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.
FAQs
To qualify for a mortgage for rental property, your DTI should ideally fall between 36% and 45%. In many cases, borrowers can count 75% of their potential monthly rental income (as determined during the appraisal) as additional qualifying income to help reduce their DTI, Tassone says.
Can you use rental income as income for mortgage? ›
Can I Use Rental Income to Qualify a Mortgage? Yes, you can use rental income to qualify for a mortgage, including potential rental income if you have held the property for less than a year. There are two different types of rental income considered by lenders during the mortgage qualification process.
Can income from a rental property be used as qualifying income? ›
Eligible Properties
Rental income is an acceptable source of stable income if it can be established that the income is likely to continue.
How do underwriters verify rental income? ›
Real rental income will be considered by underwriters. A bank could look at two years of your tax returns to see how much proven income has been generated from your leases. For your personal tax returns to be sufficient — per Fannie Mae — you'll need to file IRS Form 1040, Schedule E.
Can rental income be offset against a mortgage? ›
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.
What is the 2% rule in real estate? ›
The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.
Can you use rental income for an FHA loan? ›
Rent Out Your Primary Residence
If you relocate for your job and need to buy a second home, you may be allowed to rent your current home purchased with an FHA loan as long as you lived there for at least 1 year. The rental income from your tenants should cover your mortgage payments.
What income can be used to qualify for a mortgage? ›
Closing thoughts: Qualifying income for a mortgage
Your gross income: The total amount of your earnings before taxes and deductions are taken out. In addition to your monthly income from wages earned, this could include social security income, rental property income, spousal support, or other sources of income.
Why is rental income not considered earned income? ›
Rental income is typically considered to be unearned income by the IRS. Unlike earned income, which primarily includes wages, salaries, or business income from active participation, unearned income typically includes sources such as interest, dividends, and rental income from real estate.
Does money from a rental property count as income? ›
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them.
– Net rental income is determined by taking the lesser of 75% of the gross rent (from Form 1025 or Form 1007) minus the full mortgage payment for the property or 75% of the existing leases. – Refinance: Document the rental cash flow by obtaining copies of the borrower's most recent one years signed federal tax returns.
How to calculate rental income? ›
Gross yield on a rental property is the percentage of profit before expenses have been deducted. To calculate, first multiply the monthly rent amount by the number of months in the year to determine the income from rent; then, divide the income from rent by the appreciated home value.
How do mortgage lenders verify income? ›
Mortgage lenders verify employment by contacting employers directly and requesting income information and related documentation. Most lenders only require verbal confirmation, but some will seek email or fax verification. Lenders can verify self-employment income by obtaining tax return transcripts from the IRS.
Can I use rental income to pay a mortgage? ›
Depending on the circ*mstances, you can use the future rental income from an investment property to offset the mortgage payments, making it easier to meet the lender's debt-to-income ratio requirements and get approved for financing.
How does the IRS know if I have rental income? ›
Ways the IRS can find out about rental income include routing tax audits, real estate paperwork and public records, and information from a whistleblower. Investors who don't report rental income may be subject to accuracy-related penalties, civil fraud penalties, and possible criminal charges.
Do I subtract my mortgage payment from rental income? ›
No, your rental income does not include your mortgage payment nor is it the difference between your rental income and your mortgage. Your rental income is the difference of the amount that you received from renting your property minus ordinary and necessary expenses that you incur from renting your property.
Do I subtract mortgage from rental income? ›
While the principal portion of a mortgage payment is not an expense (because you are simply paying down your loan balance), the remaining items, including mortgage interest, property taxes, and insurance, can typically be deducted against the income received from the properties.
Does rental income count as earned income? ›
Rental income is typically considered to be unearned income by the IRS. Unlike earned income, which primarily includes wages, salaries, or business income from active participation, unearned income typically includes sources such as interest, dividends, and rental income from real estate.
Does rental income qualify as investment income? ›
Rental Property as Investment
Rental ownership is an investment, not a business, if you do it to earn a profit, but don't work at it regularly and continuously—either by yourself or with the help of a manager, agent, or others.
