Ask Phyllis: a blog series of frequently asked real estate questions. Email us here
Should I sell or rent is an older published real estate question and answer – my, how the market has changed!
Dear Phyllis,
In 2003, I purchased an 800-square-foot home, married several years later, and last year had twins. The home is simply too small. I was thinking it may be easier to just rent this home and buy another. Where do I decide if I should sell or rent? And where do I start? Jim
Dear Jim,
Qualifying for a loan is a bit more challenging than it was in 2003. Lenders use a total debt-to-income ratio when determining your income qualification. Your monthly Principal and Interest, Taxes and Insurance (PITI), and minimum payment on installment debt, auto payments, and monthly recurring debt should not exceed 45% to 49% of your gross monthly income (depending on credit scores, down payment, etc.).
For example, let’s assume your gross monthly income is $8000. Your proposed monthly PITI on a larger home is $3,500, and you have $200 monthly in revolving payments. Your debt-to-income ratio of 46% means you passed this qualification test.
In addition to not having the equity from the sale of your current residence to add to your down payment, you face another obstacle if you keep your existing home. In recent years, some homeowners have bought a new home and then strategically defaulted on their old property. As a result, lenders have tightened guidelines.
First, if you do not have 30% equity in your current home, the lender will not count rental income toward your gross monthly income. Instead, the lender adds your current monthly PITI to your debt load. Therefore, you no longer qualify.
Second, if you do have at least 30% equity, the lender may still only count about 75% of the expected rent, minus PITI, as income. However, this often creates a negative cash flow.
For example, your current monthly PITI equals $1,800. Market rent also equals $1,800. However, the lender counts only 75% of rent, or $1,350, as income. As a result, you show a negative $450. Consequently, your qualifying numbers change. Your $200 in revolving payments increases to $650. In turn, your debt-to-income ratio rises to 52%. At that point, your income no longer supports the purchase of the larger home.
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Oh how small the problems back then seem now !