How Much Rental Income Can Be Used to Qualify for a Mortgage?

Up to 75% of your rental income can be used for mortgage qualification, whether that is documented income or rental income potential. There are numerous different ways that you can have your rental income calculated when preparing to purchase another property, 

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.

• Actual Income – For mortgage approval, actual income refers to real profit documented by a rental income history or tax returns. 
• Subject Income - This is the real or predicted rental income accepted by the lender, which may be lower than the actual income. It is based on overall financial viability and is ascertained using formulas that account for unexpected expenses, like potential vacancies for an extended period.

How Does It Work?

The mortgage application process is different depending on what kind of rental income you are using to apply and the type of property you’re buying.

Your mortgage advisor will assist you in calculating how much you can afford and discuss your different options, such as a traditional mortgage, VA loans, and DSCR loans.

Below are different options for securing a rental income mortgage.

Using Projected Rental Income for the Purchase of a Primary Residence

If you want to buy yourself a new home with two to four units and you intend to rent out part of it, you can use your property’s income potential for mortgage qualification.

Develop an income projection based on fair market value for an equivalent unit and draft a lease agreement with realistic, fair rental income expectations. If you’re renting part the property to a family member, sign an agreement with them ahead of time proving they agree to your rent rate.

Using Projected Rental Income to Purchase an Investment Property

A potential borrower who is buying an established rental property can use rental history from the subject property in order to provide a predicted rental income to a lender.

The seller should provide you with information about lease agreements and property taxes, which you can use to calculate net rental income and prove that the property  has sufficient income generating potential.

Using Rental Income From Properties That You Already Own

The process is easier if you are using rental income from properties you already own, as you can easily prove how much rent you make through tax returns and leases. Remember that, in general, you can only claim 75% of the income. 

Using Future Rental Income From a Primary Residence to Be Converted Into an Investment Property

If you’re going to convert a primary residence into an investment property, you need to ascertain the future rental income through fair market rents. This is based on similar rental properties in the area of a similar size, age, and location.

Identify all potential costs associated with the investment property, such as property management fees, mortgage payments, taxes, and insurance. If it’s not currently a well-maintained property, include the cost of bringing it up to standard and subtract this from your projections.  

What Kind of Documents Do You Need?  

You will need comprehensive documentation about the rental property when applying for a mortgage, which includes the following:

• Two years of tax returns
• Two years of W2s or 1099s
• Two months of pay stubs
• Bank statements for all accounts
• Lease agreements
• Rent history of the property
• Profit and loss statement
• Signed copy of the real estate agreement
  

   

  If you are not an individual investor (i.e. you have an LLC or commercial holding company), you’ll have to include detailed documentation about your company, such as its profits, taxes, credit score, and business plan. You will also need to include personal income information, like your credit history, debt payments, and any additional property you own. If you have more than four rental properties, you’ll need more specialized mortgage products. Be prepared to provide all of this information about every property you own and calculate your rental income ahead of time based on your documentation, as this will give you and your advisor something to work with when you apply.  

How to Calculate Your Rental Income When Applying for a Mortgage

Before claiming rental income, you need to have a solid understanding of how much you’re actually making by using rental income history and market values. You’ll then be better prepared to negotiate your mortgage interest rates based on a good DTI and strong cash flow.

Calculating Rental Income Based on Federal Tax Returns

This is the simplest way to identify rental income, as it is already documented. Gather your federal tax return, which is usually Form 1040, then review Schedule E, which is for profits from rental properties. 

There will be a line item for “Rents Received”, followed by a list of deductions for property-related expenses. You’ll then determine net rental income by subtracting the expenses from the rent, and finally multiply it by 0.75 to see how much you will be able to claim when applying for a mortgage.

For example, if your rent is $2,500 and your expenses are $1,000, you have $1,500 in income. You can claim $1,125 when applying for a mortgage.

Calculating Rental Income Based on Leases and Appraisals

This method for ascertaining income from rental property relies on leases and property appraisals to identify how much the property is worth, as well as how much you can reasonably charge.

If there are previous tenants, review how much rent was charged, then compare this to the current market rent to identify whether you can raise the future rental income to better match conditions. You’ll also have the property appraised, then compare this with other rental properties in the area to see whether you’re charging a fair rent.

