Buying a home in this market can be difficult to say the least. Buying a new home with a loan when your current home is upside down seems near impossible. Not for Jim and others like him.
You see, Jim, like many people out there, makes decent money and unfortunately he paid too much for his home 5 years ago. Luckily he used a 30 year fixed loan on his current residence so the payment is set, however, the value of his home in East LA County has dropped more than 50%.
Most people will walk away from something like this, but not Jim. He’s put too much of his own money, time and heart into his home to just up and walk away. Jim will honor the repayment of his debt over time unlike many others. However, Jim now wants to move to Temecula, California, roughly 60 miles away where home prices have dropped near 60% from their 2005 high.
Needless to say, there are some fantastic homes at incredibly low prices plus interest rates are at their absolute bottom. Jim found the home he wants in Temecula, but he now faces a challenge that few are able to overcome. He must demonstrate to a mortgage lender that he is buying a new primary residence and not an investment home.
His current residence will become a rental after he takes possession of the new home, however the lender will not allow rental income to offset his debt obligation. That poses a problem as he will now have to qualify for the new home with the liability from the departing home. In order to count rental income on a departing residence you must have a) 25% equity in the home and b) have experience as a landlord – basically showing a history of renting property. Jim has neither.
The next challenge for Jim is finding a lender that allows higher debt to income ratios. Many lenders are diving into the safe haven of ≤45% total debt to gross income. That’s a good rule of thumb for all as this will enable most to survive. When your DTI is ≥50%, that poses a significant risk for future delinquency.
Jim doesn’t worry about delinquency as his income is stable and he knows that the rental income on the departing residence will offset his debt, but again, the lender doesn’t care about that rental income for the new purchase. Jim’s overall DTI is 54.2% with both residences and other liabilities (car, credit cards). That is slightly under the 55% threshold for some lenders, so we’re good, right?
Not so fast. Although he qualifies with income, credit and assets, he now has to face the labeling of “Buy and Bail.” The majority of lenders shy away from any new purchase transaction that entails a departing residence upside down in value as they feel the borrower will eventually foreclose on that home – posing a possible risk to the new home. No lender wants to contribute to the ongoing slew of foreclosures; therefore many would simply close their doors to this loan.
Jim is destined to buy this new home. He wants to hold on to the home in Los Angeles, rent it out, keep it for his children for the future. He has good intentions. So, I instruct him to do a few things for the new lender:
- write a detailed letter of explanation about the situation, demonstrate his DTI will be 38% with rental income and under the guideline of 55% without it – therefore having enough income to pay for both residences
- provide proof that he is actively marketing his departing residence for rent
- show that the new home is a ‘trade-up’ in value
- sign an additional disclosure for the lender that demonstrates he will take possession of the new home as his new primary residence within 60 days of closing
None of this guarantees approval from the lender. This is simply building his case as an attorney would build a case for his/her client.
The lender accepted the documentation and proceeded with the loan. This is a true success story not only for Jim but for FHA. Without FHA and our ability to provide sufficient evidence to overcome the objectives, Jim’s dream of building a legacy for his family would have stopped short.
Jim is now thoroughly enjoying his new home and has a solid renter in the LA home on a 3 year lease.
Who do you know like Jim that has a home upside down in value and wants to pursue purchasing a new home in California?
Call me today at 951-506-4663 to discuss the situation.
Your comments are certainly appreciated.
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