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Hey all, I have another rent or sell related question. If this is not the most appropriate board for this question, please let me know.

In a year we will be moving out of our 2BR/2BA condo and are considering renting it out instead of selling. Here are the details.

Estimated sales price: $90,000
Current mortgage balance: $57,000
Interest rate: 4% (adjusts in 2008 to 6% max, to a max of 10% in 2010)
Principal plus interest payements: $300
Condo dues: $200
Estimated rent: anywhere from $1000 to $1400 (a wide range I know...I would be SHOCKED if I couldn't rent it for $1000 EASY to the many professional students like myself in the area).

If I assume a 20% non-occupancy rate, $1000/mo rent and appropriate taxes and maintenance expenses and a fudge factor for the occational special assessment, then we are cash flow even initally, but have an after tax 10 year IRR of about 9.7%.

If instead I take out all of the equity, we are cash flow negative by about $2000 due to increased interest costs, but have an IRR of 17% after 10 years. Of course if my occupancy is (hopefully!) greater than 80% then my numbers are a lot better. But I'm trying to be conservative.

I've never been involved in rental real estate, and don't know if my wife and I want to be landlords (non-local at that). But in evaluating the decision, is it:

1) better to TAKE OUT the equity via a refinance or home equity loan, put it in safe investments (money market and/or short term bonds) and use it to pay the negative cash flow if needed? Rather than keep the equity in the home? We do not yet know if we will be renting or buying a new place when we move.

2) better to take out the equity BEFORE it is converted to a rental propery

3) better to we take out ALL the equity (even if it means a higher interest rate)

4) better to refinance for as long a term as possible (i.e. 30 years) to lower monthly payments as opposed to keeping the current loan terms with 25 years left and paying principle faster?

We have a while to make this decision, but I'm trying to get as much information as early as possible. I'm leaning towards renting instead of selling, but my wife doesn't want the risk/hassle unless it's a clear money maker. Any advice?

Thanks,
FFL
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Let me take a different tactic entirely.

If your current mortgage is a home (residential, owner-occupied) mortgage, it may have a provision in it that forbids you from converting the property to an investment property without refinancing.

Investment properties are much higher risk for banks and the loans are priced accordingly higher.

If in the process of taking out the cash-out loan you were to "forget" to tell the bank that you were planning to convert it to an investment property, it would probably be considered mortgage fraud.
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If in the process of taking out the cash-out loan you were to "forget" to tell the bank that you were planning to convert it to an investment property, it would probably be considered mortgage fraud.

Hmmm...don't want anything to do with "fraud"! I'm a "by the book" kinda guy.

So I'll likely need to research investment property mortgages, which I assume have higher rates.

I'll have to read my mortgage documents and see what they say.

What do most folks do?
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What do most folks do?

Most folks, when they move out of their house, need to move into another one, and have to sell their old house to be able to make the down payment on the new house.

This also lets them take advantage of the capital gains tax exclusion for the primary residence.
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Most folks, when they move out of their house, need to move into another one, and have to sell their old house to be able to make the down payment on the new house.

This also lets them take advantage of the capital gains tax exclusion for the primary residence.


We are likely to be renting our next place, as we are moving to either San Fransisco or Boston! Not sure I want to buy quite yet in those markets, especially since we are likely to stay less than 5 years.

As for capital gains, I thought that capital gains were exempted up to $250,000 for primary residences regardless of whether you buy a new house. On a $90,000 home, my gains are likely to come out to less that $250,000. :)

FFL
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As for capital gains, I thought that capital gains were exempted up to $250,000 for primary residences regardless of whether you buy a new house.

Yes, but if you don't sell, and time passes, you could lose the exemption. The criterion is "lived there 2 out of last 5 years".
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Yes, but if you don't sell, and time passes, you could lose the exemption. The criterion is "lived there 2 out of last 5 years".

Oh yes, right, I see. I could lose that exemption if I rent. Of course.
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Wether to pull money out of the mortgage or not depends on your risk adjusted returns from the various scenario's under consideration. There is no correct answer anyone here can give you.

