Converting a Primary Residence Into a Rental Considerations

    Buyers Busted For “Pretend” Owner-Occupancy

    We once had a buyer using vastly superior “owner-occupied” or “primary residence financing” to buy a home – only to see his financing fall through at the 11th hour.

    Our underwriter had checked a database called MERS (Mortgage Electronic Registration System) and found out that the borrower had just refinanced his existing residence as an “owner-occupant” with another lender.

    So, our buyer’s only option was to change his financing to “investment property” financing – with a larger down payment and about a 1/2% higher rate.

    Note: The buyer would have been fine but for the fact that he went into contract on his new property before his refi closed, and I explain why that was an issue below.

    In another instance, we once had a buyer promise that he was going to occupy his new home, despite the fact that it was smaller than his current home and in an inferior neighborhood.

    The lender (this was back in our broker days), however, remained suspicious and did an “occupancy check” a few months after the loan closed by sending someone to the property to knock on the door and ask who lived there (aka an “occ knock”).

    When someone other than the borrower answered the door and claimed to live there, the lender called the loan due.

    What To Consider When Converting A Primary Residence Into An Investment Property

    Many buyers take advantage of owner-occupied financing, even if they plan on renting out the properties later on, because the rates and down payment requirements are so much lower.

    These buyers do need to be careful and here are some of the considerations.

    1) 12-Month Rule

    Every owner-occupant signs an affidavit in her loan documents that says she will occupy the property for a minimum of 12 months. In my experience though, I have never seen lenders enforce this – as long as borrowers do not do anything to arouse suspicion (see below) or miss any payments. To be clear though – I am not encouraging borrowers to mislead lenders and am just sharing what I have observed.

    2) Mailing Address Same As Property Address

    One thing that might arouse suspicion is giving the servicer a mailing address that is different from the property address. Why would an owner-occupant want her mail to go to another address? There are reasons, but borrowers should be ready to explain.

    3) Larger, Nicer Current Address

    Another thing that can arouse suspicion is the ownership of other larger and nicer residences in better neighborhoods at the time of purchase. There are, of course, always valid reasons to move to an inferior property (shorter commute, closer to family, job changes, etc.), but borrowers should be ready to explain their motivation in a letter to the underwriter. They should also be prepared for additional scrutiny after close, like in my story above.

    4) “Repeat” Owner Occupants

    This is another thing that can arouse suspicion – a series of repeat owner-occupant loans. This is something we saw a few times after the 2008 meltdown when some borrowers were buying multiple properties with low-money-down, owner-occupied financing with new loans showing up every six months or so on their credit reports. Borrowers were able to use letters of explanation to justify each move – but only up to a point where underwriters grew a bit too suspicious.

    5) How Long Must Buyers “Season” Owner-Occupied Financing Before Obtaining It Again?

    If buyers take advantage of owner-occupied financing and want to do so again, they technically need to wait at least 12 months because lenders will see and know about their last owner-occupied purchase because of MERS and credit reporting. BUT – they can often skirt the 12-month rule with a strong letter of explanation that justifies the need for a new owner-occupied property. Reasons can include job changes and family needs.

    6) How Long Must REFI BORROWERS “Season” Owner-Occupied Financing Before Obtaining It Again?

    This is very similar to #5 but I am separating it because there is a bit more flexibility when it comes to refis. The key is to make sure borrowers do NOT enter into a contract to buy a new home as an owner-occupant – while an owner-occupied refi is still in progress; that would show a clear intent to mislead either the refi or the purchase lender. But, if the refi closes first, the borrower can write a letter of explanation that says something like this: “when I decided to refi, I had no intention of ever moving because I loved my darn house… but when I was driving around with my lovely wife on a sunny spring day, we just happened to run across our absolute dream house that we just had to have…” And – that usually works. 😊

    7) Jumbo vs. Conforming vs. FHA vs. VA

    Jumbo lenders tend to be stricter when it comes to owner-occupancy; they will scrutinize files for issues much more closely upfront and they are more likely to do occupancy checks after close.

    8) Conclusion/Reality

    As I mentioned in #1, I have not seen lenders enforce the “12-month rule” but that is only my personal observation and borrowers should be careful, as intentionally misleading lenders can be a serious offense. The keys are to make sure there is no obvious “intent” to mislead; to avoid suspicious activities as set out above; to be ready with strong letters of explanation; to not be cavalier about slapping a renter into a property right after close; to know that lenders are not dumb or naïve; and to be particularly careful with jumbo lenders.

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