Should I Rent My Current Home So That I May Purchase Another? Well...

Choosing to rent one's current home and also purchase a new primary residence isn't a decision to be made lightly. A homeowner's ability to take advantage of this particular arrangement depends on a number of factors about which they may not be fully aware. 

Most obviously, homeowners should consider whether they have the desire to become landlords with all the responsibilities and potential expenses of the role, especially in a State such as Massachusetts in which the laws are very pro tenant. It's relatively easy to find a tenant but not nearly as simple to sever the relationship should it take a turn for the worse. And should a landlord ever decide to sell, the presence of a tenant will play a role in the transaction especially if a buyer plans to finance rather than pay cash. The buyer may also be expected to assume the seller's obligations to the tenant.

If you are serious about buying a new home and turning your current home into an investment rental, here are just a few of the many things you should keep in mind:

• "The best defense is a good offense." Seems like common sense, doesn't it? It isn't. There are countless stories of homeowners turned landlords who regret not doing their homework first. Typically they speak with an attorney after something has already gone wrong with the deal hoping they can now fix a situation that could have been averted altogether with less expense and aggravation.

• Begin by speaking with an experienced loan officer -- emphasis on experienced -- and explain what you hope to accomplish. The LO will tell you what you need to do to successfully obtain financing for your new home in the context of retaining your current home as an investment property. If everything is in order, you should be able to obtain a pre-approval for your next home.

• Expect to be asked about the reason for your desired move (especially if the two properties are less than 50 miles or so apart). Your reason will need to be acceptable by current financing and fraud standards. Your LO and underwriter must prove that you're not engaging in "buy and bail" fraud. Buy and bail is simply buying a new home with intent to dump the previous one -- and lenders are expected by the government to be on the lookout for fraud. Understand that it's nothing against you personally. 

• You may be expected to show sufficient equity in the existing property -- the magic number is generally as high as 30%. Should you lack sufficient equity, ask your loan officer what other options might be available to you (e.g. paying down the existing mortgage to an appropriate level, or using a different loan product that might allow for less equity in the soon-to-be investment property).

• You will only be able to apply a portion of rental income toward qualifying income if you meet the requirements of the specific loan product and lender. In some cases, a signed lease agreement from a renter and proof of the security deposit is sufficient (e.g. FHA), while in others the lender may require a 2 year history of rental income as documented in your filed tax returns. Absent the required proof, you'll have to qualify to carry both mortgages as well as any other debts based solely on your income from sources other than rental income.  

• Secure the services of an experienced real estate attorney. Explain what you plan to do and have your attorney walk you through everything that must be accomplished from a contractual perspective, especially your obligations to the tenant (and vice versa) once you assume the role of landlord. While you're at it, ask your attorney to explain what will be expected of you should you ever decide to sell the property. 

• When you do finally go home shopping, if you fall in love with a home that is currently occupied by the seller's tenant get your attorney involved right away before making an offer. Your goal is to fully understand and assess the opportunity up front to avoid headaches, unanticipated expenses and disappointment later.

[UPDATE 3/21/2014] There are a number of other factors and considerations beyond those highlighted above. For example, you'll pay for two appraisals, one for each property. You'll be expected to show several months of liquid reserves for each property beyond the funds required for closing (i.e. typically as much as 6 full mortgage payments per property). Your credit history and scores will have an impact on everything from the cost of the interest rates available, to the loan products available, and the minimum required size of your downpayment. The existence of a second mortgage, home equity line, etc. may affect refinancing in the future especially if the liens are with a different lender (resubordination can quickly complicate refinancing). This list goes on an on which is why it's so important to consult with your loan officer and attorney very early in the process before making any plans. [/UPDATE]

Can turning your existing property into a rental be a great way to transition into your next home, and potentially generate some additional income? Absolutely! So long as you prepare yourself, put together an experienced support team (loan officer, attorney, real estate agent, etc), identify any potential issues early on, swiftly address the issues and think ahead, but never get ahead of yourself.

As always, I wish you all the very best.

Weighing the Cost of Refinancing

First, thanks to Jim Moran for giving me the opportunity to contribute to his excellent community-focused website. This is my inaugural article and I hope the first of many. I chose a topic that weighs on the minds of many people across the country and right here in our community - refinancing. Feel free to contact me if you have questions about anything I post.

Never underestimate the power of refinancing -- from lowering interest rates or monthly payments to providing cash for mounting debts or speeding up loan pay-off. It's up to you to weigh the benefits of refinancing against the potential impact of the status quo. Below are a just few examples of ways in which homeowners can leverage refinancing to address their ever-changing needs and goals.

Refinancing to Lower Monthly Payments

Let's say a couple begins to feel the burden of their $150k 15yr 3% fixed payment of $1,035 perhaps due to a recent increase in their property tax or homeowner's insurance or a new and unanticipated expense. Whatever the reason, they feel that they must lower their monthly payment to make ends meet. Yes, 3% was an amazing rate when they refinanced a couple years ago, but it's irrelevant. They have already identified and dealt with other expenses (i.e., they have reduced or eliminated as much as they could) and now they've turned their attention to their monthly mortgage obligation before it begins affecting their quality of life. 

What to do? Well, they should avoid making too many assumptions and resist treating assumptions as facts. Maybe income will increase. Maybe taxes will go down (don't we all wish!). Maybe in a year or two things will turn around, right? Perhaps, but is the couple prepared to take that risk? Can they afford to absorb the consequences if they're wrong? Millions of people made similar assumptions about their finances and the future and we all know how that turned out in 2006-2007 when all those assumptions went right out the window along with income and equity few homeowners could afford to lose. These days, it's all about facts and outcomes.

