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When Renting Out Your Home Can Help You Buy a New One

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One of the biggest obstacles homebuyers will face is being able to show enough income to offset their debts — in addition to a proposed housing payment. If you don’t show enough income to offset your debts according to the bank’s requirements, you may have trouble getting the loan. With that in mind, there is a little-known lending guideline that allows you to show more income, which can help you seal the deal.

In order to take advantage of this guideline, however, you have to turn either your new home or your current home into an income property. Essentially, by doing this, you can use the projected fair market rents for your property in order to show additional income, but you need to meet one of the following financial requirements in order to qualify.

Two Equity Requirements

When we’re talking about equity, we’re talking about cash in the form of a down payment to buy a home, or equity in an existing residence defined as the difference between any loan amounts owed on the property against the value.

20% Down on the Home You’re Buying If you are purchasing a home, you can use the projected fair market rents to offset the mortgage payment, but you’ll need to have a 20% down payment in order to use this strategy.

Let’s say your mortgage payment on your new property is going to be $2,400 per month. Fair market projected rents on your current residence are $2,200 per month. Lenders will use a 25% vacancy computation to hedge against default. Using the 75% vacancy factor, you’ll get the additional benefit of $1,650 per month more income, so in other words, your take-home income only has to offset a liability of $750 per month versus $2,400 per month. A $750 per month differential is equivalent to as much as $175,000 in purchasing power.

30% Equity in the Home You Currently Own — Don’t have enough income to purchase the new home and debt service the other? If you have 30% equity in your primary home and you plan to keep the home as a rental, the same rule applies here — a lender will use up to 75% of projected fair market rents to offset the loan payment.

Much like the acquisition of a new investment property, the reversal works similarly when converting a primary home to an investment property. Assuming your mortgage payment on your current home is $1,700 per month, for example (including taxes, insurance, homeowner association fees, private mortgage insurance if applicable), assuming the mortgage payment on the new property is $3,000 per month. Projected fair market rents indicates a gross rent of $1,600 per month, using the 75% vacancy factor, $1,200 per month helps offset the liability, meaning now you have a $3,500 per month liability to account for rather than $4,700 (carrying both homes) as you are effectively leveraging buying power by the use of fair market rents.

Rates & Fees More Costly

There’s a caveat to this approach, as taking out a mortgage to purchase an income property costs more. Lenders price income property loans higher than they do if the property is a primary residence. Rightfully so, as in a foreclosure situation, most banks consider which property a consumer would be more likely to fight for: the roof over their head, or a property they don’t live in? As such, expect an income property loan to be approximately a quarter of a percentage point higher in interest rate than a primary home.

As a consumer, you agree to pay for the additional risk in the form of higher interest rates and higher low-level pricing adjustments — which are incremental pricing adjustments due to things such as occupancy, loan-to-value and credit score. But most lenders will allow projected fair market rents to qualify you for the loan. A word of caution, however: your scenario must pass the lender’s litmus test, which we’ll look at below.

Documenting the Rental Property

If purchasing an income property, expect the transaction to bear a higher appraisal fee. A traditional lending appraisal is typically around $400-$500. However, it is not unreasonable to expect upwards of $650-$700 for an income property appraisal (the same goes for an additional unit on the home).

You’ll also need to provide a fair market rent survey and operating income statement as a component of the income property appraisals. So be prepared to shell out a few more bucks.

Loan Tip 1: When buying a new house for investment purposes, the new house does not need to be rented in order for you to be approved.

On the other hand, if you’re converting a primary home to an investment property, expect to jump through more hoops in providing concise documentation, an extra home appraisal fee, an executed lease agreement, along with evidence of a security deposit being deposited into your bank account. Yep, the lender will request all of this paperwork.

Loan Tip 2: Most lenders have a valuation algorithm that uses the data from closed sales in the vicinity of the subject property, and this is something that can be done in lieu of paying for an appraisal when converting a primary home to an investment property.

[Editor’s note: Your credit score is an important factor in determining how much interest you’ll pay on your mortgage. That’s why it can be helpful to know your credit score before you start shopping for a home. By checking your credit scores ahead of time, you can determine whether you’re ready to buy, or whether you need more time to build your credit before you buy in order to get better rates on your loan. Credit.com allows you to monitor two of your credit scores, and also gives you a plan to help you build your credit if you need — all for free.]

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  • sharon

    is it possible to rent your current house and then rent an apartment at the same time?

    • http://www.credit.com/ Credit.com Credit Experts

      To rent out your current house and then to rent an apartment? Yes — many people do it after a job transfer.

      • Shryl

        can the rent paid for the apartment be treated as an expense for renting current home?

  • sharon daniels

    Is it unwise to refinance your home before renting it

    • http://www.credit.com/ Credit.com Credit Experts

      Do you mean to refinance it and then rent it out as a landlord? If you will be renting it out long term (long enough to make closing costs worthwhile), it can be. But terms are often better for owner-occupied houses, so if you already have a mortgage, that may be your best bet. Still, you have nothing to lose by asking.

    • ScottSheldonLoans

      Yes,generally the pricing is much better for an owner occupied home than non-owner occupied. If you know you want to refinance your home complete the refinance first, then pursue this other option.

  • http://batman-news.com Not me…

    I have a home that I want to rent for 1600. a mouth out, and buy a smaller home for 40,000. to fix up and live in, I make 1,800. a week, but I had fallen on hard times last year. Which put me be hind and ruined my credit. If I rent it out and live in a less expletive home. I could not only fix up the less expletive home, but be able to payoff my debt, and still be able to payoff the renal earlier… I don’t know where or how to start….

  • Gessel Valdez-Garcia

    Hi I currently own a 2 family house, I rent the 2nd floor and I live on the 1st fl. I would like to purchase a single family home and would like to rent out my 1st fl that I live in. How much house can I afford if I purchase a single family? and how would the bank look at my income if I rent out the 1st fl? I live in NY in Long Island

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