Mortgages, rentals and accidental landlords

Before the mortgage / housing crisis, it was easy enough to sell your old house and buy another.

Then came the market drop. It created a class of "accidental landlords" -- people who couldn't sell their home but were still able to rent it out as they bought another. That helped keep the housing sale skids greased.

Problem is much of that grease is gone.

Lenders have tightened down on rental income arrangements, making it harder for people who want to buy a home but can't unload their old one.

It's one of the quieter problems facing housing markets in the Twin Cities and the country. If you can't sell your own house to buy another and if lenders won't let you count income from renting it, then what do you do? What does the market do?

We asked Alex Stenback, a Twin Cities mortgage banker and writer of the Behind the Mortgage blog for some insight. He writes:

Rental income on a primary residence being converted to rental can only be used if there is 25 percent to 30 percent equity in the subject property (as measured by appraisal or in some cases an automated valuation, not tax or other valuation methods) along with a signed lease and evidence of a security deposit.

[Mortgage giants] Fannie Mae, Freddie Mac and the Federal Housing Administration all take this position and also generally require that the borrowers have at least six months payment reserves on both properties, though exact reserve requirements can vary according to circumstances to numerous to list here.

Fannie/Freddie/HUD created these rules to get in the way of the "Buy and Bail" phenomena, where a borrower would purchase a new primary residence with no intention of making payments on the old home.

The theory being that these leases were not real, or at least not worth the paper they were written on.

With an equity position, at least there were some assurances that the trailing primary residence could be sold without the borrower suffering a major loss that might severely impair the borrowers financial position.

The only "work around," he adds, is if the house is converted to a rental and the departing borrowers establish residence somewhere else -- "once they can show rental income from the (formerly primary) rental property on their tax returns, these rules no longer apply."

The rental hangup isn't driving the current market struggles in the Twin Cities. But it's not making the trip back to "normal" any easier.

This week's market update from the Minneapolis Area Association of Realtors says the housing market remains "in a sort of frozen state" compared to last year, when federal tax credits were driving business.

The inventory of Twin Cities homes for sale continues to climb. There was an estimated eight month supply in September, the report showed. It's much higher than last year and greater than the five to six month supply typical of a market in sync.

Here's the Realtors' inventory graph (click for a larger view):

The rental-sale jam-ups aren't a huge influence on the market's overall health, says Stenback, "just one of many contributing factors to the general real estate market malaise: Poor economy, anemic job market, blight of upside down homes, too much supply, too little demand."

Correction: In an earlier version of this post, I inadvertently included some of my introductory comments into Stenback's analysis. I've since removed my remarks.

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