Changes to FNMA's handling of primary conversion loans

As an agent you've probably had a client or two throughout your career that has decided it was time to move up.  But instead of wanting to sell their current home they wanted to keep it as a rental.  A sound investment, something they can draw some income off of while building equity.  In the lending world we refer to this as primary conversion, a buyer that is purchasing a new primary residence and converting their current primary to a rental.

Effective immediately Fannie Mae is changing both the documentation requirements and more importantly the way the converted primary residence, or new rental, will be counted in the debt to income ratio.  The documentation requirements are much looser, however the debt to income changes have a negative impact on buyers that are looking to potentially purchase a new home without selling their current residence.  Since FNMA implemented these changes effective immediately there is no grace period for loans currently in process.  This could lead to some of these loans being declined because of the new method for adding the current home to the obligations.

First the good part of the change- Documentation:

Previously if a buyer wanted to convert their primary residence to an investment while purchasing a new primary home FNMA would require an appraisal to document sufficient equity in the current home. They also required proof of receipt of a security deposit and first month's rent for the property that is being converted.  So if a buyer wanted to convert their primary they had to not only have a renter in place, but collect the security deposit and first month of rent.  Of course if something happened and the purchase fell through that could be a difficult conversation to have with the potential tenant.  FNMA has removed these requirements and only requires an executed lease agreement now..

BUT......the bad part of the change- DTI calculation:

Up until now underwriters were able to credit 75% of rent amount on the lease agreement and net it against the liability.  So if the borrower had a $1000 PITIA payment and an agreement for $1000 in rent, the underwriter could reduce the liability to $250,  Under the new guidelines the underwriter must still count the entire PITIA payment as part of the liabilities and credit the income with $750.  So why does this matter as it seems like there is $250 added to the liabilities either way?  I'm glad you asked.  The answer is it's all about percentages.  Because the DTI limit for most borrowers on a FNMA loan is 45%, the borrower is truly only benefiting from $337.50 in rental income because the liability increased.  

Here is how it breaks down:

The new Way

Previous Home Payment          $1000

Rental Agreement                      $1000

Less 25% Vacancy                      $(250)

Net Rental Income                      $750

45% of net Rental Income         $337.50

Net Amt. added to Liabilities    $662.50

So under the old method the borrower's liabilities would increase by a net of $250/month which is $412.50 less than the new method.  As you can see that will have a major impact on debt to income ratios and loan qualifications. 

Again, the fact that there was no lead time provided for these changes will likely impact quite a few borrowers already in the process of converting their primary residence to an investment.