Dennis' Mortgage Blog

Our current real estate market is mostly on the lower end of the price spectrum--first time buyers and those moving up from their first home to their second. With the decline in values in most markets we are also starting to see activity with the move up buyers--but many are trying to move up without selling their homes. 

By holding on to their homes until the market turns around, and with Southern California coastal property (almost any area in LA and Orange Counties that are fully developed) it is not if the market will turn but when, homeowners are looking to take advantage of depressed prices on their move up market and buy a new home before they sell their existing home.  In doing this they convert their existing home to a rental and also can reap some tax benefits if they are able to sell within the 2-in-5 time limits:  if you have used a property as you primary residence for two of the last five years you can sell it and not pay investment capital gains (check with your CPA or tax preparer before planning on this strategy to ensure you qualify--I am not a CPA and not qualified to give tax advice). 

This activity is positive for the real estate markets, any activity that involves families buying homes at any price level is positive for the markets.  The problem is that Fannie Mae and Freddie Mac have posted new guidelines effective July 1, 2008 that prevents most homeowners from converting existing homes to rentals and purchasing new homes.

Under the new guidelines rental income for primary residences converted to rental will not be eligible for qualifying for a new mortgage unless: a) the existing property being converted has at least 30% equity b) the borrower provides a copy of an executed lease, and a copy of deposit check from renter and a copy of the deposit of that check into borrower's bank account and c) borrower has reserves of at least two months PITI for both properties.

So if your home is worth $500,000 your existing mortgage must be $350,000 or less, and we need a copy of the lease and the deposit check from your renter to be deposited into your bank account and after the close of escrow on the new home you will need several thousand dollars--enough to cover two months payments on your old and new homes--in your bank account.

I understand the reasoning from Fannie and Freddie; they are trying to prevent buyers from moving up in the market to a bigger home or nicer neighborhood and then just letting their existing home go to foreclosure due to lack of equity.  We saw this happen in Southern California in the late '80s and early '90s.  Yes, I understand the reasoning behind the new guideline, however I feel they have made it too restrictive and it will cause a lot of buyers to pull out of the market due to their inability to qualify and meet the guideline.

Or instead of pulling out maybe they will decide it is best to go ahead and move up now and sell their existing homes for whatever the current market will bear. 

This guideline caught us by surprise when it was announced, and it reinforces the importance of being in constant communication with your mortgage professional and also making sure all the qualification guidelines are met as the first step in the process to purchase a new home.

Does this guideline affect you?  Call me and let's discuss your situation!