The “Buy-and-Bail” Scenario
Buying a home and keeping your old one as a rental? You’ll want to avoid the scenario which lenders have come to call “Buy and Bail”.
“Buy and Bail” is a pre-meditated foreclosure event, which means that the homeowner has advanced plans to default on its loan and, last decade, Buy and Bail strategies cost the nation’s lenders something huge.
This decade, then, it should be no surprise that lenders are tough on borrowers with scenarios even remotely resembling a Buy and Bail.
It can be a challenge for buyers to get approved when they’re planning to rent a former residence.
Know the rules ahead of time, and you’ll have an easier time getting approved.Verify your new rate (Dec 10th, 2018)
“Buy and Bail” Defrauds Banks
The term “Buy and Bail” has a negative connotation — and rightfully so. The strategy defrauds banks and mortgage markets by definition; and, generates foreclosures, which can lower home values broadly within a neighborhood.
The strategy was not uncommon between 2007-2009 as home values dropped and homeowners found themselves underwater on their homes.
Being “underwater” means owing more on your home than your home is worth and Buy and Bail emerged as a (morally-suspect) way for a homeowner to get out from under its massive liability.
The strategy called for homeowners to abandon their existing home under a ruse.
First, the homeowner would go into contract for a new, less valuable home which carried a lower monthly payment.
Next, as part of the mortgage application process, the homeowner would tell its mortgage lender that the “former home” would be converted to a rental.
And, then, once the new home was purchased and closed, the homeowner would “bail” on the former loan, putting the home into foreclosure. This move led to massive damage on the buyer’s credit report, but few actually cared.
With the new home purchased and the new mortgage in place, many figured, there was little need for high credit scores anyway.
Time heals all credit wounds, after all and, today, 7 years later, many of last decade’s Buy and Bail households are eligible to purchase new homes.Verify your new rate (Dec 10th, 2018)
Government Stops The “Buy-And-Bail”
Homeowners had taken a matter-of-fact approach to getting out from under their underwater homes. Foreclosures (and fraud), many reasoned, was a justifiable means to an end.
To say that mortgage lenders were displeased would be an understatement. In response, underwriting guidelines morphed to identify and thwart “Buy and Bail” applications and, for the most part, the changes worked.
However, the updates also ensnared buyers who were legitimately purchasing a home and converting their trailing property to a rental and, today, those guidelines remain in place.
If you plan to purchase a home and convert your existing home into a rental, knowing these guidelines will help you successfully pilot your way to a mortgage approval.
The key figure is 30% — as in “30 percent equity in your trailing home”. With thirty percent equity, mortgage lenders are willing to make a lot of exceptions to help you with your plan.
Specifically, with 30 percent equity in it, your trailing home can seamlessly convert to an investment property, and pose you little to no issues in underwriting.
30% equity is a magic line of demarcation in the underwriting process.
When your trailing home has 30% equity, your mortgage application can include the rental income attached to the home; and you can show your lender you intend to keep both homes, in earnest.
With less than 30% equity in that home, the rental income cannot be included at all — not even a percentage of it.Verify your new rate (Dec 10th, 2018)
The Rules For Renting Your Old Home
For homeowners who want to convert a “trailing home” into an investment property, there are specific guidelines lenders use to make sure the scenario’s not Buy-and-Bail.
First, the lender will verify whether the former residence has at least 30 percent equity. There are three ways to determine this.
The most accurate method for a lender to determine your home’s value is to commission an appraisal of it. However, appraisals cost money and take time, so it may be your least preferred method of valuation.
A second, less accurate method for home valuation is the Automated Valuation Model (AVM).
An AVM uses mathematical modeling, drawing information from comparable sales to establish market value for a home. The accuracy of an AVM is limited to the accuracy of the information available on public record.
An AVM is also known as a “desk appraisal” because it can be performed by an underwriter from a desk.
The third valuation option, which is the least accurate, is the Broker Price Opinion (BPO) method.
BPOs are performed by real estate agents with knowledge of the specific area in which the home is located. BPOs may include public record information, and information not publicly listed.
Lenders can choose between any of the three available methods, often beginning with an AVM. Upon request, however, a borrower can request a complete home appraisal.
Once a value is determined, the homeowner will either have 30% equity or not. With sufficient equity, the approval can move to the net stage.
Without it, the homeowner retains the option to reduce the home’s loan-to-value (LTV) so that the 30% equity standard is met. This is done via “cash paid at closing”, with the cash being directed to the existing mortgage on the trailing property.
Even without 30% equity, though, there’s still a chance to qualify. Here’s how.
As part of the approval process, your lender will want to make sure that you have sufficient reserves to make the required mortgage payments on both homes — at least in the near-term.
Reserve are proved using bank statements and, depending on your trailing home’s equity percentage, your lender will look for varying amount of reserves.
For homeowners with the required 30 percent equity, underwriting standards call for sufficient reserves to cover 2 months of payments on both properties, inclusive of taxes and mortgage insurance, where applicable.
As an illustration, if the combined principal, interest, taxes, and insurance (PITI) for both homes totals $4,000 monthly, you must show at least $8,000 in reserves.
For homeowners with less than 30 percent equity, the reserve requirement moves to six months of payments on both homes combined.
The good news, though, is that if you’re able to meet the asset reserve requirements, the remaining mortgage approval guidelines are the same as for any other home loan program.
There are no additional employment requirements, and no credit score hurdles to meet. The key is that you don’t look like a Buy and Bail applicant from last decade.
With sufficient equity and reserves, you can do it.
What Are Today’s Mortgage Rates?
Do you own a home and plan to keep it as rental property after moving? You’ll want to do your homework first; plus, have some equity and money for reserves. Preparation will keep you from looking like a “Buy and Bail” candidate.
Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.Verify your new rate (Dec 10th, 2018)