Not every repeat buyer decides to sell their current home prior to buying the next. Some homeowners make the choice to become a real estate investor and others choose to rent out their current home because it did not sell. Either way, counting rental income on a departing residence can be tricky. Many assume that full rental income or maybe 75% of the rental may be counted. Yet, in true mortgage guidelines fashion, each loan program treats this new income differently. The most popular VA, FHA, USDA, and conventional (Fannie Mae and Freddie Mac) loan programs vary widely in their rules- ranging from requiring 2 years of income to be reported on schedule E of the tax return to counting 100% right away. Additionally, lenders may add a few layers of guidelines on top. So, let’s discuss the differences that can make or break buying your next new home.
What is the Big Deal About a Departing Residence?
Departing residence is a term used in the mortgage world to describe a currently occupied home which the homeowner is going to move out of. Most of the time, the reason to move out of the current residence is to buy another home. Occasionally homeowners may decide to move from one residence to another they own. Either way, lenders care about the resulting disposition of the real estate. There needs to be answers to questions like: Do we need to count a debt? Is there an income to use in qualifying? Does the new purchase make sense? The last one deals with a term called occupancy fraud.
Options for Departing Residence
- Sell the home
- Retain ownership for second home
- Let family live in it
- Rent the home
If a home is sold prior to a new home purchase, the departing residence mortgage payment, taxes, and insurance are not counted as a debt anymore. But, if the seller received cash from their sale, it may be used towards purchasing the new home.
Choosing to keep the home as a second or vacation home, or allowing someone to live in the home rent-free, means any liability for that home must be counted in the new loan qualification. Thus, any mortgage payments, homeowners association dues, property taxes, and insurance premiums must be included in the debt-to-income ratio.
Deciding to rent out a current home is where things can get tricky. Although the simplest path for a strong buyer is to qualify using both the departing residence and the new home. In this case, there is usually no requirement for documenting rental income. If you need to count rental income to qualify, here you go!
Counting Rental Income on a VA Loan
Current military service members, Veterans, and buyers using survivor’s benefits have the best option for counting rental income on a departing residence. When buying another primary residence, VA loans allow the buyer to count up to 100% of the new rental income on the departing residence. In order to count the rental income, a 12 month lease must be provided and most lenders even require proof of the first month’s rent or security deposit. For qualifying, the full mortgage payment plus any HOA dues are subtracted from the new rental. If the debt is higher than the rent, the figure will reduce the qualifying income by that amount. If the rental is higher than the monthly debt, the extra amount may not be used towards qualifying.
There is an additional, little-known VA rental income guideline which allows the buyer to count market rent on the departing residence without a lease. The home does not need to be rented prior to closing if the market rent is sufficiently proven. There are none more lenient than that! If you have questions on this solution, ask your OVM Financial loan officer.
Using Bonus Entitlement to Have Multiple VA Loans at Once
First of all, did you know that it is possible to have multiple VA loans at once? Many believe that the only way to convert a residence with a VA loan to a rental is to refinance to a conventional loan, but this is not the case. Actually, each person who qualifies for a VA loan has what is called bonus entitlement. Also called 2nd tier entitlement, it allows a buyer to use VA again while keeping another VA loan. This can be quite a helpful tool for military buyers. So, converting a departing residence with a VA loan into a rental will reduce the Veteran’s entitlement. Depending on the loan amounts for both properties and the price on the new home, there may or may not be a down payment requirement.
FHA Rental Income on a Departing Residence
FHA is much more strict on counting rental income than the VA option. Like VA, it is possible to have two FHA loans at once and use the rental on the departing residence. But, it comes with two requirements; in order to count a portion of the new rent, the move must result from an employment relocation. Furthermore, the new residence must be over 100 miles from the prior residence. Finally, buyers without rental experience must have 25% equity in the departing residence to count the rent. That appraisal must be ordered by the FHA lender, but it does not need to be an FHA appraisal. FHA is well known for being lenient in many areas when it comes to home buyer qualification, but this is one area where it is more strict than some other options.
Assuming these requirements are met, 75% of the new gross rental income may be used towards qualifying for the new home. Also, the borrower must provide a copy of a signed 12 month lease and document the first month’s rent along with a copy of the tenant’s check and the borrower’s proof of deposit.
If you feel an FHA loan is a possible solution for you, it is highly recommended for you to read, “FHA 100 Mile Rule Helps Buyers…” It will go into more detail about the 100-mile requirement. As always, feel free to reach out to one of our experienced Loan Officers for more information.
FNMA Rental Income on a Departing Residence
There are still more options available. Buyers who qualify for a conventional loan have two options: Fannie Mae and Freddie Mac. Even though both are conventional loans and mirror each other at first glance, many guidelines are different. Counting rent is one of the differences. First of all, make sure you are not one that believes conventional loans require 20% down payment. To the contrary, conventional buyers may put down as little as 3 to 5% of the price. Because Fannie (FNMA) and Freddie sometimes differ in rates and qualification requirements, borrowers may not have a choice in which program is used for this rental income. But, here is what can be expected if FNMA rental income guidelines could work for you.
Fortunately, using FNMA rent is simple. No matter the type of loan is on the prior residence, Fannie Mae allows a buyer to qualify with 75% of the new rent. Like FHA, the buyer must provide a signed 12-month rental agreement, copy of the first month’s rent or security deposit check, and proof of deposit.
So, if the new rental income is $1,000 and the total payment including taxes, insurance, and possible HOA dues is $750, then it is a wash. No income counted and no reduction of income.
But let’s say the total payment is $1,000. In that case, the borrower would have a $250 monthly loss and it would be counted against the borrower. That is a whole lot better than counting a $1,000 payment plus the new mortgage!
Freddie Mac Rental Income on a Departing Residence
Recently, a buyer had a scenario where he needed to count rental on the current residence and Freddie Mac was the better interest rate. Therefore, a Freddie conventional loan was the first choice. But, there ended up being a problem because Freddie takes it a step further in documenting this new rental income. Freddie Mac income from a new rental requires a few things:
- Signed 12 month lease
- First month’s rent or security deposit
- Net profit on rental may not be used (if applicable)
- One year landlord experience
That last one is the tough one as many buyers that use rental from a departing residence are doing so for the first time. Thus, Freddie Mac may not be the option unless the buyer has the required landlord experience.
Does USDA Allow Rental Income on a Departing Residence?
First of all, it is important to point out a few USDA facts before getting into rentals. Borrowers may not have more than one USDA loan at a time (USDA may be used over and over again though). B
USDA will allow a buyer to own another property if it is over a one hour commuting distance away or is not considered habitable. Assuming both requirements are met, let’s discuss the strict rental guidelines that are in place.
USDA does not allow new rent on a departing residence and requires two years of tax returns to prove rental income. Therefore, a USDA buyer who retains their current house must qualify on both full mortgage payments
One final tip to remember if considering the use of rental income in any way is to not accept cash. Why? Because it is rare that a buyer can prove where those funds came from. If you remember, most of the examples provided require a copy of the rental check. Safeguard your purchase by always requiring a check or even a money order. If for some reason cash was provided, providing the tenant’s bank statement to show the exact amount was withdrawn on the date of the deposit could possibly work.
Has a lender told you something different? Were you denied a mortgage loan? Give OVM a call for a second opinion.