For example, if you can get a mortgage at 7% up to 80% LTV with 0 cost (increased interest rate causes a rebate which covers any closing costs) then that is a risk free return of 7%. What happens to the price of the house is immaterial as wether you have 20% or 40% down it is the same.

Put that money in the market and maybe you will make 8-10% but that is with additional risk. You may have other investment options open to you which are better than the above.

Another factor is if you take it out it is available to help with any cash flow difficulties you may face, a significant risk reducing aspect. Conversely it is available so you might be pretty tempted to spend it to pay off the credit cards (e.g. on depreciating & consumable items). You've got to answer these risk related questions for you and your personal situation.


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If in the process of taking out the cash-out loan you were to "forget" to tell the bank that you were planning to convert it to an investment property, it would probably be considered mortgage fraud.

They will of course find out when your insurance company mails them the changes made from owner occupied to investment housing.

IP
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They will of course find out when your insurance company mails them the changes made from owner occupied to investment housing.

And of course if you "forget" to tell your insurance company, then you're committing insurance fraud too.
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And of course if you "forget" to tell your insurance company, then you're committing insurance fraud too.

Not to mention paying more money than you have to. Usually, insuring a rental property is cheaper than owner occupied because the contents are not insured.

I also would be worried about the house burning down and their deciding they wouldn't pay the claim because of the improper classification.

IP
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I would definitely tell the insurance company but not the bank.

The insurance company can refuse to pay the loss if you dont keep them informed of the correct status.

Even if your loan docs require owner occupancy, even if the bank finds out and even if they care, no bank is going to foreclose on a technical default like this one.

It is NOT bank fraud. It might be fraud if you took out the loan under the guise of owner occupancy, knowing that you did not intend to occupy the dwelling. Converting to a rental after living in it a considerable amount of time is not the same thing.

Even if it was fraud, that is a criminal offense. Do you really think the state's attorney is going to prosecute something like this?
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I would definitely tell the insurance company but not the bank.

The insurance company can refuse to pay the loss if you dont keep them informed of the correct status.

Even if your loan docs require owner occupancy, even if the bank finds out and even if they care, no bank is going to foreclose on a technical default like this one.

It is NOT bank fraud. It might be fraud if you took out the loan under the guise of owner occupancy, knowing that you did not intend to occupy the dwelling. Converting to a rental after living in it a considerable amount of time is not the same thing.

Even if it was fraud, that is a criminal offense. Do you really think the state's attorney is going to prosecute something like this?


Sometimes the advice given on these boards never ceases to amaze me.

If you are refinancing, you will have to specify whether the property is purposed to be an owner occupied dwelling or an investment property. Banks want more for the risk of investment properties. Moreover, you must sign a form to that effect. If for one's personal residence you'll usually you'll be expected to live in that property for a minimum of one year. If you are found to have lied, you can be charged with fraud. You can have the bank demand immediate payoff. Can you really guarantee this wouldn't happen?

"Sure, it's not my money and butt on the line. Yeah, baby, let's roll the dice and see how you make out...oops! You got forclosed on and & prosecuted for federal fraud? Bummer. You should't have listend to my ingnorant, throw caution to the wind advice on a public discussion board. See you at the welfare office in 5-10."

People like you should stay on the yahoo boards. People are accustomed to getting worthless advice there. Stay away from here, please!

TicoHombre
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Hi FFL,

In a year we will be moving out of our 2BR/2BA condo and are considering renting it out instead of selling.

"Will" on "may"? It's NOT a question of semantics... but a question of your truest expectation certainty and intent (because law is ALL about "intent.")

Your loan application, and closing certifications, will ask if you "intend to occupy the subject property as your primary residence." It will NOT specify HOW LONG your intentions are for (although, case law has allowed borrowers to be found guilty of fraud and/or misrepresentation when they'd converted to a rental as quickly as 6 months after financing when certified as 'intended-primary.')