So, what about refinancing to lower their monthly payment? Here's a fact: a 30yr 5% fixed refi -- even with 100% of the closing costs rolled into the loan -- would lower the couple's monthly payment to $826. Is it ideal? Of course not. In fact, the rate is higher, the term twice as long, and if they never sell the house or refinance again (though most will), they'll pay considerably more interest than the current loan terms. Under ordinary circumstances most families would say no, thank you. However, recent years have been anything but ordinary. Depending on this couple's circumstances that $200/m reduction in their mortgage payment might make a huge difference in their day-to-day quality of life and ability to stay afloat. For too many families in and around Longmeadow that's a reality and other avenues such as finding alternative ways to reduce current expenses may not be enough.

The scenarios are endless: refinancing from an adjustable rate mortgage (ARM) into a longer-term fixed rate loan, or from one ARM into another to put off the inevitable rate increase, or increasing the duration of the current fixed rate loan, and so on. 

Yes, in today's market with rising interest rates a refinance isn't quite as attractive as it was during the depths of the recent recession, but those historically low rates are gone. Still, we are a long way from the 17+% peak interest rates of the early 80s. You may find or feel that you have no choice but to refinance even at today's rates. You can either lower your minimum monthly payment obligation knowing that the long term overall cost may be higher, or you can deal with the fallout from a monthly payment that has already proven itself to be unsustainable even in the short term. Will it feel as if you've taken a step backward? Initially, perhaps. But if it means freeing up current income to pay other equally important expenses, sometimes we have to take a step or two backward in order to make ends meet and move forward.

Depending on how dire your situation has become, or the direction in which it may be headed, refinancing may not be an option available to you. For example, if your home's value is currently less than what you owe on it (a.k.a. being "upside down") or you've already begun making late payments, or you have a second mortgage with a different lender that is unwilling to resubordinate the lien, then refinancing may no longer be an option. However, other options such as mortgage modification, regular sale, or short sale may still be available. It's best to consult a real estate attorney to understand your rights and protect your interests before entertaining a mortgage modification or a sale of any type. Often the initial consultation is free. Frankly, you're not going to be thrilled by any of the options, but with so much at stake the worst possible decision is to do nothing at all. Just remember, the amount by which you could reduce your monthly obligation will depend on your specific circumstances, and the terms available to you. 

Refinancing to Draw Cash Out or Consolidate Debt

While a majority of homeowners have used refinancing to lower their monthly payments in recent years, there are other uses for it. For example, if you have sufficient equity in a property you may be able to extract some of that equity through what is known as a "cash-out refinance".  There is always a limit to exactly how much equity you can access and it will depend on several factors including but not limited to how much you currently owe on the property as well as how you're using it (i.e. as a primary residence, second home, or investment property) and whether or not your current income and assets can support a larger loan amount.

Let's say you own a primary residence with a current appraised value of  $250,000 and a mortgage balance of $125,000 (50%). If the lender with whom you're dealing allows up to 80% loan-to-value on a cash-out refinance of a primary residence, you may be able to draw out up to 30% of the home's value in cash to use as you wish (minus closing costs if you choose to roll the costs into the new loan). Homeowners use cash out refinancing -- as well as related financing such as home equity loans and lines of credit -- for a variety of purposes from remodeling and repairing their property to paying for their child's education, paying off debts that carry significantly higher interest rates, or even taking vacations.

Would your monthly payment be higher, lower or about the same? Again that will depend on a number of factors including how much equity you wish to cash-out as well as your original terms versus your new terms. You should consider the benefits of a cash-out refinance (e.g., paying down high-interest debts, putting a child through school, etc.) versus the costs (i.e., the higher loan amount and new terms). You should also consider whether a home equity line or loan would make more sense -- both are usually available with lender paid closing costs and without altering the terms of your current mortgage. 

Refinancing to Build Equity Faster

No discussion about refinancing would be complete without mentioning how to leverage it to pay off a remaining loan balance more quickly and at a lower cost. Should you have the means to do so, you may be able to refinance into a more aggressive payment schedule, possibly at an interest rate lower than your current rate if you haven't already refinanced in the past couple of years. 

Before you entertain refinancing to build equity more quickly, keep in mind that you can accomplish the same basic goal without refinancing by making additional payments toward your principal. Even an extra $100 per could potentially trim months or years off of a mortgage at your current rate and terms. You can use any online "early payoff" calculator to determine how much you'll save in time and money for a given size additional monthly payment in the context of your current mortgage. Nevertheless, refinancing may offer a favorable combination of financial and tax benefits that additional payments toward principal cannot. 

Proceed with Caution 

What seems like the best option intuitively, may not be. For example, many consumers are under the mistaken impression that purchasing a home with cash is always better than having a mortgage, or that shorter loan terms are best. There is no universally correct answer because it depends on your unique set of circumstances (i.e., your tax position, investments, assets, goals, etc). This is where your financial advisor, tax advisor and loan officer can be of tremendous help.

Make the time to speak to your local loan officer and professional advisors about your situation to find out which options are available to you and how they compare. With rates steadily creeping upward since this time last year, now is definitely not the time to procrastinate. 

Whatever you choose to do, all the best to you and your family in 2014.

Home Financing 101

2014 is shaping up to be a good year for purchasing a home in Longmeadow.  Price affordability is good with mortgage rates at historically low levels and prices significantly lower than the 2007 peak.

Mr. Joseph Martins, a Longmeadow resident and Home Financing Educator explains the basics of how to purchase a home including details about how to consider financing, insurance, maintenance and other costs of home ownership.

 

If you are a first time buyer and looking to purchase a new home it makes good financial sense to listen to this video to gain some good advice as to complete the process