As a general rule of thumb, a landlord should charge 0.8% to 1.1% of the home’s overall value. If the previous tenant was charged $2,200 when the home was worth $250,000, but the home is now worth $300,000, you can reasonably expect up to $3,300 in rent.

Assuming operating expenses have risen to around $2,300, you’d have $1,000 in profit, and you’ll have $750 rental income to qualify for a mortgage. 

Calculating Rental Income Based on DTI Ratio

This is used to identify if you have enough rental income to qualify based on DTI, and is a good indicator of whether you can afford a rental income mortgage.

You should gather all the documentation of your net operating income from all investment properties, determine all the debts associated with your properties, such as mortgage, insurance, taxes, and property maintenance, and then divide this 75% of the total income.

For example, say that you have three properties with a combined debt of $2,160 and a combined income of $7,600 per month. You can claim $5,700 of this rental income to qualify. Dividing the debts by the income gives you a DTI of 37%, which makes you a well-qualified buyer.

Calculating Rental Income Based on Your Net Cash Flow

Mortgage lenders want to see a strong positive cash flow when you use rental income to qualify for a mortgage. You can calculate this by seeing how much money is flowing into your properties versus how much is leaving. In other words, subtract all the operating expenses and debt service from the gross rental income.

For example, assume your gross rental income is $3,000 per month and your operating expenses are $1,200 per month. Your net operating income would be $1,800 per month. Lastly, you’ll subtract your monthly debt service of $1,500 to get a net positive cash flow of $300.

Calculating Rental Income Through Fannie Mae Worksheets

Fannie Mae has a variety of helpful worksheets that can assist you in ascertaining the rental income of a rental property. There are four worksheets: one for a principal residence with up to four units, one for an individual rental income for up to four properties, a worksheet for those with more than four properties, and one for business rental income.

These aren’t necessary when applying for a conventional commercial mortgage, but they have the formulas embedded, making it much easier to complete your calculations without mistakes. They also have a rent schedule which can be used by a licensed appraisal to identify fair market rents, which you’ll need if you’re buying an investment property with no lease history. 

Key Takeaways

Real estate investors can leverage rental income to improve their financial stability and develop a steady income stream, but they can also use it to buy other property, such as vacation homes and more rentals. A borrower’s ability to leverage rental income depends on how many rental units they have or are purchasing, as well as market rent and their other debt obligations.

Q: Can income from a rental property be used as qualifying income?

A: Yes, rental income can be qualifying income. It can increase your changes of qualifying for a larger loan, as it reduces your debt-to-income ratio. It must be properly documented with income statements, or projected if you’ve owned the property for less than a year.

Q: What income can be used to qualify for a mortgage?

A: Besides qualifying rental income, there are numerous other income streams that can be used to get a mortgage. These include hourly wages, salaries, self-employed or freelance income, leave pay, government benefits, and investment income. 

Q: Does rent count as debt to income ratio?

A: If you are making rental income, 75% of it can count toward your income to lower your DTI. Those making rental payments to a landlord do not count their rent toward their DTI because it is assumed that this expenditure will be replaced by a mortgage. 

Q: Do I subtract mortgage from rental income?

A: In order to determine your net operating expenses, you need to subtract all operating expenses from the rental income, which identifies how much profit you’re making. For tax purposes, you’ll identify your profit and then make deductions for interest, mortgage insurance, and other expenses, which will reduce your overall income. 

Q: Why is rental income not considered earned income?

A: Rental properties are considered passive income, similar to investments from stocks and bonds. This is because you’re not required to pay payroll taxes or subtract for Social Security and Medicare.

Q: How much income do you need to qualify for a $200,000 mortgage?

A: The minimum you can make is $45,000 for a $200,000 mortgage, but most experts suggest an annual income of $62,000 from all sources. This assumes you have few debts beyond the mortgage payment. Those with more debt service need to make more money in order to qualify.

Q: Can I use rental income to offset DTI?

A: Yes, you can generally use up to 75% of the rental income generated by your investment properties to reduce your DTI. 

Q: How do you calculate DTI with rental income?

A: To calculate rental income for DTI, first identify your net rental income, which is your total rental income minus all your debt service. Next, multiply it by 0.75 to ascertain how much will qualify toward your DTI. For example, if you make $10,000 per year in rental income, $7,500 would count. 

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