If you merely SUSPECT you MAY be moving in a YEAR or so... you are likely safe enough in financing today as your primary residence, in intent and action. (And, if in doubt, consult your own attorney.)

But in evaluating the decision, is it:
1) better to TAKE OUT the equity via a refinance or home equity loan, put it in safe investments (money market and/or short term bonds) and use it to pay the negative cash flow if needed? Rather than keep the equity in the home? We do not yet know if we will be renting or buying a new place when we move.


I'll make a program recommendation to consider, below... but regarding what to DO with available funds left unused, I'd recommend actually NOT drawing out the equity now, but merely establishing an available HELOC up to the full equity level at your current principal residence terms.

2) better to take out the equity BEFORE it is converted to a rental propery

You will never be able to secure as low of rates and lenient of leverage terms on THIS home as you are able to right now while you are still, in action and intent, occupying as your principal residence.

3) better to we take out ALL the equity (even if it means a higher interest rate)

Just set up your HELOC undrawn.

4) better to refinance for as long a term as possible (i.e. 30 years) to lower monthly payments as opposed to keeping the current loan terms with 25 years left and paying principle faster?

OK... here's what you *MIGHT* consider doing (note the uncertainty due to the relatively LOW actual loan amount, versus the savings it might capture versus the unavoidable minimum transaction costs of the refinancing...)

STRATEGY;
1) Refi to a 30 FRM, and buy the interest rate down as far as the secondary market levels will allow you to do so. Every dollar of discount points paid in closing will have an approximate breakeven from monthly interest savings of 3-5 years, and since you have the equity you can finance the discount points so that the equity itself is paying for your 5 year breakeven point without hitting YOU for a cash outlay.

2) Set up a 100% CLTV 2nd HELOC, left undrawn, but available to you from here forward at principal residential rates (likely Prime + 1 to 2.)


NOW... having just curcumscribed that strategy (which I have, indeed, employed on a SFR I own, while occupying, about a year prior to moving & converting to a rental...)

LET ME ALSO EXPLAIN that I still own the 2/2 Condo that I bought as my first home... and we financed it on the (back then) red-hot 6 month LIBOR ARM, which was (back then) about 3.125% interest.

While short term interest rates have indeed steadily crept upwards... that 6 month LIBOR ARM is still just 5.75% on a remaining $90,000-ish balance... which is less than (or too close to matter) what a 30 FRM could be secured for... and a bought-down 30 FRM wouldn't reap sufficient savings to pay the transaction costs (even for me,in the biz.)

SO... to boil that all down;
KNOW the strategies and legalities... and then, still, run the real numbers to see what makes sense or not.

Best of luck as you grow & move!
Dave Donhoff
National Mortgage Banker/Broker
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OK... some further clarifications from the prior posts in this thread;

In my shy-decade in the mortgage biz, I've yet to see a Due-On-Sale clause written to trigger upon change of occupancy. AND, while I don't discount the POSSIBILITY, I can't imagine it's very common in any institutional loan you'll ever see. FURTHER, in today's highly unstable loan portfolio market, banks are bending over backwards to avoid having to book actual foreclosures... so you have to damn near insult their mother AND default for 3-12 months before they tack a notice-of-default on the door.

IP is correct that the servicing company will be alerted when the hazard insurance policy is amended to cover tennant liability (which you would be insane NOT to get,) however, once again, the servicing departments are playing twister among themselves to keep their portfolios from turning over or booking NODs.

Liqudatr;
Even if it was fraud, that is a criminal offense. Do you really think the state's attorney is going to prosecute something like this?

Happening near you, daily;
http://www.mortgagefraudblog.com/

TicoHombre's right on, as well.... ALWAYS double check what you read from unsupervised anonymous boards.

Best!
Dave Donhoff
National Mortgage Banker/Broker
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Disclaimer: I am not a lawyer, please contact a lawyer to find out where I'm wrong.

