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No FHA Mortgages to Buy & Bail

by Peter G. Miller
September 24th, 2008

Okay, here’s the problem. You want to buy a home but already own one. With markets slowing house #1 does not seem likely to sell so you decide to rent it out to avoid the problem of two mortgage payments.

Not a bad idea — I’ve done it myself. In a rising market such an approach can be attractive while in a down market such a strategy could well be a necessity as homes linger on the marketplace for months and months.

Now, however, those who hope to finance with an FHA mortgage will have to deal with a new wrinkle from HUD: Renting house #1 may be a no-no unless certain standards are met.

Under a new rule HUD says that the “FHA and others in the mortgage industry have observed an increasing number of homeowners who have chosen to vacate their existing principal residence and purchase a new residence. This has been occurring as some homeowners, given the rising price of fuel, are relocating to homes nearer their employment, or are taking advantage of other home buying opportunities arising in the marketplace.

“Due to FHA’s concern that some homebuyers in these transactions may attempt to provide misleading information regarding the rental income of the property being vacated to qualify for the new mortgage, FHA is instituting underwriting guidance designed to assure that the homebuyer can make payments on the full debt service of both mortgages.”

HUD provides no numbers and does not say a survey or poll was taken to confirm its suspicions. In other words, the new action is based on rumor and worry.

The new rule tries to prevent “the practice known as ‘buy and bail’ where the homebuyer purchases, for example, a more affordable dwelling with the intention to cease making payments on the previous mortgage. Although the property being vacated will not have a mortgage insured by FHA, surrounding properties may and, thus, FHA may be indirectly negatively affected should that property result in a foreclosure.”

Now that’s an amazing justification for a HUD regulation. It’s unfortunate that the same logic does not apply to delinquent conventional buyers who need to refinance with FHA loans.

Here’s the deal. You CAN rent house #1 and still get an FHA loan on house #2 but only under the following conditions:

___The homebuyer is relocating with a new employer, or being transferred by the current employer to an area not within reasonable and locally recognized commuting distance.

___There is at least a one-year lease on the property.

___The homeowner has obtained a security deposit and/or the first month’s rent.

___Not all rental income can be considered when qualifying for the new FHA mortgage. Lenders must consider a vacancy factor.

___”The homebuyer has a loan-to-value ratio of 75 percent or less, as determined by either a current (no more than six months old) residential appraisal or by comparing the unpaid principal balance to the original sales price of the property.” (Actually, you would hope the property has a loan-to-value ratio and not the homeowner….)

___The rules does not apply “to existing rental properties disclosed on the loan application and confirmed by tax returns.”

The rule plainly impacts those who are not moving because of a job change (think of those who are self-employed) and it surely hurts “recent” homebuyers.

For instance, suppose you buy a home for $220,000 and have a $210,000 mortgage at 6 percent interest. It’s a 30-year loan and you make full and timely payments each month. The loan balance will not be reduced to 75 percent of the original sale price ($165,000) for more than a decade — longer than many people own a property.

However, imagine that the value of the property has fallen to $200,000. In that case the loan balance would need to be below $150,000 to qualify under the new HUD rule — something that will not happen for 164 months (13.67 years).

Just a guess, but the betting here is that the overwhelming majority of individuals buying a replacement home and renting the current one have no intention of buying and bailing. At a time when a core housing goal should be to get inventory off the market, the HUD rule does just the opposite.

For the full rule, please press here.

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This entry was posted on Wednesday, September 24th, 2008 at 5:43 am and is filed under . You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.

4 Responses to “No FHA Mortgages to Buy & Bail”

  1. JM Arias Says:

    Sadly this rule is beginning to claim victims. I am one of them. My mother and I share the home that she and my father built and I grew up in. When my dad passed away twelve years ago, I moved back home because she could not afford to live on her own on her minimal salary. Although as a widow(er), you can claim your spouse’s Social Security, you have to wait until you reach the age of 60. My mom was 47 when my dad died. So I became her roommate. The house needed repairs several years back so she tried to refinance. Because of her low income (even though SHE made her payments on time) the bank with whom she had the mortgage refused to refinance the home for a home equity loan for home improvements. Because I wanted to help my mom I reluctantly offered to assume the mortgage so that we could repair and update the house.

