If You are Buying a Second Home and Renting Yours Out, Read This

Westcoe Realtors, Riverside, California…If you are planning on buying a new home and renting out the one you currently live in instead of selling it, you need to be very aware of new financing laws effective October 1, 2008 that could put a serious crimp in your plans.

Everyone knows that homeowners have taken a serious hit the past couple of years on the equity they may (or may not) have in their home.  Yesterday’s large equity cushion may easily be today’s equity deficit.  It is not unusual for many people to now have a loan balance that far exceeds the current value of their home.  Those who cannot make their payments for whatever reason become future bank repossessions, and much has been written about those unfortunate situations.   

But what about those homeowners who can easily make their payments, but are not exactly happy about the fact that it may take years for the value of their homes to rise back to even the level of their mortgage balance?  Do they stay, and stick it out…or do they find some alternative to their situation?

Well, some homeowners have elected to take a path that is non-traditional at best, and loan fraud at worst.  At an ever increasing rate, many homeowners who could afford their payments but do not want to wait for their equity to “come back” have chosen to buy a new home at a lower price and tell the new lender they simply intend to rent their existing home…only to then walk away from the old home once the new home has closed escrow.  They understand that this path will trash their credit for up to 5 years, but they are willing to take that chance in order to get out from underneath a “negative equity” situation that could take equally as long to bounce back. 

Ethical and moral considerations aside, many lenders are taking a very dim view of people who go this route.  Certainly the existing lender on the “old” home is not happy…they will now have to repossess the old home, and potentially lose many thousands of dollars on a home in which the homeowner could afford the payment.  Remember, the loan documents signed upon the purchase of the home made no provisions about payments only being due if the home is increasing in value!  The other problem here for the homeowner is that it is entirely possible that either one of the lenders (the old or the new) could sue the borrower for loan fraud, since the new loan was predicated upon “rental income” from the old home…the same home that is now being repossessed because the borrower simply walked away.  A sticky wicket to be sure….and as a result of the ever increasing frequency of the above happening, there are now lending changes being enacted to make this harder to do.

Effective October 1, Freddie Mac and Fannie Mae (as previous blogs have stated, these are the two major players that affect almost every loan) will now state that anyone who is trying to purchase another home and use their existing home as a rental will be required to have at least 30% equity in their current home for the “rental income” to count on their new loan application.  If the existing equity is below the 30%, then whatever rental income is shown will not be counted, effectively making the borrower have to qualify for both house payments…and since most people cannot do this (that is why they need the “rental income” to count as income), it will make it almost impossible for the buyer to purchase the second home.

As you can see, the concept here is to prevent homeowners from simply “buying and bailing.”

For now, some enterprising souls have discovered that they can still do this by using FHA as the lender on the new home (Fannie and Freddie are not involved in FHA loans), but expect this loophole to close soon, as FHA is actively considering enacting the same restrictions.

The bottom line is that lenders make loans to individuals based upon their ability to pay…not the continued rise in pricing and resulting equity.  No one likes what has happened to the equity position of many homeowners…but you can now expect the lenders who have lost so much money on foreclosures to begin to fight back against those individuals who willingly walk away from their loan obligations.