One reason I see to take cash out of rental property is to reduce risk. Given the appropriate situation someone can put the property in a corporation (LLC or otherwise), remove the equity, and if sued, the corporation has assets with no or minimal value. However, to avoid being sucessfully personally sued, they cannot manage the property themself, and must hire an appropriate professional manager/management company. This management company, which a absentee landlord probably needs anyway raises costs.

Second, is what is being proposed really an interest rate bet? Generally at any specific time and at the same risk level it is more expensive to borrow then lend, so either the interest rate difference must be eaten, risk increased, or there is a gamble that interest rates will increase.

Third, my HELOC's set their interest rate when the money is taken out, not when the unfunded loan was established. At the time I take the money out of the HELOC, the loan will be at the current interest rate.

While in CA transferring a property from your name to a trust is not a "sale", transferring it to a LLC is and does trigger the due-on-sale clause. However, I've heard the mortgage company generally finds out when the insurance changes or if you're caught in a random audit. I've also heard that some mortgage companies don't care (until they want to) if you're current because they have a lot more to worry about than someone who is current. Also, homeowners, renters, and landlords insurance are all different, different costs and coverages. I suspect if someone files a claim on a rental and has a homeowners policy, they will be very unhappy.

My 2 cents, I hope this was helpful, check with your lawyer.

Jack
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<I would definitely tell the insurance company but not the bank>

My comments were directed towards a loan already in-place, not any new financing taken out in contemplation of moving.

Sorry for the confusion.

I wouldnt definitely NOT recommend lying on any financial application.
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In a year we will be moving out of our 2BR/2BA condo and are considering renting it out instead of selling.

"Will" on "may"? It's NOT a question of semantics... but a question of your truest expectation certainty and intent (because law is ALL about "intent.")


Well, MAY. I am starting a medical residency in June of 2007. But I won't find out where I go until late March of 2007, when I informed of which program has selected me. One of the programs to which I am applying is here in Birmingham. So I MAY have to move, but will not know until much later.

FFL
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My comments were directed towards a loan already in-place, not any new financing taken out in contemplation of moving.

Sorry for the confusion.


I think the confusion is that you don't understand that this is a meaningless distinction. It's still fraud. Any time you enter into a contractual agreement with someone, and you withhold a relevant piece of information because you feel that you'll benefit, that's fraud.

- Gus
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But I won't find out where I go until late March of 2007, when I informed of which program has selected me. One of the programs to which I am applying is here in Birmingham. So I MAY have to move, but will not know until much later.


That would work for me, I would refi. There is an intention to seek employment right where you are, which should suffice, IMO. Who can plan more than 1 year ahead?

Ask a lawyer rather than believe me though. I don't have your documents in front of me and am not a lawyer.

IP
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I think the confusion is that you don't understand that this is a meaningless distinction. It's still fraud. Any time you enter into a contractual agreement with someone, and you withhold a relevant piece of information because you feel that you'll benefit, that's fraud.


And I think you need to back off.

If the loan was taken out years ago when the poster had every intention of living in the home as their primary residence and in fact did so for years, it is definately not fraud. Obviously, that is what the poster is referring to when he states, "My comments were directed towards a loan already in-place, not any new financing taken out in contemplation of moving."


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And I think you need to back off.

And I think you need to reconsider what you think is "ethical."

If the loan was taken out years ago when the poster had every intention of living in the home as their primary residence and in fact did so for years, it is definately not fraud.

Very true. So long as he's living there, it's not fraud. But if he decides "not to tell the bank" because he thinks the bank might consider moving out and converting to rental a breach of contract, that's unethical.

Maybe the bank won't care. In fact, I think you're generally allowed to do this as long as you've lived there at least a year. But if you think it's material, and you're considering keeping it secret because it will affect your agreement, your intent is fraud.

Is honesty with a contractual partner such a difficult concept to understand?

- Gus
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And I think you need to back off.

And I think you need to reconsider what you think is "ethical."

