Mortgage refinance rules for primary residences are more flexible

Buying a house is an attractive proposition in these days of low mortgage interest rates and fallen prices. But if you want to buy a new home, while renting out the old one, you could face a glitch. It might be hard to refinance a house that you're renting out.

That's because "things change when you're no longer dealing with a primary residence," warns Ben Chenault Jr., regional manager at Fairway Independent Mortgage in Birmingham, Ala.

"A lot of people want to jump on the great deals, but they still have their current home and don't want to wait for that home to sell," Chenault says. "They think, 'Aha! The rental market is good; I'll just rent it out.' But what if someone stops paying the rent? Are you sunk? If the answer is yes, you probably shouldn't do it."

Let's suppose, for the sake of discussion, that you've already done it. Now you own two houses -- one that you occupy, and one that you don't. To cut monthly interest expense, you want to refinance the house you're renting out. It might not be easy.

Often, equity is the biggest hurdle in the effort to refinance a house you're renting out. Lenders typically require a cushion of 25 percent or more to refinance a loan secured by a non-owner-occupied house, says Stephen LaDue, a senior loan officer at Prime Lending in Brookfield, Wis. The reason: An owner who has a substantial stake in the property is less likely to default.

"If you're upside-down or have a minimal investment, you might walk away," LaDue observes.

Some lenders might be flexible about credit scores, income and cash reserves, but that 75 percent maximum loan-to-value ratio is usually a "hard and fast rule," Chenault adds.

A second mortgage on the rental house will make refinancing difficult because that lender probably won't agree to remain in the lesser position if the first loan is refinanced.

"Whoever has the second mortgage probably won't be willing to work with us," Chenault says.

You might assume that rental income can be counted toward the guidelines to refinance a house you're renting out. But Gary Parkes, formerly a mortgage loan officer with Acopia Home Loans in Woodstock, Ga., says lenders tend to be suspicious of rent unless the landlord is a professional property investor. Consequently, lenders typically allow only a portion, if any, of that rent to be relied on to qualify, especially in the case of a new tenancy.

Rent is even trickier if the tenant is a family member because the tenancy isn't an arm's-length transaction, LaDue warns. That close relationship between the landlord and renter creates a different set of risk criteria for the lender -- and more documentation requirements for the borrower.

Other restrictions apply when you want to refinance a house you're renting out. For instance, most lenders won't allow one borrower to have more than four mortgages on residential properties, according to LaDue. That limit, he explains, exists in part to prevent the misuse of government-insured loans to acquire multiple homes as investment properties.

Homeowners who want to move out and rent out might be tempted to sneak around these issues by refinancing before they vacate their current home. That's a sensitive subject because it involves intent and loan fraud.

One year of residency is often cited as a guideline to determine intent to occupy. But that's not an absolute rule.

MORTGAGE RATES

The 30-year fixed-rate mortgage fell 3 basis the week of March 28, 2013 points to 3.75 percent. A basis point is one-hundredth of 1 percentage point.

The 15-year fixed-rate mortgage was 2.97 percent, the same as the previous week. The average rate for 30-year jumbo mortgages, or generally for those of more than $417,000, fell 3 basis points to 4.1 percent.

The 5/1 adjustable-rate mortgage stayed at 2.71 percent. With a 5/1 ARM, the rate is fixed for five years and adjusted annually thereafter.