Primary residence: kind of?

Question

Good morning BP!

I am a new investor trying to figure out an innovative way to fund my first investment property due to a lack of capital. I currently live with my boyfriend in a house he owns, and I have been told by several people that I should purchase my investment property as a primary residence in order to have a lower down payment. Instead of living actually there I rent it out and my lender would be none the wiser.

My question is whether this is legal? How would this work with needing to report the rental income on taxes? Should I go for it or is it too risky?

Steve K. · Answer

@Margaret Hill Mortgage companies used to employ door-knockers to catch people renting out what is supposed to be their primary. Now they use companies like LexisNexis Risk Solutions who uses a digital program that instantly taps into multiple proprietary and public data resources, then uses algorithms to pinpoint borrowers who lied on their applications. If they catch you, they will likely immediately call your loan, and if you can’t pay, foreclose on the property. If someone has several “primary residences”, they may be reported to the FBI. Lying on mortgage applications is bank fraud and can trigger severe financial penalties, prosecution and prison time if convicted. There’s usually a time period that you need to owner-occupy for (often a year), after which you can rent out the property using the same loan. I may be wrong about this, but I believe if your life circumstances change unexpectedly you can also move and rent out the property without being penalized, but that would be a question for your specific lender. However going in without planning to ever owner-occupy and lying on the application is bank fraud. You might get away with it, but in my opinion the risk isn’t worth the reward.

Mikael Winkler · Answer

@Margaret Hill

Though it may be tempting, I wouldn't recommend renting out the place after you state you'll be living there. I know it is tempting - I contemplated it at one point myself. But, mortgage fraud is still mortgage fraud. Depending on your market, you really can find deals that allow you to bring little to closing, if you're using an owner occupant FHA loan.

I'm in Columbus, OH, and my first investment is a duplex I purchased for $70k, used a 3.5% down FHA loan, and only had to bring about $3,500 to closing. My wife and I lived in it for about 5 months, did repairs, and refinanced. The new appraised value was high enough that we were able to get back all the money we invested initially, and get into a conventional mortgage. This replaced the FHA loan and we were free to move out of the property and rent it out fully.

You say your boyfriend owns the house you both live in? How long has he owned it? If he's built up enough equity, you guys could explore taking out a home equity line of credit on that house to use for acquisition and/or rehab of investment properties.

Hope this helps a bit!

Joe Splitrock · Answer

@Margaret Hill your primary residence is where you sleep. It is your Federal tax mailing address that you will claim on your Federal taxes. If you live there the utilities would be in your name. It is where all your tax and mortgage documents will be mailed.

When you take out the loan, you are certifying you will live there. In exchange you get access to federally backed first time home buyer programs, designed to help people LIVE in their home. The FHA program is specifically not for investors. In addition, owner occupied properties may also qualify for property tax discounts. So if you are stating owner occupied, you are committing fraud on your mortgage on a Federal program and potentially tax fraud at a state level.

I would avoid doing this. Have people done it before and not gotten caught? Yes of course. People commit all sorts of fraud, theft and even murder and get away with it. My point is just because someone does something without getting caught doesn't make it legal and doesn't mean you won't get caught.

Owning rental property comes with lots of natural risk. There is no reason for you to increase it with your actions.

George Blower · Answer

Here are the general considerations regarding 401k loans.

401k Participant Loans

• If your 401k plan allows for 401k participant loans, the maximum loan amount is equal to 50% of the balance up to $50k. The repayment terms for a 401k participant loan are equal monthly/quarterly payments of principal and interest (typically prime plus 1%) over a 5 year term (longer if used to acquire your principal residence).
• Please note that if you take a full $50,000 and then pay back the loan, you can't take another $50,000 until 12 months after the first loan was fully paid back.
• Per the loan offset rules that went into effect with the 2018 Tax and Job Act: if you leave your job and the loan is current at the time you leave your job but then the loan goes into default because you left your job, you will have until your tax return deadline (including any timely filed extension) to make the loan current by depositing the outstanding balance into an IRA (and thereby avoid the taxes and penalties that would otherwise apply).

Please keep in mind the multiple loan rules:Under those rules, the sum of the balances of a participant's outstanding 401k loans under a single 401k plan (using the highest outstanding balance of each loan over the last 12 months) can't exceed 50% or $50,000 whichever is less. Thus, if you took a $50,000 loan and paid it back within 6 months, you would need to wait another 6 months before you could take another $50,000 loan.

Ron Todd · Answer

Hey Margaret, if you wanted to get an investment property and be legal, why not buy a new primary and move into it and rent your boyfriend's house out? Lying on loan docs will probably lead to lying on taxes will probably lead to a new 1bd/1ba in jail.

Margaret Hill · Answer

@Steve K. Hi Steve! Thanks for the info! I’ll definitely be trying to find a different creative strategy to fund my investment that is both legal and affordable. At least now I have the facts to argue with people who keep telling me this is a good idea 😊.

Megan T. · Answer

As many people mentioned, saying a house will be your primary residence and then using it as a rental property instead is mortgage fraud and not recommended

Additionally, you would not be able to get a conventional loan if you used a 401k loan for your down payment. The lender will not allow any part of your down payment to be borrowed money. You could do this with hard money lenders and then refinance out later when your equity increases, but not with a conventional mortgage up-front

Mikael Winkler · Answer

@Margaret Hill

Yeah, I realized right after I posted that you guys were probably not looking to move from your boyfriend's house haha.

I don't know the intricacies of 401k loans, but that may certainly be a great option. On the project I'm currently working on, I used a HELOC for the down payment and am working with a hard money lender, who financed the remainder of the project. Thus far, it's worked out well. We're in contract to sell as a flip but we could've also refinanced into a conventional mortgage after renovations and kept as a rental.

Margaret Hill · Answer

@Mikael Winkler Hi Mikael! I totally agree with your plan but right now we are not really looking to leave our primary residence as we really love the location. But we are slowly building some equity for when the day comes that we do sell.

I’ll have to think of another solution to fund my first property as I do not want to wait. I’m now leaning toward taking out a 401k loan for a down payment since this does not affect my Debt to Income.

Margaret Hill · Answer

@Jody Sperling Hi Jody! We are pretty attached to our current residence and likely won’t be moving in the near future, however we have been slowly completing some home improvement projects to build up our equity for when that time does come. It would probably make a good rental, but it’s also in a rural area and I’m not sure what the demand is for that kind of property.

Primary residence: kind of?

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