FHA bans "BUY and BAIL" strategy
FHA just released new rules which specifically address loan transactions in which a borrower is purchasing a NEW primary residence WITHOUT selling their existing resident.
Commonly known as "BUY and BAIL", many people have been buying a new (usually cheaper) home then purposely letting their old home go into foreclosure. Many of these original homes had been For Sale without selling for a significant amount of time, and are usually worth LESS than what is owned.
To achieve this, many new applicants "claimed" their existing home was to become a rental property, then used fake "rental income" to qualify.
The conforming market also recently closed this loop hole by mandating new loan-to-value guidelines on homes being converted to rentals, proof of security deposits, significantly higher amounts of money in application bank accounts for reserves, and new rules as to what can and can't qualify as rental income.
The entire FHA Mortgee Letter text follows, but is also available at http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/files/08-25ml.doc
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Mortgagee Letter 2008-25
Through this Mortgagee Letter, the Federal Housing Administration (FHA) takes steps to immediately respond to an unscrupulous practice arising in the housing mortgage market that poses a risk to FHA, FHA-approved lenders, and consequently to FHA’s ability to help new homeowners.
Recently, FHA and others in the mortgage industry have observed an increasing number of homeowners who have chosen to vacate their existing principal residence and purchase a new residence. This has been occurring as some homeowners, given the rising price of fuel, are relocating to homes nearer their employment, or are taking advantage of other home buying opportunities arising in the marketplace.
Due to FHA’s concern that some homebuyers in these transactions may attempt to provide misleading information regarding the rental income of the property being vacated to qualify for the new mortgage, FHA is instituting underwriting guidance designed to assure that the homebuyer can make payments on the full debt service of both mortgages. Consequently, beginning with case number assignments on or after the date of this Mortgagee Letter and until further notice, the underwriting analysis may not consider any rental income from the property being vacated except under circumstances described in this Mortgagee Letter. The exclusion of rental income from property being vacated is being instituted on a temporary basis while FHA further analyzes this situation to determine whether permanent measures may need to be taken. This will assure that a homeowner either has sufficient income to make both mortgage payments without any rental income or has an equity position not likely to result in defaulting on the mortgage on the property being vacated. In either case, this guidance is directed to preventing the practice known as “buy and bail” where the homebuyer purchases, for example, a more affordable dwelling with the intention to cease making payments on the previous mortgage. Although the property being vacated will not have a mortgage insured by FHA, surrounding properties may and, thus, FHA may be indirectly negatively affected should that property result in a foreclosure.
Exceptions:
Rental income on the property being vacated, reduced by the appropriate vacancy factor as determined by the jurisdictional FHA Homeownership Center (see http://www.hud.gov/offices/hsg/sfh/ref/sfh2-21u.cfm) may be considered in the underwriting analysis under the following circumstances:
· Relocations: The homebuyer is relocating with a new employer, or being transferred by the current employer to an area not within reasonable and locally recognized commuting distance. A properly executed lease agreement (i.e., a lease signed by the homebuyer and the lessee) of at least one year’s duration after the loan is closed is required. FHA recommends that underwriters also obtain evidence of the security deposit and/or evidence the first month’s rent was paid to the homeowner.
· Sufficient Equity in Vacated Property: The homebuyer has a loan-to-value ratio of 75 percent or less, as determined by either a current (no more than six months old) residential appraisal or by comparing the unpaid principal balance to the original sales price of the property. The appraisal, in addition to using forms Fannie Mae1004/Freddie Mac 70, may be an exterior-only appraisal using form Fannie Mae/Freddie Mac 2055, and for condominium units, form Fannie Mae1075/Freddie Mac 466.
The guidance in this Mortgagee Letter applies solely to a principal residence being vacated in favor of another principal residence. This Mortgagee Letter is not applicable to existing rental properties disclosed on the loan application and confirmed by tax returns (Schedule E of form IRS 1040).
