Making Your Primary Property an Investment Property? It Just Got Harder.

When a homeowner buys a new home, he has 3 options on how he can handle his current residence:

1. Sell the home, paying off the mortgage in full.
2. Keep the home as a second home.
3. Convert the home to an investment property.

The most common action plan is the first one -- sell the home and pay off the mortgage. However, with home prices poised to rebound at some point in the future, some homeowners are trying to avoid "selling low".

Unfortunately -- as of August 1, 2008 -- waiting out the market just got harder.

Burned by foreclosures and scared by their own shadow, Fannie Mae issued new conforming mortgage guidelines that specifically apply to home buyers planning to convert an existing primary residence into a second home or investment property.

Among the highlights of Fannie Mae's changes:

Selling the primary residence
If the new home being purchased closes prior to the existing home's sale, both payments must be used to qualify the buyer for the new mortgage.

Converting to a second home
If the home has less than 30 percent equity in it, the home buyer must show 6 months of PITI reserves for both properties to qualify for the new mortgage.

Converting to an investment property
If the home has less than 30 percent equity, its rental income may not be used to help the buyer qualify for the new mortgage.

If it seems like mortgage rules are getting strict, that's because they are. And they're expected to get tougher. With each foreclosure and high-profile bank collapse, mortgage lenders tighten up their guidelines just a bit, freezing out the "marginal" borrower from access to mortgage money.

Mortgage rates may rise through 2009, or they may fall. We don't know. But what we do know is that borrowing money to buy a home will be tougher.

If you plan to buy a home in the next 12 months, consider moving up your timeframe or -- at least -- planning ahead. Understanding the mortgage rules and how they can change may be the difference between getting approved for a home loan, or getting turned down.

Changing Mortgage Guidelines Impact Buyers of Second Homes and Investment Properties

Conforming mortgage guidelines are the Home Loan Rule Book, delineating between applicants that get approved for a mortgage and those that do not.

Effective today, the rule book just got a little bit tougher.

According to Fannie Mae, homeowners converting their primary residence into a second home or investment property will be subject to additional underwriting scrutiny. Fannie Mae is leery of lending to people that may be over-extended.

The complete underwriting update is available at the Fannie Mae Web site but some of the more important points are summarized below, divided into Second Home and Investment Property.

Second Home Guideline Changes

Without 30 percent equity in the second home, mortgage applicants must have 6 months worth of PITI reserves for both properties in their bank accounts.

With 30 percent equity, the PITI reserve can be reduced to 2 months.

Previously, there was no minimum reserve requirement.

Investment Property Guideline Changes.

With 30 percent equity in an investment property, 75% of the monthly rental income can be applied toward the applicant's monthly household income.

Without 30 percent equity, rental income may not be applied to the applicant's monthly household income and 6 months PITI is required for both properties.

Previously, 75% of the rental income was allowable regardless of equity, and minimum reserve requirements were 2 months.

Even though just a small percentage of Americans own second homes or investment properties, the conforming mortgage guideline changes impacts homeowners everywhere.

This is because more restrictive guidelines lead to two separate, but concurrent, outcomes:
The demand for homes reduces because fewer buyers qualify for mortgages
The supply of homes increases because fewer sellers can refinance into more affordable home loans.

Less demand and more supply places downward pressure on home prices.

Now, remember that mortgage guidelines continuously evolve and what's accurate as August 1, 2008, may not be accurate six months down the road. In other words, confirm what you're reading about mortgages online with your loan officer before making any real estate-related decisions.