When financing an investment property using a conventional FannieMae loan, there is a little-known rule that often bites investors. You’ll typically hear it called “The 2% Rule” and refers to a restriction on the amount of incentives that you can receive as an investor. It’s most often applicable to new home purchases, but technically applies to resales as well. The rule states that for any standard conforming FannieMae loan (your typical “conventional” loan), the amount of funds that can be paid to or paid on behalf of an investor borrower is capped at 2%. There is actually a cap for non-investors as well, but it’s significantly higher.
The logic behind the cap is to keep people from buying above their limits. For example… let’s say a builder wants you to buy their $250k new home, and as an investor, you’re required to put down at least 20% ($50k). Without this rule, the builder could raise the price of their home to $300k, give you back $50k at closing, and you walk away with a house for $0 down. It’s the same net cost to the builder, but you also walk away with a house that is $50k underwater from its true market value. It’s also what got us into the recession mess in the first place. The rule would restrict the builder in this example to a maximum of $5k.
The rule applies to all parties in connection with a loan (seller, lender, agent, etc) and limits the SUM TOTAL to 2%. This is significant because… Let’s say the builder in our example is offering $3k cash, the lender is offering $3k in closing costs, and your REALTOR® is a friend of yours so is giving you $500 of their commission. You’d now be at $6,500 in incentives and in violation of the rule.
So what can you do? By law you have to get your cash incentives down to 2%. Even if your sales agent or loan officer doesn’t catch it, the underwriter will, and it’ll be much harder to deal with later. Be upfront about it. Ask the builder to credit the difference toward the price. If they won’t do that, then ask for some upgrades. Remember, it isn’t the seller’s rule… they just want to sell you a house!