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My wife and I are currently saving for a home. We currently own a small condo, which we would like to keep as a rental unit once we purchase the second home. Currently our home costs are under 12% of our take home pay, so we would comfortably be able to afford both mortgages if we couldn't rent it out. Worst case scenario, we could sell the home if we cannot find a suitable renter.

Will we have any trouble getting a mortgage for a second home if we decide to keep this home?

Some more information

  1. We only have about 20% equity in our current home, but we would looking to put that amount down on the second home (from our cash on hand -- not from current home's equity).
  2. We have no revolving debt.
  3. We have one car payment. $320? I don't remember we pay $400.
  4. Current mortgage is $603.50 + $100 HOA. We should be cash flow positive on this property from day one according to going rates in our area.
  5. Next home will probably cap around 300K with 20% down, so ~240 - 250K mortgage on the top end. So it will all depend on interest rates then (we both have excellent credit).
  6. Current gross combined is ~11K / month.
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You lost me here. You're looking to use the 20% equity you have to put down on the new house, then how are you considering keeping the first one? –  JoeTaxpayer Jun 27 '11 at 17:27
    
Updated to reflect that we have that amount of cash on hand, and would not be looking to use a HELOC to help with a down payment on the second home. –  Scott Jun 27 '11 at 17:34
    
If you're anxious to move, and want to keep the condo for rental income, you can always rent another place until you are in a situation where you can get a mortgage. In any case, shop around and you'll find out easy enough whether you can get one. –  Andy Wiesendanger Jun 27 '11 at 18:44
    
given most guidelines are based on debt as a percentage of income, it might be useful to know what kind of payment you are looking at in the second (new primary) residence, and also the car payment, (both as a percentage of income) as that then makes it pretty easy to add things up and see where you sit. –  Chuck van der Linden Jun 28 '11 at 0:40
    
If you are taking deductions for taxes and 401K into account, you are figuring NET income, not GROSS.. Gross is the raw salary, before any deductions for anything. you might need to revise that 6K number you currently have there. –  Chuck van der Linden Jun 28 '11 at 22:46
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4 Answers

up vote 4 down vote accepted

The general rule for mortgage ratios is 28/36. 28% of your gross monthly income is what you can spend on the mortgage, property tax, insurance. 36% of gross is including all debt payments. If the second home is to be rented, they count 3/4 of the rent as income, and not in the first 28%, but in the overall 36% total expense number.

Edit - Current FHA guidelines suggest 29%/41% are the current ratios for mortgage qualification.

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This is in line with what I know, but do you have a source? –  MrChrister Jun 27 '11 at 17:57
    
@MrChrister: That's the general rule of thumb for underwriting. FHA/Fannie Mae/Freddie Mac rules and bank underwriting policy will dictate whatever the actual ratios are for a particular loan. How "tight" the bank is with underwriting depends on general conditions, whether they are reselling the loan and the requirements of the particular program. –  duffbeer703 Jun 27 '11 at 19:04
    
Looks like we will have to either increase our down payment amount or we will need to decrease 401k contributions to pull the gross amount up to stay within the 28 to 29% range. Thanks all. –  Scott Jun 28 '11 at 12:15
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@scott, isn't gross pay figured prior to 401K deductions? If they were working off net numbers I can see the issue, but I'm pretty sure that gross is looking at your raw salary, not take-home. Gross is income before taxes, SSI, FICA, benefits deductions, pension and retirnment plan deductions, etc. –  Chuck van der Linden Jun 28 '11 at 22:44
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Yes - the percents are from gross income. Scott, if you need a bit higher downpayment, a 401(k) loan would shift some of that percent from the 29 to the next level, as the 401(k) loan is counted as personal debt, not mortgage. –  JoeTaxpayer Jun 29 '11 at 0:12
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If you can swing it and the math works out for renting out the property, that's the way to do it. That's what we're doing. Take the time to get a good tenant, and when you find a good one, do what you can to keep them happy. even if your cash flow is a little lower.

It all gets down to how much the bank will let you borrow. If you have stellar credit, I don't see why not. I was floored with how much I was allowed to borrow when I did this just a year and a half ago.

Can you knock the car payment out? That would help.

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Newer car, so not easily (unless we sold it and got a much less expensive used car). We could pay it off in cash, but that would reduce greatly our down payment for the next house. We are already overpaying on it as it is, so it will be paid off early. We're at least 18 months out, so it's possible to get it paid off prior to looking for the next home. –  Scott Jun 27 '11 at 16:33
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It's up to the bank to decide, and from what I understand they don't like the idea. They'll like you better if you tell them you want to sell the condo when buying a new house, then your housing expenses will be 0% of your income which in their view is much more favorable.

Of course, even if you decide to sell your condo when getting approvals for the mortgage on your new house, you're always allowed to change your mind after the closing on the new house if you find a good renter for the condo, no-one will come after you then.

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Most banks allow a certain amount for market rent and then discount that some. I have gotten loans with rental houses, etc.

It is not an issue if you cross your Ts and dot your Is and show you are capable of paying.

High down payment certainly helps.

Showing good market rents is helpful - if you can prove to the underwriters that your rental market is strong you will be ok.

This all assumes that you would be able to afford the new home without the rental at all. (no income/no payments)

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