If the loan was taken out years ago when the poster had every intention of living in the home as their primary residence and in fact did so for years, it is definately not fraud.

Very true. So long as he's living there, it's not fraud. But if he decides "not to tell the bank" because he thinks the bank might consider moving out and converting to rental a breach of contract, that's unethical.

Maybe the bank won't care. In fact, I think you're generally allowed to do this as long as you've lived there at least a year. But if you think it's material, and you're considering keeping it secret because it will affect your agreement, your intent is fraud.

Is honesty with a contractual partner such a difficult concept to understand?


First of all you called it fraud, a legal term. It is not fraud.

Now you switch to unethical. What is unethical is more subjective. The contract and agreement probably says something to the effect of intend to live their as your primary residence and maybe even has some stipulation about at tleast one year. In both cases he has lived up to his side of the contract regarding these items.

If the contract says you must notify them if he ever decides to move or rent the property then I agree he is bound to do so. But if it does not I do not beleive the person is ethically bound to notify them nor being dishonest by not doing so. Just because someone in a contractual obligation would be an interested party does not, in my opinion, create an ethical obligation to notify. They might be interested if he rented the property out, or lost his job, or if he significantly remodeled (home made indoor swimming pool anyone) or many other things. I know if I carried his note I would. However, this in my mind does not create an ethical obligation for him to notify them every time one of these things happens.
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I think the confusion is that you don't understand that this is a meaningless distinction. It's still fraud. Any time you enter into a contractual agreement with someone, and you withhold a relevant piece of information because you feel that you'll benefit, that's fraud.

The occupancy clause from my current mortgage:

Borrower shall occupy, establish and use the Property as Borrower's principal residence within 60 days after the execution of this Security Instrument and shall continue to occupy the Property as the Borrower's principal residence for at least one year after the date of occupancy, unless Lender otherwise agrees in writing, which consent shall not be unreasonably withheld, or unless extenuating circumstances exist which are beyond the borrower's control.

I.e. as far as my mortgage is concerned, since I occupied the place as my primary residence within 60 days of the mortgage agreement and have occupied it for more than one year, I'm free to move out and rent it without notifying the bank. It ain't fraud. It ain't unethical.

The OP should either read his own mortgage documents end-to-end or have a trusted lawyer do so to ensure that his contract does not contain a more strict occupancy clause. But, barring one, I see no reason why the OP could not rent under his current financing situation.

Of course, the real issue is with the new financing the OP is considering. The OP will be in violation if he states that he will use the home as his personal residence, yet intends to move and rent out the place. Also, the new financing may have a residency clause like the above one, in which case, the OP would be in violation if he were to move out and rent less than a year after obtaining the new financing.

Puss
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HOw about this.

Take as much equity as you can out now. Use the equity to put down on another home, the soon to be personal residence. Refinance the old personal residence loan, including the refinced amount as an investment property.

Now, the main problem is carrying costs. If you can't afford to finance the funds (mortgage #1 + 2nd on old home at new investment property rate) from the cash flow generated from renting, the don't move or don't rent.

cat
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I took out a home equity loan on a property I was renting last year. I used the money towards purchase of another. I was worried no one would give me a home equity loan given it was an investment property, but my local bank did without question 100% LTV. Banks love to lend people money, without a doubt. As an aside, my first mortgage several years ago was an owner-occupied mortgage. I never contacted them to know I was moving out a few years later. I changed my insurance coverage from owner-occupied to tenant occupied. A copy of it was sent to the mortgage company. Communication from the mortgage company was changed from the house to my current home. Despite these clues, still have not heard a peep from the bank.
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Well I know this is an old thread but I thought I'd chip in this...

My mortgage on a duplex that was half owner occupied just stipulated that I'd live in it for at least 1 year to qualify for the owner occupied rate. From reading the documents it doesn't seem to me that the loan paperwork is any different for a single family home up to a 4-plex. Its all boilerplate.

So assuming my loan is common you can likely (you would need to check of course) rent your place out without any trouble.
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