New mortgage and renting current house?

[edro]

We have a small house in a great neighborhood, where most of the houses are rentals for college students.

We want to buy a new house, but also rent our current house.

How do mortgage companies handle this?

We have enough cash for a down payment (20%) on a new house, and the balance on our current mortgage is <$100k. After checking the rental market on our street and in the surrounding area, we can rent the house for more than our mortgage/insurance/taxes.

Does the bank look at your total debt to total income ratio when qualifying you?
ie... Income + Rental Income - mortgage 1 - mortgage 2?
Or do they assume that you might not rent it out and use:
Income - mortgage 1 - mortgage 2?

Thank you for any insight.

 

[BTA]

I've talked to a couple of mortgage guys recently because we were considering doing the same thing.

They really don't care what you say you're gonna do with your current home. They will still only approve you for what you can afford assuming you still have that debt, and they don't consider any possible rental income.

So for me, it was Income - mort 1 - mort 2

It could be different depending where you live or what banks you are talking to, but it seemed pretty consistent when i was looking that they do not take into account any possible rental income.

 

[edro]

I do not see anything consistent online.
It must vary by bank and loan quite a bit.

Some say they add a ~.75 multiplier to your rental income to counteract maintenance and vacancy.
Others say they require a ~12 month rental history to prove it is rentable at a said rate.
More say rental income is not counted at all during pre-approval.

I guess I just need to go to some mortgage companies and see what their policy is.
Based on generic calculators online, even if we can't count rental income, we should be preapproved because our current mortgage amount is small.

 

[highland145]

IIRC, heard about a similar situation and the mortgage co. on the first property was way pissed when they found out it wasn't owner occupied. Don't know the outcome. Useless information in my brain.

 

[SunnyD]

I've talked to a couple of mortgage guys recently because we were considering doing the same thing.

They really don't care what you say you're gonna do with your current home. They will still only approve you for what you can afford assuming you still have that debt, and they don't consider any possible rental income.

So for me, it was Income - mort 1 - mort 2

It could be different depending where you live or what banks you are talking to, but it seemed pretty consistent when i was looking that they do not take into account any possible rental income.

Actually, they will consider rental income - but only if you're already getting it and reporting it accordingly. You need proof of income. Speculation that you will be receiving income doesn't count, which is what the OP wants to be relying on.

OP, rent out a small apartment to live in and find tenants for your house. Once you have that income coming in, you can report it as income to the lender, and have it counted toward a new mortgage application.

 

[dullard]

After checking the rental market on our street and in the surrounding area, we can rent the house for more than our mortgage/insurance/taxes.

I'd like to say that you are looking at the picture incorrectly. Don't fret, most people do the same thing. You aren't including all of the variables in your calculation, thus, your calculation could be quite far off and could leave you miserable.

Case 1: keep the old house and rent it out.

* Yearly Income: Monthly rental price * 8 months a year + gain in house value. Remember, you won't likely be renting it all the time because renters come and go and you need time between to fix it up and find a new rentor, so just use 8 months, not 12 months. The house value gain varies dramatically with location, but you can expect a $200k house to gain about $300 a month in value if you maintain it well. Adjust up or down depending on your area , level of care, and current house value.

* Yearly Expenses: interest (not mortgage amount, since that includes principal) + real estate taxes + rental income taxes + insurance + added accountant fees for running your own business + repairs + maintanence + advertising + headaches from having do deal with all of this.

Not only did you over-count your income, but you under-counted your expenses in your math that I quoted above. But, you also left off the more important question: is the profit from case #1 more or less than case #2 (selling the house).

In case #2, the math is simple. Take the house value, minus the amount you still owe and multiply by the interest rate that you'll be paying on your new house. To be fair, don't count realtor fees in this math, since you'll have to sell it eventually in case #1 too, so doing so in case #2 but not case #1 would be an unfair comparison.

 

[OCGuy]

You have to have 30&#37; equity in your current home in order to count rent into your DTI.

<----- Underwriter

I am talking about Fannie/Freddie standard loans here. There may be portfolio products with less strict guidelines, but those are getting harder to find.

