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FHA Moves to Prevent 'Buy and Bail'

Rental income excluded from current residence unless 75% LTV or less

September 22, 2008

By staff

The Department of Housing and Urban Development is taking steps to thwart borrowers who commit mortgage fraud in order to buy another home at today's discounted prices then let their current residence fall into foreclosure.

Federal Housing Commissioner Brian D. Montgomery issued Mortgagee Letter 2008-25 Friday indicating the Federal Housing Administration has observed a rising number of instances where borrowers are abandoning their current residences to buy another property. Some borrowers are choosing to relocate closer to their employment while others "are taking advantage of other home buying opportunities arising in the marketplace."

FHA is concerned that some borrowers fraudulently represent that their current residences will be leased out so they can qualify for a mortgage on the new property. But once they purchase the new property, the borrowers "buy and bail," an unscrupulous practice where they stop making payments on the old residence.

All new FHA loan submissions must be considered excluding any rental income on the current residence. The temporary rule is being implemented to ensure that the borrower can make payments on the full debt service of both mortgages.

"The exclusion of rental income from property being vacated is being instituted on a temporary basis while FHA further analyzes this situation to determine whether permanent measures may need to be taken," the letter said. "Although the property being vacated will not have a mortgage insured by FHA, surrounding properties may and, thus, FHA may be indirectly negatively affected should that property result in a foreclosure."

But if the loan-to-value on the current residence does not exceed 75 percent, then rental income may be considered as long as it is reduced by the appropriate vacancy factor.

"This will assure that a homeowner either has sufficient income to make both mortgage payments without any rental income or has an equity position not likely to result in defaulting on the mortgage on the property being vacated," Montgomery stated.

Rental income can also be considered when the borrower is relocating with a new employer that is located beyond a reasonable commuting distance. In that case, the lease must have at least a one-year term and be backed up with evidence that the security deposit or the first month's rent was received by the borrower.

Rental properties reflected on tax returns are not impacted by the new policy.

Fannie Mae recently took similar steps for existing residences with less than 30 percent equity.

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