as income if the borrower is being relocated to an area “not within reasonable commuting distance” or if the borrower has “suffient equity” in the home that is being vacated to become a rental (75% loan to value) which will also require documentation. FHA credits 85% of the rental payment towards the borrowers monthly income.
For both conventional financing and FHA, equity in the residence that is being converted to a rental is documented with either an appraisal, AVM or broker price opinion at the lenders discretion. The borrower must also be able to provide a fully executed lease agreement and conventional financing requires documentation to show the security deposit from the tennant has cleared the borrowers account.
USDA. USDA does not approve purchase loans for borrowers that own livable real estate…so you probably cannot convert your existing home into a rental and use USDA for your the financing of your next home.
Before you convert your home to a rental, be sure to discuss the pros and cons with your tax advisor.
If have questions about a mortgage scenario for a home located in Washington state, I’m happy to help. Click here if you would like me to provide you with a rate quote.