What part of rental income do lenders consider?

Question

I’m planning on purchasing rental properties in the near future. Once I’ve gained rental income, I would like to finance a Condo and even more rental properties with my income from rentals. However, I’m a bit confused on what underwriters consider income when calculating DTI. Do they look at your total rental income (top line, before expenses)? An example: If I have 80k from total rents, but my NOI is 47k (no debt), would I qualify for a 350k loan on a condo?

John Wade · Answer

Hi Shivani,

Conventional lenders will use Fannie Mae Form 1038 to calculate rental income most of the time. Underwriters will go from the Schedule E on your personal tax return to complete the form. Here's a link to the form: https://singlefamily.fanniemae.com/media/15601/display

If you vest title in an LLC, and file taxes for your rentals on a business tax return, it's important to note the net rental income can only offset the PITI payment (no positive income can be used over and above the PITI for each property). As an alternative, underwriters can do a cash flow analysis from the business tax return (2-year average) and exclude the personal liabilities from your credit report if the mortgages have been paid from a business bank account for 12-months.  If you vest title on the properties in your personal name and report the rental income on a personal tax return, you can use positive net rental income over and above the PITI payment for each property as qualifying income.

Patrick Roberts · Answer

For Conventional, there are two basic ways that income is evaluated - properties being placed into service (such as a new property being purchased), and properties already in service. For properties being placed into service for the first time, 75% for the gross rent (based on the appraisal/1007) is used. 25% is assumed as expenses/vacancy.

For properties already in service, the bottom line on Sched E (or however you're reporting) is used. Start with the bottom line, then add back mortgage interest, property taxes/ insurance/HOA fees (assuming they are escrowed), and any noncash and onetime/extraordinary expenses, such as depreciation. Once you have this figure, net it against the mortgage payment for that property (if there is one). If the net figure is positive, meaning there is positive cashflow, it's added to your gross monthly income. If it's negative, it's considered to be a liability/debt and feeds into your DTI. If there is no mortgage payment at present, escrow items are not added back in the above explanation.

It's more nuanced than this and there are many exceptions/caveats, but this gives a high-level explanation.

For DSCR loans, in most cases, the raw rental income is used, whether based on the rental appraisal (1007) or an actual lease. Some lenders compare this to only the actual mortgage payment and some include an expense factor. DTI and personal income are not considered.

Carlos Valencia · Answer

Hello Shivani,

Lenders allow you to use 75% of your lease agreement if you acquired your property within the last 12 months and have not filed your tax return for the year when the property was acquired. When looking at your next investment property make sure to look at what is the max rents you can receive for that property. the goal is to cash flow or at the very least break even at 75% of rents received. In the event where you have owned your rental property for 2 years and you have filed your taxes claiming that property as a rental then they will have to use your net income based on what your tax return show for income. At that point they will use 100% of what the net is minus your monthly mortgage including taxes and insurance.  Its best to discuss your scenario further with a investor friendly lender so they can best advise and help you plan to build your investment portfolio because if you make one bad investment that can derail your progress. This is why its good to make sure you still have active income to continue to build your portfolio. Without active income it will become challenging to grow.

@Albert Bui @Matthew Kwan

Patrick Roberts · Answer

For Conventional, there is no percentage/factor reduction where there is historical income figures to work with (reported a tax form)- the figures from the tax return are used. For DSCR loans, this literally varies by lender and by rental type (LTR, STR).

Jay Hurst · Answer

Account Closed    For a conventional loan IF the rental income is not on the tax returns because, for example,  you purchased the property in Jan of this year you can use 75% of the lease to cover your debt. For example, if the rent was 1000, and your total prin/int/taxes/insurance/HOA payment for that property  was 800, you would only have to carry 50 dollars a month with the rest of your income. This is because you would get 750 (or 75% of 1000) for rental income against your 800 payment.

If you do have the property on your latest tax returns it gets a bit more complicated because there are more inputs. This is the form that would be used:  Fannie Mae rental income

Account Closed · Answer

Thank you for the information! Do lenders use the 80%/75% rule for in-service rental properties(non commercial)? Or do they just go by the bottom up calculation you outlined? I’ve heard that lenders take your total rent and consider 75-80% of it in your monthly income to get your DTI.

Ziad Hamati · Answer

There is so much that goes into it, but previous answers are very well thorough and great responses.DSCR is the way to go if DTI is an issue. I am a broker in Texas so feel free to reach out. We will always find a solution :)

Albert Bui · Answer

HI Shivani,

Each individual property would be calculated separately based on when you purchased it (tax returns or lease agreements used either or or both in some cases) which the lender would subtract from the monthly PITI or mortgage obligation/taxes/insurance/assessments/etc.

All the rentals whether positive or negative would then be added up into one number (net net).

This resulting number would be either net positive or negative. If its positive it adds to your job/self employment income as a total income figure to determine your DTI or debt to income. However, if this total income number is negative it will count against you like any other liability would (think car loan or other mortgages with no rental income or credit card min monthly payments/etc) against your DTI.

DTI is typically maxed out around 45-50%, so half of your monthly figure so if you make 10,000 gross per month your max liability at @50% DTI is 5000 a month max payment. This will be the maximum you can handle before a lenders system will go "ineligible/decline."

Some lending programs are more or less (there are various programs) but in general 50% DTI is max.

In order to ensure you accurately plan for your future mortgage its good to know up front how these situations would be affected and what borrowing power you will need when the come times to purchase this upcoming "condo."

Have you given consideration to where this condo will be and what price range it will probably be available at?

We could work backwards from the condo's upper tier pricing (that you would likely get into contract at) and backwards calculate how much income you're going to need to qualify given the probability of how the rest of your rental income and liabilities will be caluclated.

We do these calculations (plan A, B, C, etc) on a daily basis. Let us know and we can run through some possibilities with you.

@Matthew Kwan

@Carlos Valenciaenc

Craig Warner · Answer

If you have current rentals properties on your tax return reporting for a full tax year, we'll use the net after expenses but add back depreciated and any one time extraordinary repairs. If a new property, typically we'll use 75% of gross rent. However the way to go nowadays is DSCR (debt service coverage ratio) where the rent may or may not cover the new PITIA payment on the rental. Our DSCR are priced even lower than full doc, so save yourself the headache of over documentation or being declined for high DTI. Go DSCR.

Tanner Lewis · Answer

Hey Shivani, since you are looking to qualify based on the property's rental income, I suggest looking into DSCR loans. They are based on the DSCR ratio, which is rental income/(principal + interest + taxes + insurance + HOA).