EDITORS NOTE: These guidelines have changed. If you’re buying a home in Washington state, please contact me for current guidelines.
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:
CONVENTIONAL
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).
FHA
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.
Dear Rhonda,
We have a mortgage question for you. We have an existing home that we have owned for seven years and never refinanced. This home has a mother-in-law appartment that has always been rented (and shows up on our taxes). When we move our home will cashflow $600 each month if we are allowed to use both the home and the rental appartment. We have about 20% equity in the property as well we think…but how is that actually caculated?
We would like to move to a bigger home a few doors down. What are the potential problem you can see right of the bat? Can we apply for an FHA loan for our new property even thought our current home is NOT an investment loan?
Thank you for any guidance you may have.
Rachel
Hi Rachel,
You should be able to convert your existing home to a rental. A lender may use various methods to determine the current value of your existing home (to calculate equity) from tax records to a full blown appraisal.
If the home a few doors down “makes sense” as a primary residence, you shouldn’t have issues with that – and being a larger or nicer home is something that lenders look for when financing a “primary” home.
I refinanced my primary house 2 months ago. We were thinking of buying another property but didn’t really planned. We went to an open house in our neighborhood ended up putting an offer. We want to move to this house and make it our primary, but our refi has a clause to stay in the house for one year. What happened if we get a primary loan on the house? Should we notify the financial institution about our intention ? If we don’t what woulda happen?
Shahla, I recommend you speak to a real estate attorney. You recently signed documents that probably state that you intended to reside in your home and yet on my blog, you’re commenting that you were thinking about buying another one. I cannot advise you on what to do in your situation because I’m not and attorney and I do not provide legal advice.
It is possible that the lender on your current mortgage from the refi could call the loan due and it’s also possible that the lender on the new purchase may treat it as an investment property (higher rate, more down payment and reserve requirements).
Hi Rhonda,
We would like to refinance, rent out our home, and purchase a new home. We have been told we can refinance as an investment property to avoid having to occupy our current home for another 6 months with a primary residence refinance. However, we don’t like the higher rates, fees, etc.
#1 Does that sound correct and appropriate? Are there other legal ways to avoid the occupancy requirement?
#2 Are there benefits to refinancing as an investment property that we are missing? Is refinancing as an investment property required to receive certain tax benefits?
Thank you very much!,
Anne B
Hi Anne,
Thanks for your excellent questions!
IMO it sounds appropriate if you are not intending to occupy your property for 12 months – which is what the Deed of Trust states. Do you want to sign a legal document stating you’re going to reside in the home for at least 12 months when you know that you’re probably not going to? Current rates for investment properties are very low – historically speaking.
You’ll need to check with your tax professional as to possible benefits to an investment property vs primary residence and potential tax benefits.
Bottom line, to refinance your home as “owner occupied” and then immediately rent it out is great potential for mortgage fraud.
Some home buyers have found themselves in a sticky situation when they refinance a current residence as owner occupied and then a few months later, try to buy another home as owner occupied only to discover they may difficulty getting financing on the new home and having to explain the refi to underwriters on the new mortgage.
You’re stating that you would “like to refinance and rent out our home” — to me, that means your home is intended to be a rental.
My question is that I have an investment property 2 family because I had to move away and originally I bought it as a primary but because of a job had to move across the country. So I want to refinance the primary loan to take advantage of the new rates but I am under the 30% LTV but I heard it might be possible to convert my loan into an FHA loan which then allow me to refinance it to todays rates. Is that a possible scenario?
Hi Garrett, if the existing mortgage is FHA, you may be able to do an FHA streamline refinance. If it’s not FHA, then I don’t believe you can if you are not living in the property.
If it’s not FHA and it qualifies for HARP (conventional mortgage securitized by Fannie or Freddie prior to June 1, 2009) then you may be able to refi – I have more info about HARP on this blog.
Hi Rhonda ~
Is there any problem with purchasing a home as owner-occupied, if we plan on renting out one of the rooms in the home to a roommate immediately?
We would be living at this new home as our primary residence midweek (during weekdays), though we’d plan to spend weekends at an investment property we own (this is a cash purchased investment home estate, with multiple other tenants in it, and any refi on that investment property would be at investment property rates obviously, not owner-occupied, and would probably be done later this year)…
Thanks
Bob
Hi Bob, this is a good question for you to ask whomever will be helping you with your mortgage loan.
Dear Rhonda,
VERY helpful information! Can you speak to how this would change if the existing property is a duplex, so that half of the property owned has already been rented out with full lease agreement and has been generating income for over a year already? I would assume that the half of the duplex i have lived in cannot be used for income calculations for the debt to income ratio, but that the rented half would be considered a different property and usable income. True?
Hi Rhonda,
I have an fha loan and is on ARM will it be ok to refinance (streamline fha) and then rent it out later this year as I may have to relocate. My arm will end next year so I want to be ready for a refinance. I do not plan to buy another home for at least next 6 months.
Jayashree, you can refinance an FHA mortgage using an FHA streamline for an investment property. It will fine to refinance doing an FHA streamline refi.