Changes to Fannie Mae Departure Residence Guidelines
In addition to the changes that Fannie Mae has announced for some of their underwriting guidelines on how to calculate income, they are also making big changes to how move-up buyers will calculate their liability (and income) on departure residences.
What Is a Departure Residence?
Fannie Mae and Freddie Mac define a departure residence as the home that is currently owned and resided in by the borrower looking to mortgage a new home.
Borrowers who currently own a home typically have three options when they decide to purchase a new principal residence. They can:
- Sell the current residence and pay off the outstanding mortgage
- Convert the property to a second home, assuming they can qualify for both the existing and new mortgage payments, or
- Convert the property to an investment property and provide documentation that they will rent the property and use the income to offset the mortgage payment
In July 2008, both Fannie and Freddie significantly tightened underwriting guidelines regarding departure residences. In July 2013 they finally loosened them.
Changes to “Departure Residence” Underwriting Guidelines
The sometimes overbearing “departure residence” guidelines were imposed during the height of the financial crisis and intended to be temporary in nature despite lingering for more than 6 years.
The purpose of this policy has been to ensure that borrowers have adequate capacity and financial reserves to successfully manage multiple properties.
In July 2008 Fannie Mae laid down these underwriting guidelines regarding additional properties owned:
- They will need to verify 30% equity in their current home. (This mitigates concerns that they may be considering a "strategic default" on the old home. An AVM (Automated Valuation Module) or appraisal will be needed to prove their equity position.
- Rental income must be documented with a fully executed lease agreement. The lease may be month-to-month.
- The lender will require a copy of the security deposit and proof of deposit.
- Rental income from a family member or an individual with an established relationship to the borrower is not allowed.
- 75% of the verified rental income can be used to offset housing expenses.
The new guidelines in effect now will remove or loosen several of these burdensome qualifications.
Most importantly, Fannie Mae is removing the 30% equity requirement. They are also allowing more latitude for those planning to hold on and rent their current residence by easing guidelines regarding the immediate use of rental income.
More importantly for homebuyers that have their current residence under contract to sell, they are no longer requiring you to close that transaction prior to closing your new one.
Direct from the horse's mouth:
- Because there are other policies now in place that adequately address credit history, rental income, and financial reserves, Fannie Mae is eliminating some of the requirements specifically associated with the conversion of a principal residence
When the borrower owns mortgaged real estate, the status of the property determines how the existing property's PITIA (your all-in monthly principal, interest, taxes, insurance and homeowner's association payment) must be considered in qualifying for the new mortgage transaction.
If the mortgaged property owned by the borrower is the borrower's current principal residence that is pending sale but will not close (with title transfer to the new owner) prior to the subject transaction, the lender can now use an executed purchase contract, that has seasoned past the financing contingency stage, to eliminate the current mortgage payment from the borrower's debt to income ratio.
Mortgage lenders should continue to follow the standard rental income and financial reserve requirements when the borrower converts his or her current principal residence to an investment property.
Both changes are reasonable and overdue.
These changes are also gratefully welcomed from real estate and mortgage professionals in addition to many would be homebuyers previously affected by the old set of underwriting guidelines.