The Scenario: Buying a home and keeping your old one as a rental
Getting approved when you’re planning to rent a former residence can be a challenge. If you plan to purchase a home and convert your existing home into a rental, knowing these guidelines will help you successfully pilot your way to a mortgage approval. The key figure is 30% — as in “30 percent equity in your trailing home”. With thirty percent equity, mortgage lenders are willing to make a lot of exceptions to help you with your plan. Specifically, with 30 percent equity in it, your trailing home can seamlessly convert to an investment property, and pose you little to no issues in underwriting. 30% equity is a magic line of demarcation in the underwriting process. When your trailing home has 30% equity, your mortgage application can include the rental income attached to the home; and you can show your lender you intend to keep both homes, in earnest. With less than 30% equity in that home, the rental income cannot be included at all — not even a percentage of it.
The Rules For Renting Your Old Home
For homeowners who want to convert a “trailing home” into an investment property, there are specific guidelines lenders use. First, the lender will verify whether the former residence has at least 30 percent equity. There are three ways to determine this. The most accurate method for a lender to determine your home’s value is to order and secure an appraisal of it. However, appraisals cost money and take time, so it may be your least preferred method of valuation. A second, less accurate method for home valuation is the Automated Valuation Model (AVM).
An AVM uses mathematical modeling, drawing information from comparable sales to establish market value for a home. The accuracy of an AVM is limited to the accuracy of the information available on public record. An AVM is also known as a “desk appraisal” because it can be performed by an underwriter from a desk. The third valuation option, which is the least accurate, is the Broker Price Opinion (BPO) method. BPOs are performed by real estate agents with knowledge of the specific area in which the home is located. BPOs may include public record information, and information not publicly listed. Lenders can choose between any of the three available methods, often beginning with an AVM. Upon request, however, a borrower can request a complete home appraisal. Once a value is determined, the homeowner will either have 30% equity or not. With sufficient equity, the approval can move to the net stage. Without it, the homeowner retains the option to reduce the home’s existing loan to value so that the 30% equity standard is met. This is done via “cash paid at closing”, with the cash being directed to the existing mortgage on the trailing property. Even without 30% equity, though, there’s still a chance to qualify. Here’s how.
As part of the approval process, your lender will want to make sure that you have sufficient reserves to make the required mortgage payments on both homes — at least in the near-term. Reserve are proved using bank statements and, depending on your trailing home’s equity percentage, your lender will look for varying amount of reserves.
For homeowners with the required 30 percent equity, underwriting standards call for sufficient reserves to cover 2 months of payments on both properties, inclusive of taxes and mortgage insurance, where applicable. As an illustration, if the combined principal, interest, taxes, and insurance (PITI) for both homes totals $4,000 monthly, you must show at least $8,000 in reserves. For homeowners with less than 30 percent equity, the reserve requirement moves to six months of payments on both homes combined. The good news is that if you’re able to meet the asset reserve requirements, the remaining mortgage approval guidelines are the same as for any other home loan program. With sufficient equity and reserves, you can do it.