It is important to note that if the property being vacated had a mortgage insured by FHA, eligibility for a second FHA insured mortgage can only occur under the exemptions described in handbook HUD-4155.1 REV-5, paragraph 1-2.
If you have any questions regarding this Mortgagee Letter, call 1-800-CALLFHA.
Joesph, nicely written. I had written a similar blog today about the mortgagee letter as well.
Great
This is one of the welcome changes! I have seen it happen and had prospective clients ask me to participate in this practice and I have refused. I'm going to pass this along to a few other agents I know who have considered get sucked into this practice.
Thanks Joseph, Great information that I was unaware of. Probably a good idea too on FHA's part. Might help cut down on abandoned homes.
Thank you for the useful info! I will pass this along to buyers who are thinking about buying and bailing!
Hopefully this will slow down the foreclosure, short-sale market - every little bit helps. Thanks for the information.
Joseph, this is a good thing. This actually happened to us - we were going strong, many potentials, then all of the sudden we could not find the owners - next thing you know they foreclosed. Too bad that this did not happen before, I think it would have went along way in helping the current situation - not solving, but certainly helping.
Well its all and good that step are finally being taken to somewhat control the situation but from a prespective of homebuyer who owns a property already and looking to upgrade will definately encounter obstacles to qualify for a loan. esp those who taking advantage of the lower prices have taken out equity on thier current home just to pay for the downpayment and closing cost on thier second purchase. As an agent a few of my clients are in a similar position and some no doubt will not be able to qualify for thier second loan.
It was necessary and makes sense with the one problem in which they acted too hastily and didn't think it all the way through. To begin with, there are too may people who have been pre-approved and are shopping for homes based upon that pre-approval. I guarantee you there are many legitimate buyers out there waiting for an answer on an offer they made and now will not be able to go through with it or they already received the contract & turned in it on Thursday or Friday yet the processor did not get around to pulling the case # until Monday or Tuesday. A minimum of 15 days notice should have been provided for just those cases. The other issue is they left out a much needed exception of outgrowing your current home. There are too many people that purchased their first home while they were single. It was a 1 or 2 bedroom condo or townhome. A few years later they find themselves married with a child (or more) either here or on it's way and no longer fit in that small first purchase yet there is no way they have built up 25% equity in that short time frame, especially in this market of declining values. It's a real shame those people were not considered when FHA made this decision. They are not the exception, they are the rule.
Is this conditional on both exceptions being fulfilled (you move and have enough equity) or one or the other?
Is this conditional on both exceptions being fulfilled (you move and have enough equity) or one or the other?
I agree with Liana Jimenez - The Underwriting Center, Inc
"I AM" a legitmate buyer....I have a home that's now valued at $110K and I owe $120K and now that I'm married, my husband and I REALLY DO need more space.
I was pre=approved for loan on Oct. 1st and 30 mins after I received my pre-approval letter, the Loan Agent told me that NOW, FHA won't allow you to purchase w/ only 3.5% if you have a 2nd home...you MUST have 25-30% of equity in it for it to be considered income (Who in the hell has equity in their homes anymore....????) I mean really...I've been trying to sell my house for 2 years...2 and no ones buying.....so it doesn't make a difference if I rent or not, --If we can't buy another home then what's the purpose....
So, legitimately, we're wanting to buy a home in North Carolina....but b/c of this...we're stuck here in Georgia...BLAH!!! I anticipate there being at least 2-3 yrs b4 we can sell....
I'm definitely one of those legitimate buyers that just got tken out of the market. I own my home and have owned it for almost ten years. We were preapproved back in June and we finally founf the perfect home, but a week too late!!! After shopping around for months we finally fell in love with the perfect house but can't seem to find a way around this FHA rule. We can't even go to a conventional loan because those have gotten even stricter as well. Are only option, so we are told, is to sell our current home...at today's market, we are basically giving it away!!! We were ready to put down 10% but conventional loans now require 15%. Who has 15% to out down on a house now a days???