“Departing Residence” Rental Income – More Important Than Ever!
“Housing Crash In Austin!”
Somebody posted that on Twitter last week, citing climbing inventory, price reductions, and fewer buyers. That same day, however, Heejin and I had dinner with a very successful agent in Austin, and I asked him about the tweet. This was his response: “What, seriously? Nobody told me. All of my investor-clients are coming back now in droves to take advantage of a softer market and I am busier than I have ever been.” I share this to remind everyone (again) that doom and gloom predictions rarely come to pass, and that opportunities abound in all markets.
What Is A Departing Residence And Why You Should Care!
A “departing residence” is a currently occupied home that the owner is going to move out of – usually after purchasing a new home.
Departing residences are a big deal right now for two reasons: (1) the rental income from a departing residence can make or break deals – especially in this higher rate environment; and (2) a lot of buyers with departing residences don’t want to sell their current homes for a variety of reasons (want to keep an inflation hedge; want the rental income; don’t want to sell in what they think is too soft of a market; etc.).
Can Only Use 75% Of Gross Rent
The most important reminder is that lenders can usually only use 75% of the gross rent for “income” on a loan application.
Hence, if a homeowner rents out her departing residence for $1,000 per month and her total housing payment (principal, interest, taxes, insurance, HOA) is $750 per month, she will have zero net income from the rent to use towards qualifying.
If her rent is $1,000 and her total housing payment is $1,000 too, she will show a net LOSS of $250 on her loan application.
NOTE #1: VA loans are an exception to this rule, as they allow applicants to use 100% of the rental income.
NOTE #2: Some loan programs will not allow any “positive income” from rent when there is limited “landlord history” (see below) – no matter how high the rent is.
Proving The House Is Rented
Applicants have to “prove” their departing residence is actually rented by providing a fully executed lease; a copy of the first month’s rent and/or security deposit; and proof that the first check was actually deposited into the applicant’s account.
Some lenders and loan programs require one or two years of “landlord experience,” meaning applicants have to prove they have rented out a property before (by showing rental income on their tax returns). Most of our best jumbo loans require a full two years of landlord experience, for example, while Fannie Mae requires none.
After the 2008 meltdown, almost all loan programs required proof that applicants had at least a 25% equity cushion in their property before they could use rental income from a departing residence to qualify. If a home is worth $1 million for example, and the loan against it is $700,000, there is a 30% equity cushion.
Lenders had to order appraisals for departing residences every time applicants needed to use departing residence rental income to qualify. These requirements were in place because landlords were notoriously willing to walk away from their properties when their equity cushions got too thin, as few of them expected real estate to rebound in the manner that it did.
Equity cushions are still required in some cases, but on a far more limited basis. FHA only requires a 25% equity cushion though if applicants have no landlord experience.
Our best jumbo loans require equity cushions of 25% to 30%.
Rule Of Thumb
It is a good rule of thumb to remember that only 75% of gross rent can be used for qualifying purposes in most cases, but it will be offset by the full housing payment for the departing residence.
Fannie Mae is the most flexible when it comes to departing residence requirements, but borrowers should always check with their lenders to make sure “equity cushion” and/or “landlord experience” rules do not also come into play for the type of loan they are seeking.
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167