Packing Light for Your Departure Property
I fielded a call this week and it's one that comes in quite frequently. "We saw a place we really like and are thinking about putting in an offer. But we don't know what we're going to do with our existing home and don't think we have time to sell it first..." It's the classic "buy first" dilemma that I've covered before.
It's fair to assume that one place the mind goes when dealing with the "what to do" of the existing home is the notion of lining up a renter. Our buyers in this situation recognize that it may not be financially convenient or possible to support two mortgage payments and they believe that with rental income from the departure property, it might all work out. Are they right?
There's a simple way to test if the above theory can work --- down payment. Can the buyer of the new place come up with the down payment first and without selling the existing home? If the answer is "no," then we really don't have a rental/departure property dilemma yet. Obviously, if the equity in the current home is earmarked for the down payment on the new, then the existing home must sell prior to moving. But it's the cases where a down payment is possible without the sale that we must better understand the rules and regulations surrounding what we in the industry designate as a "departure property." Now, our buyer has the ability to purchase first, and that can bring us to the next stop on our destination --- qualifying for the mortgage that enables him to do so. We'll look at the way conventional, FHA and jumbo mortgages permit the rental income from a departure property --- aka, "the old home" --- and then how it factors into the overall qualification for the new loan on the new property. But first, a little history lesson.
Guidelines for departure properties have been influenced heavily by the real estate downturn and a phenomenon during that time called "buy and bail." It worked like this. In the early part of the crash, buyers who had purchased at the peak recognized that homes perhaps even on the same street were selling for far less than what they'd paid just a few short months before. Some of these individuals recognized that they could take advantage of the loose lending guidelines that had yet to catch up with the times. First, they would go into contract on a home they could purchase at a great discount. Next, they would tell the lender that they planned to get a rental agreement on their current home and would fabricate one for use in qualifying. They'd buy the new home, then foreclose (bail...) on the "rental." Lenders quickly realized they needed new measures to prevent this abuse and here's what resulted.
Not too long ago, conventional mortgages required that in order to use future rental income on a departure property, the home had to have at least a 30% equity position, meaning that the owner was far from being "underwater." This needed to be verified with an appraisal. The owner of the home then needed to get a lease agreement from a future tenant (who was not a family member) and the security deposit from that tenant needed to be cashed by the landlord/owner. With those hurdles cleared, the owner could then use 75% of the gross rental income from the lease. Here at the end of 2018, all lenders still require the lease agreement, many require the deposit but none mandate the equity test.
Want to buy a new home with an FHA loan and get rental income from your existing home? Better pack up the station wagon and settle in for a longer trip. FHA requires that the properties be more than 100 miles apart. If you meet this test, then you need a verified lease agreement, negotiated security deposit and you're held to using 75% of the gross rent indicated on the lease. FHA will require that your departure property has at least a 25% equity position, which must be verified with an appraisal.
Lest you think you're flying the Concorde just because you're in jumbo territory, it's a good idea to get ready for some turbulence. Jumbo guidelines for departure properties will vary from one investor to the next, but in general, you may still be held to an equity test on the departure property (usually 25% or more, verified with an appraisal on the departure property), plus an enforceable lease agreeement and a security deposit that has cleared the bank. Here again we'll use 75% of the rents, but note that if the appraisal on the departure property shows market rents that are less than the lease agreement, we will use the lesser of the two amounts. As if this bar wasn't at cruising altitude already, check with your lender to assure that they will allow you to even consider using the rental income without a "property management history." In other words, some jumbo lenders don't care if you can verifiably rent the old place if you have no prior experience being a landlord. If their guidelines require management experience, you must meet it to use any of that income.
If you need to clear your ears upon hearing all the guidelines and rules above I get it. But qualifying with income from a departure property has actually gotten easier over the last few years and may continue to improve. It's not the warm fuzzy friendly skies yet, but it's getting there and if you need help understanding your options when you plan to buy a new home before selling your existing one (and you have a down payment ready to go without the prior sale...), we're here to help. Just press your flight attendant button and we'll be down the aisle to assist.
Boarding group A,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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