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Using Rental Income on a Departing Residence to Purchase a New Home

In recent months, the Bay Area's relatively low inventory of homes for sale has created a bit of a seller's market. Although sellers remain open to negotiations once in contract, they are almost universally unwilling to consider any offer that is contingent on the sale of the buyer's current home. For this reason, homeowners looking to trade up or move to a new area are left with three options: 1) sell their home and rent until a prospective new home is found, 2) Qualify for the purchase mortgage carrying both properties' housing payments or, 3) qualify with projected rental income on their current home. 

Although most buyers would prefer to have their new home lined-up before parting with their current, for many there may be no choice. If sale proceeds are needed for down payment funds, or if their income would not otherwise allow them to qualify for the new mortgage, then sell first they must. Those able to qualify carrying both their current and the new home's combined housing payments can generally move forward with the purchase (though some lenders may require assurances that they will continue to make payments on the old mortgage). Borrowers who fall into the third category generally have adequate down payment funds to satisfy the new purchase loan, but lack sufficient income to qualify with both housing payments. For these buyers, using rental income on their current home to offset housing expenses may be their best bet.

With conventional financing, buyers will need to work within the strictures of Fannie Mae guidelines, along with any additional requirements imposed by their chosen lender. In general, these are the rules that will apply:

  • They will need to verify 30% equity in their current home. (This mitigates concerns that they may be considering a "strategic default" on the old home. An AVM (Automated Valuation Module) or appraisal will be needed to prove their equity position.
  • Rental income must be documented with a fully executed lease agreement. The lease may be month-to-month.
  • The lender will require a copy of the security deposit and proof of deposit.
  • Rental income from a family member or an individual with an established relationship to the borrower is not allowed.
  • 75% of the verified rental income can be used to offset housing expenses.

Perhaps the biggest obstacle in operating with this strategy is in lining-up a prospective renter who is happy to wait until you have entered into contract on a new home. But if you want the best terms on 30-year fixed money, it's the game you'll have to play. There are, however, other good options, such as 5 and 7-year ARM products that will allow for a rental offset based only on a rental survey to determine fair market rent. In this example, you will still need at least 20% down payment funds and the established rental income will be discounted to 75%, but you won't need to provide lease agreement.

 Finally, there is another good option for buyers with limited down payment funds who may have little or no equity in their homes. FHA loans provide financing as high as $729,750 on great 30-year fixed money with down payment funds as low as 3.5% of the purchase price. And for those whose equity has eroded and who may even be upside down on their current home, the FHA requires just 25% equity in the departing home and will base this figure off of the original purchase price!! But the borrower will still need to provide an executed lease agreement and proof of deposit for security money.

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