 

[Thump553]

-Take note that your insurance will go WAY up when you convert this property to a rental. You also get a lot less coverage (for example, contents coverage is gone). Talk to your insurance agent first.

-Remember income tax law effects-you will have to start depeciating the house when you convert it to rental. This has the positive effect of sheltering current income, but it comes back to bite you when you sell the rental. Also when you sell the rental, profit you make off it is taxable (barring a swap), even a paper profit whereas with a minimal amount of effort the average person can shelter any gain off the sale of their home for life (up to 500,000 in gain). It would be more complicated in your case as some of the profit is attributable to when the property was your home.

-check your mortgage, nearly all allow you to move out and rent after 60-90 days, but some require you to live there so long as the mortgage is in force. Usually the restrictive ones as from a special loan program.

-Finally: Rent to college students-ARE YOUR CRAZY? Just torch the place, it's quicker and the same result with a lot less grief (even counting the prison sentence for arson).

Talk to a few landlords, being a landlord is a lot more involved than cashing a check once a month.

 

[wyvrn]

I do not see anything consistent online.
It must vary by bank and loan quite a bit.

Some say they add a ~.75 multiplier to your rental income to counteract maintenance and vacancy.
Others say they require a ~12 month rental history to prove it is rentable at a said rate.
More say rental income is not counted at all during pre-approval.

I guess I just need to go to some mortgage companies and see what their policy is.
Based on generic calculators online, even if we can't count rental income, we should be preapproved because our current mortgage amount is small.

The .75 multiplier is correct. I get this all the time, and I have multiple rentals. Some banks also want reserves because of this market. They think they are afraid of investors, when in actuality investors are the largest part of the current market. But they will ask from anywhere to 6 mos to 12 mos in cash reserves PER rental property.

You may get pre-approval without this, but they will check it during underwriting. You can use approx 1/2 of your 401K/IRA against these requirements, but you must have some of this in cash reserves or underwriting won't approve it.

 

[wyvrn]

-Take note that your insurance will go WAY up when you convert this property to a rental. You also get a lot less coverage (for example, contents coverage is gone). Talk to your insurance agent first.

-Remember income tax law effects-you will have to start depeciating the house when you convert it to rental. This has the positive effect of sheltering current income, but it comes back to bite you when you sell the rental. Also when you sell the rental, profit you make off it is taxable (barring a swap), even a paper profit whereas with a minimal amount of effort the average person can shelter any gain off the sale of their home for life (up to 500,000 in gain). It would be more complicated in your case as some of the profit is attributable to when the property was your home.

-check your mortgage, nearly all allow you to move out and rent after 60-90 days, but some require you to live there so long as the mortgage is in force. Usually the restrictive ones as from a special loan program.

-Finally: Rent to college students-ARE YOUR CRAZY? Just torch the place, it's quicker and the same result with a lot less grief (even counting the prison sentence for arson).

Talk to a few landlords, being a landlord is a lot more involved than cashing a check once a month.

In Texas, my insurance is actually quite a bit cheaper. As low as 1/3 in some cases. In our state, we use one type of policy for home owners, and another for rentals called fire dwelling. The renters are then responsible for renters insurance, which is stated in their leases.

The local property tax authority, however, will raise taxes higher on rentals because they don't have the Texas homestead exemption. Not sure how it works in other states, so I would suggest a call to the local taxing authority to find out.

As far as depreciation, this is correct mostly. Depreciation is a tax shield against business income, not personal income. So if his rental only makes $100 per year, his effective depreciation is only $100 per year. Therefore, it is not as if he is liable for the entire depreciation schedule in recapture when he sells. Depreciation is a benefit, not a detraction, because it shields current business income, and if the investor so desires, allows them the ability to build their business, tax deferred, for as long as they wish. Not many other business models have this advantage.

Also there is the 1031 like property exchange, where one can avoid (defer) capital gains taxes upon subsequent deals for as long as one wants, as long as they follow a couple of rules. Real estate is the most tax advantaged investment there is.

If you rent to college students, have a strong lease and enforce it, and you won't have any more problems than you do renting to anyone else. I have several properties near a college, and they are BY FAR the most profitable ones I own. I wish all my properties were next to colleges.