When the real estate market was booming, it was not difficult for someone who wanted to own a second property to do so. With today’s economic downturn and the high foreclosure rate, lenders have increased underwriting standards and have been more cautious when it comes to lending for a second home, especially when a borrower plans to make their first home a rental. Nevertheless, if you have enough income and good credit, buying a second home when your first home is underwater may still be an option.
Buy and Bail
When it became common for homes to be underwater, some borrowers decided that it was better to buy another home rather than pay into a home declining in value. Some homeowners qualified for second homes by telling lenders that they planned to rent out their first home. After buying the second home, they instead walked away from their first home. This practice became known as “buy and bail,” and it left lenders with no option but to foreclose.
Converting First Home to a Rental
Because of the buy-and-bail practice, the Federal Housing Administration tightened its underwriting guidelines for converting existing homes into rentals. If you plan to rent out your first home and live in the second home, you must have enough income to afford both mortgages, unless an exception applies. If you are relocating for a new or current job or have at least 25 percent equity in your home, then rental income, minus the vacancy factor in your area (an amount subtracted from the rent to account for vacancy), can be considered. Other lenders have similar requirements and may even insist that a borrower have at least 30 percent equity.
Buying property as an investment rather than to live will eliminate some of the concern from lenders, but you will need to qualify in other ways. For example, you will need a down payment of at least 20 percent, a good credit score (at least 740), enough income to pay both mortgages, and savings to cover six months of personal and investment related expenses. In addition, your debt-to-income ratio must not be too high, typically not above 45 percent.
Financing Options for Investment Property
Besides getting a loan from a big bank, there are other options, such as a loan with a local bank, owner financing or a private loan. Local banks are a good option if you have less than the needed down payment or if your credit score is high, but not quite as high as required by a larger bank. Before the real estate boom, owner financing was an unpopular choice, but in today’s market owners are more willing to offer this option. Another choice is to seek a peer-to-peer loan, which is from an individual lender who is not a family member or friend. Typically, in this case, your credit history and income will be carefully scrutinized but it is a good option if you are lacking a 20 percent down payment or a traditional borrower profile. You can connect with a private investor at websites like Prosper.com and LendingClub.com.
Jessica McElrath has been a freelance writer since 2000. McElrath is the author of "The Everything John F. Kennedy Book" and "The Everything Martin Luther King Jr. Book." McElrath has a Bachelor of Arts in history from the University of California at Berkeley and a Juris Doctor from Santa Clara University School of Law.