Debt to Income Calculation

[Michael Osborne]

I currently have no debt except 2 mortgages that are on rental properties and plan to purchase a new primary residence soon. The mortgages on the rentals (PITI including HOA fees) are $4,451 monthly and monthly rent is $5,200. From what I have seen mortgage companies typically only count 75% of rental income as income, so that brings the income down to $3,900.

How does this look for DTI calculations?

Are the rentals looked at as a group, so in this instance a loss/debt of $541 ($4,451-$3,900 monthly), so DTI is calculated as ($541 loss + new primary residence expenses) divided by (rental income plus W2 income).

Or is DTI calculated as ($4,451 in rental expenses + new primary residence expenses) divided by ($3,900 in rental income plus W2 income)?

[Julee Felsman]

Hi @Michael Osborne! 

Rents are calculated one of two ways... the 75% rule you mentioned is one of them. For each property your lender will subtract 75% of the rents from your PITI/HOA.

$4451 - $3900 = $541 rent loss

PITI on new primary + 541) / monthly W2 income = DTI

(Although in the real world this math is run per property... but the aggregate numbers would be the same.)

The 75% rule applies to any property you've acquired recently (or put into rental use recently) such that it doesn't yet show up on your tax returns or was acquired midway through the year such that the info on your Schedule E wouldn't be representative of ongoing income and expenses).

For a property that shows up on your prior year's tax filing, we analyze the Schedule E the math goes like this:

Net Sch E income or loss + depreciation + amortization + HOA dues + mortgage interest + MI + homeowners insurance = net income

(net income / 12) = monthly income

Monthly income - PITI/HOA = rent income or loss

There's one more add-back that can go on the list above... if you've had unusual one-time expenses during the prior year (major renovations, disaster losses... pipe burst, flooding, fire) you can add those back.

If the property was out of service for a period of time due to the above unusual expense, but has been re-rented, you can sometimes make a case for going back to the 75% rule.

I should add that this goes for properties that show up on your personal tax return (whether titled to you or an LLC). If you hold title through an entity that files its own tax return, the figuring is done differently... there's a bit of an if/then flow chart we use:

If the liability is in the individual (not the businesses name) we analyze the form 8825 from that entity (the "schedule e" that a business entity like a partnership uses). If that analysis gives us a negative number, the income flows through just like it would if it were on Schedule E. 

If the liability is in the name of the entity and/or the the property is free and clear and/or the cash flow is positive, then we analyze the income using the appropriate methodology for the business entity... but I'm already deep in the weeds and some new COVID rules for self-employed folks have just thickened that plot a bit... so I'll stop while i'm behind. :)

Oh and for jumbo or portfolio loans, the worst-case average of 2 year of Schedule E income is likely what will go into the DTI (24 month average if income is trending up between the two years, 12 months if the more recent year had lower income).

Cheers!

Julee