One of the most common forms of income included on mortgage loan applications that we see is rental income. Unfortunately, the rental income figure that most applicants list on their application is much higher than what can actually be used. This is not a result of people being dishonest, but rather it is a result of conservative and tricky-to-navigate loan guidelines.
The amount of rental income that can be used is determined by loan program, property type, and to some extent length of ownership. For a better understanding of how much rental income you can use to qualify for a mortgage, continue reading below.
Scenario # 1: Using projected rental income for the purchase of a primary residence
With the exception of a few niche loan programs, in order to use projected rental income to qualify for a primary residence purchase, the property must be 2-4 units. Rental income will be calculated by taking 75% of the lessor between the current lease(s) being assumed or the market rent schedule which is completed by a licensed appraiser. Furthermore, this income is not used to offset the entire payment, but rather just counts as an additional stream of income for calculation purposes. For example, if the rental income comes out to $2,150 and the total mortgage payment comes out to $1,900, both of these numbers will be included in your debt-to-income ratio calculations by the mortgage lender.
Scenario # 2: Using projected rental income to purchase an investment property
In this scenario, the property can be either a single-unit or multi-unit property. The calculation used will be 75% of the rent schedule which is once again completed alongside the appraisal by a licensed appraiser.
This income can be used to offset the total mortgage payment associated with the property. For example, if the rental income is calculated out to $2,150 and the mortgage payment comes out to $1,900, you end up with $250 in net rental income. This $250 difference is added to your income calculations in your mortgage file.
Scenario #3: Using rental income from properties that you already own
In order to be able to use rental income for properties that you own, you must report the income on your tax return. Typically, this income is reported on Schedule E of your personal tax return. Assuming there are 365 fair rental days this income is calculated using the following formula: (Rents Received + Insurance + Mortgage Interest + Taxes – Total Expenses) /12. This rental income will be used to offset the mortgage expense associated with the property.
Scenario #4: Using future rental income from a primary residence to be converted into an investment property
In order to be able to use income from a departure residence, a lease agreement must be in place and the 1st rental payment must be received before the 1st mortgage payment on the new property being purchased. Either 75% of the new lease payment or 75% of the rent schedule completed by an appraiser will be used to calculate the income whichever is less. This income rental income will be used to offset the mortgage expenses associated with the property.
Occasionally, depending on risk factors, in order to utilize rental income you must have a 12-month history of making on-time rent or mortgage payments. Some programs also require that you have a documentable history of being a landlord.
Also, keep in mind that in certain scenarios, because the amount of rental income being used is determined by a rent schedule, the maximum approval amount can become property-specific. In these scenarios, it is important to work with your real estate agent to determine what the estimated fair rental value is in advance so you can provide your lender with an accurate estimate to use.
If you have any questions about qualifying for a mortgage, please reach out to our office at (760) 930-0569 to discuss your options with one of our mortgage loan originators.