The following numbers are purely hypothetical. I suggest that you try to plug in numbers that you consider realistic.
Suppose your negative cash flow from the condo rental is $600/month. Add loss and vacancy factors. Every landlord has a period of time when there is not a tenant in residence, or worse, a resident tenant who does not pay. While a landlord, you will have maintenance and repair responsibilities. Budget for these. Between tenants, you will have painting and cleaning bills. What amount of time will all of your landlord duties take, and do you have a valuation for that?
Assume you can qualify for your 350K mortgage with the negative cash flow.
What do you project the appreciation rate to be for the next 2, 3, 5 years (the time period you anticipate holding this condo.)?
Will the appreciation offset the carrying costs and expenses? By how much? How much does it need to represent in postive gain in order to make it worth the risk, the time, and responsibilities?
What would you do w/ $600 (my hypothetical negative cash flow #) per month if you did not use these $$ toward the condo?
In theory, it would be nice to say that you would invest the $600 each month, but in fact, that is unlikely.
Unless the anticipated appreciation is strong enough, it might not make sense to hold on to it soley to avoid a one-time loss. Whatever loss you aborb on the sale of the condo will be offset by the purchase you make, if your are buying in the same neighborhood and market condiditons.
Suppose you calculate that you would take a 25K loss on the sale of the condo. You might be realizing a net gain of much more than that by buying well. It is a good time to move up; harder time to downsize.
You need to plug in the numbers and ask yourself upon a reveiw of those calculations what the risk/reward is for you. I suspect you need to anticipate decent appreciation in order for it to be beneficial to hold on to the condo.
I can't comment on the mortgage situation. There are a few mortgage brokers on Trulia who will be able to answer that question.
On the real estate side, if you can hold onto your condo for a couple years and be able to afford your new home, then that's the way I would go.
What you need to do is to figure out how much negative income you will get from your condo (potential monthly rent minus mortgage, minus insurance, HOA fee, rental expense (advertising, potential vacancy, reparirs, cleaning - although some of those should be covered by the security deposit)), remember that you can write off your loss and you can also depreciate your rental property (which will also decrease your cost basis when you want to sell) and come out with your really monthly negative cash flow on rental property that way.
Then you have to find out how much new mortgage you can afford after that; do you have a decent downpayment and what kind of house can you get after $350K loan? Will you also be paying PMI? Will you be buying something that needs to be fixed up or move in, what kind of location? Not knowing Riverside, it's hard for me to see what you might be able to buy and if there are great deals out there.
My other assumption is that as you are still paying off student loans, you and your wife are probably looking at stable increased income. so you might be tight on your budget for a year or two and then be able to live more comfortably after a while. However, make sure you have some cushion in case there is emergency - you don't want to lose your house(s) should that happen.
All something to consider when you are making 'long' term investment such as real estate.
Your income is high enough you likely could qualify for the new house even with including the whole condo payment and even with going with a low down payment on the new home.
As far as qualifying? There are many factors that come into play when qualifying someone. Many people purchase homes when they own another property with negative equity. What matters is if you have sufficient income to cover the loss, your debts, and your new housing obligation. In addition, credit, down payment, loan type, etc also come in to play. So anyone who gives you an answer here is just blowing smoke without actually getting into more detail with you.
Here's what I'd do. I would meet with a loan officer first to see if in your current situation where you stand in qualifying for another home. Take that information and run it by your CPA. Keep in mind if you have to do a short sale on the condo it could affect you qualifying for a new loan as well. You need both of these professionals help for you to make an informed decision.
I hope this helps you to go at least in a starting direction. Happy Holidays!
Talk to a mortgage broker to best get the latest info and interest rates and how your circumstances fit in.