    Flash forward to 2008, my mom turned 60 last year, currently receives part of my dad’s social security every month, and can afford to assume her mortgage again. Knowing this, I began the process of building my own house back in February. The home mortgage lending climate has changed dramatically since then. This new rule about rental property is extremely unfair. It is assuming that every potential home buyer is going to buy and bail. The mortgage on the home I am building is double the amount of mortgage on my mom’s home is. According to the letter put out by HUD, these “bail and buy” people are buying cheaper homes and bailing on the more expensive property. My mother will continue to live in HER home and will eventually refinance to put it back in her name. In the meantime for the purpose of my new home loan she was going to make the mortgage payments and for formalities sake, lease HER house from me. This new rule, however makes it impossible for me to do this not to mention that my mom’s house had to appraise at 25% higher than the debt and it appraised at 22%, a mere 3% shy. This slight difference makes it impossible for me to qualify. They will not accept buying down the principal for the $3275 appraisal shortfall. Long story short, if my mom can’t get approved to buy back her house, I will lose the home I spent the last eight months building.

    How’s that for sour grapes!

  2. Nina Says:

    I also agree with the last writter, my husband and I have been repairing our credit and awaiting for me to finish college to purchase a new house. The current house that we live is very small for the family of four that have two growing boys that have to share a room. It is about 900 sq. Since Sept 2008 we have been working a mortage broker that has been guiding us. Everything was looking fine I finished school and we both made good money and fair credit. Our mortage broker stated that we would get approved for a mortage and we could rent out the current house. Inthis market houses are not selling and besides the house was built but my husband grandfather. So, we needed to keep the house either way. We had everything was set in place and we suppose to apply for a mortage, broker called us and statedthat we can not purchased a house because of the buy and bail thing that is going around. Now, we had no idea or plan for a bail out plan, we had several people wanting to rent our house. Four years of denial of mortages and now we had a very good chance to move and the carpet has been taken from under our feet. I have done everthing that the mortage lender told us to do. Everything little thing they told us to do and now it was for nothing. Instead of repairing Michigan, it is making it harder to own a house. For people that are honest and trying to get ahead they are just getting puched back down. They told that I would have to have 6-12 months worth of payments of the old house in the bank, then I would qualified, but now I have the money saved up,they tell me that I sell will not qualify for a mortage. I do one thing and they change everytime I qualify. I just can not win. I tried putting the new mortage in my name because I am not on the current mortage and have nothing to do with it, it is still part of my income no matter what I still will not qualify unless we sell, which is impossible to do right now since everyone is losing jobs. I am at lose in what I suppose to do. and stick in a house that way too small for our family. We was so exicted to move and now I ahve to tell my kids that we can not and they have to stay in the same room for a while. Depressing…..

  3. Ledeen Says:

    Do all the guidlines apply????

    My employer wants to transfer me to Virgnia, but I own a home here in California and I cannot sell it (worth less than teh mrotgage)

    wanted to buy in VA and lease this one out, so Id meet all the criteria with the exception of the ltv on the existing home,

    so basically Ill be stuck RENTING in VA…..

  4. Frank Allgood Says:

    I am dealing with this issue right now and it is disastrous! I have a home that is worth less than the mortgage is on it and have secured a five year lease agreement with deposit covering the monthly mortgage payment. I am under contract to purchase a 270k home and have the 3.5% in cash to put down, plus I am paying closing costs out of pocket. My credit score is 770 and I have never been late or delinquent on any payments for anything. And now FHA is saying that I can’t count the rental income. Come on, how about half! I am frustrated to say the least!

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