Fannie and Freddie Won't fund a "legal non-conforming"

[Michael West]

So, I have an interesting situation here that I've never come across before and could use some additional insight from other's experiences.  I have a client who is buying a Duplex with intentions to make his primary residence, live in one side, rent the other.  He's fully approved as a buyer, however, it appears that the property itself is in an R1 zoned area and is "grandfathered" in as a duplex.  So, on the appraisal it is "legal non-conforming (grandfathered).  This then caused a question to be raised by the lender asking the city's zoning department "If a catastrophic event occurred that required a complete rebuild of the property, would they allow for the zoning variance to continue to allow it to be rebuilt the same as it is - a duplex."  The city said "absolutely not.  It must be compliant with the current zoning."  This shut the deal dead in the water. I've been told that this is a Fannie/Freddie requirement, yet not a single other person or lender has ever experienced such a thing.  To make it worse, we found another property in a completely different city to move onto and its going to be the same exact situation. My buyer is currently homeless after selling his former residence a few months back (with a different agent). 

I don't know that I'm fully believing what I'm being told and looking for someone with some experience in this to confirm or deny this as true.  What other options might we have.  Portfolio, hard/private money options are not within my buyers means.  Seller's are not willing to provide seller financing.

[Michael West]

@Kevin Sobilo thanks for the response! I've been digging deep into this matter and the first thought I had was the same about the insurance. My insurance guy has a policy that would indeed do that as well as one that would cover up to 30% property value for zoning issues. The lender says that would do nothing for this deal.

It's my understanding that the buyer does qualify for the loan on his own personal income, but they were also looking into doing it using the rental income. In the end it appears that a big part of the issue is that the loan is being sold through Fannie/Freddie and the end product on the note needs to be able to remain the same as is. Duplex to Duplex. If the lender were holding the loan in house or as a portfolio, it sounds like they may be able to do it, but it's not possible for my buyer as the terms on that is beyond what he can afford.