Have you thought about investing in rental property? What about renting out your existing home?
If your home would make a good rental property, and you are enjoying a super low interest rate, keep it! You can use up to 75% of its potential rental income to qualify to buy a new home.
Here’s how it works: let’s say your home could rent for $1,000 per month. Instead of selling it to buy your next home, covert it to a rental property. You can use up to 75% of the potential rental income, or $750, to offset your current home loan payment. Thus, you will more easily qualify to buy your next home.
Of course you will need down payment money for a new home, but you can typically buy a new primary residence for as low as 3.5% down payment with an FHA loan, 3 or 5% down payment with a conventional loan, or 0% down payment with a VA loan.
VA borrowers – read my article for Military Investors.
Rental Property Qualifying Income – Lender Requirements
When I started writing this article, I was surprised by how easy it is for lenders to count rental property income as qualifying income.
Lenders typically require only three items to count rental property income as qualifying income:
- Rental Survey – the lender will send an appraiser to evaluate the fair market rent of your current home. The rental survey costs approximately $150-$200.
- Lease Agreement – during the escrow period, you need to submit to the lender a one-year minimum lease agreement for your rental property.
- Proof of Rental Deposit – during the escrow period, you need to submit to the lender a copy of your tenant’s rental deposit check, with proof that it was deposited into your bank account.
How Long Do I Need to Live in My Current Home Before Converting it to Rental Property?
When you purchase a home, you agree with the lender that you intend to occupy the residence for one year. After that year, there is no requirement for you to live in the home.
NOTE: Certain exceptions to this policy include down payment assistance programs and reverse mortgage programs. Check with your lender.
How Much Equity Do I Need in My Current Home?
For most loan programs, there is no minimum requirement of equity in your departing residence. The loan you currently have on that property does not change.
What Types of Loans Qualify with Rental Property Income?
When you convert your existing home into a rental, you can use any loan you would normally use to buy another primary residence. This includes conventional loans, FHA loans, and VA loans. You can even use jumbo loans, as long as you can qualify for the payments, have landlord experience, and have a higher credit score (700+). You can also read about mortgage limits.
Generally, the minimum FICO score needed to qualify for most home loans is 640.
How Much Does This Cost? Are Interest Rates Higher?
Lender fees do not increase when you use rental income to qualify for a new mortgage. The only additional fee involved is the rental survey, which costs approximately $150-$200.
There is no interest rate impact. Rates are not higher when you qualify for a new loan with rental property income from an existing home.
How Do I Get Started?
Becoming a rental property investor is easier than you might think. The first step is to estimate the fair market rent of your current home. An easy way to do this is to look on Craigslist for rental postings in your area. When you have a good idea of your home’s fair market rent, contact a lender to estimate your qualification amount. Then you can contact your real estate agent and start shopping for your next home.
What About Down Payment?
Depending on the loan program you utilize (FHA 3.5%, VA 0%, conventional 5%), you will need a minimum down payment for a new home purchase. Remember, 20% down payment is not required to buy a new primary residence.
The down payment funds can even come from a gift or a line of credit tied to your current home. If you have enough equity, you can open a HELOC and withdraw funds for the down payment.
What About Reserves?
Some lenders require that you have reserves after buying a new home if you own multiple properties. Reserves means monies left over in your account after the close of Escrow. Most current loan guidelines allow for $0 Reserves after buying a new primary residence.
If, instead of buying a new home, you buy an investment property, typically 6-12 months of Reserves are required for each property you own. Example: if your monthly payment on your current home is $2,500 and the monthly payment of your investment property is $1,500, 6 months of Reserves equals $24,000 ($2,500 plus $1,500 = $4,000 x 6 months). This is another reason why it’s easier to buy a new residence, and keep your first home as an investment, instead of buying an investment property.
What If I Already Live in my Forever Home?
If you want to stay in your existing home, you can still use the 75% income strategy to purchase a rental property. The difference is the loan program. Loans for investment property are usually more expensive than for primary residences.
Loans for investment property have a 15% minimum down payment requirement, which includes expensive mortgage insurance. Most savvy investors utilize 25% down payment to obtain best interest rates and try to ensure the investment property will cash flow.
Interest rates are usually 1/2% to 1% higher than if you were buying a primary residence.
The Bottom Line
Converting your current home to rental property can be the least expensive way to become a real estate investor. You don’t have to pay the higher down payment and interest rates associated with investment property loans. You enjoy the benefits of primary residence loan programs.
One reason this strategy may not work is if you need the equity from your current home for the down payment for your next home. In this case, you may need to sell your home, instead of keeping it as rental property.
As always, contact me with any questions.
I couldn’t have written this article without the expert advice of Nick Richardson:
Nick Richardson is a mortgage banker with EZ Fundings in San Diego, California, NMLS #966361. He can help you finance or refinance properties located in California. Nick can answer all of your questions about mortgage programs, with no hassle, no obligation. Contact him at 760-402-6962 or e-mail nick@ezfundings.com.
