As a landlord, you might be looking for a way to finance your next investment. This guide is about using rental income to qualify for a mortgage.
Since the national housing crisis of 2007, which resulted from relaxed mortgage lending standards, mortgage lenders have been raising their lending standards and making it difficult for investors to obtain a mortgage.
Table of Contents
- Can I Use Rental Income to Qualify for Mortgage?
- How Does It Work?
- What Kind of Documents Do You Need?
- How to Determine Your Rental Income When Applying for a Mortgage
- How to Calculate Your Rental Income to Qualify for a Mortgage
- Key Takeaways
- Frequently Asked Questions
Nowadays, potential investors looking to receive funding for their next investment should be prepared to dive deeply into their savings, earnings, and debt-to-income (DTI) ratio, which is a metric used to compare how much you owe to how much you earn every month.
Speaking of income, many types of income can help you access a mortgage. Many mortgage lenders also don’t impose a minimum income requirement to access a mortgage.
In today’s post, we’re going to look at how to use rental income to qualify for mortgage for rental property.
Can I Use Rental Income to Qualify for Mortgage?
Yes, many mortgage lenders will accept your rental income as your primary income and grant your application for a mortgage.
Like many other loan providers, mortgage lenders are mainly concerned with your financial situation and whether you can afford to make the monthly payments in a stable and risk-free way.
Mortgage lenders understand that some investors may not have any other source of income, such as a salary. If an investor receives a salary, it might be low or irregular and therefore not reflect their economic situation and ability to pay the debt.
By taking rental income into consideration to help investors access a mortgage, they’re acknowledging that every situation is unique and some situations don’t apply to every investor when seeking financing.
As such, it’s important to understand the definition of rental income from a loan officer’s standpoint. It’s the rent you receive from tenants who live in a property you own. You can break it down into two types:
- Actual income: This is the documented rental income that you receive regularly and is recorded on your tax returns. A loan officer can calculate and verify your actual rental income to help you qualify for a mortgage.
- Subject income: Subject income is the estimated rental income you expect to generate from the property you want to acquire through financing. Lenders treat subject rental income differently from actual rental income.
In some cases, a loan officer can also evaluate your ability to pay off the loan based on evidence of past rental payments made on time.
How Does It Work?
First things first, you need to know that every lender is different. They all have a unique set of requirements and eligibility criteria. It can complicate the process of using rental income to qualify for a mortgage. Make sure you work with an expert broker to help you understand the details of the application process.
Now that we’ve gotten that out of the way, how does the process of using rental income to qualify for a mortgage actually work?
The amount of mortgage that is granted based on your rental income is determined using a few factors, such as:
- How long you’ve been a landlord
- The number of rental properties you own
- Your ability to give evidence through tax calculations
Various lenders will need you to provide proof of rental income for at least three years. Ensure the income is legitimate and can’t just be proven through your bank statements or rental agreements.
Of course, you must be able to meet the minimum requirements and eligibility criteria. Remember, they vary from lender to lender.
Related: 3 Best Investment Property Lenders for 2023
Rental Income for Residential Property Mortgages
You can use rental income to obtain a mortgage for a buy-to-let or residential property. However, there are some significant differences in lender requirements based on the property type you want to purchase.
Many lenders will treat them equally, but others will require complete income verification for investors applying for a primary residential mortgage.
Most lenders will accept the rental income listed on your bank statement if you’re buying a residential property, especially if you haven’t been receiving the income for more than a year.
Using rental income to qualify for a mortgage for a buy-to-rent or residential property is simpler for experienced investors with a diversified real estate portfolio than for newbies just starting out.
Proof of Rental Income for Residential Mortgages
Like many other landlords, you might be self-employed or relying on multiple sources to show proof of income. In this case, the burden of proof becomes harder. Typically, most lenders accept employment income and even offer friendlier terms—some even factor in bonuses, overtime, and commission.
As such, most lenders don’t accept rental agreements or bank statements as proof of income. They require that the income be supported by self-employed accounts for at least the past three years.
However, some mortgage lenders offer relaxed requirements. They’ll accept financial documents for at least two years. Others will grant you a self-employed mortgage based on one year’s financial history if you want to use rental income to finance the debt.
In short, while rental income can be taken into account when applying for a mortgage or seeking to refinance a property, it must be well-documented and meet some eligibility requirements, just like other sources of income.
Fannie Mae’s Requirements
For example, some of the eligibility requirements by Fannie Mae, one of the largest mortgage financing companies, include:
- You must show the likelihood of rental income in the future.
- The investment property must comprise between one and four units. It can also consist of between two and four units if the borrower lives in one of the units.
The rental income from a property owned by the borrower is acceptable if it’s not from the property being financed. The income can be from the borrower’s primary residence, whether it’s a single family home or a specific unit in a multi-family property. Revenue from short term rentals is also acceptable.
If your property meets the above requirements, getting your rental income taken into account involves filling in the correct paperwork and providing the appropriate supporting documents. The documents you’ll need to supply are based on the property’s history of rental income (or the lack thereof).
Related: Alternative Ways to Finance Investment Property
What Kind of Documents Do You Need?
The process of applying for a mortgage using rental income is more or less the same as applying for one without rental income. The difference is that you might need to go through a thorough screening process. Besides, be prepared to show proof of your actual or anticipated rental income.
When providing other necessary financial details of your application to your lender, also be prepared to include your rental income.
Generally, prepare copies of the following documents:
- Two years of tax returns
- Two years of W-2s or 1099s
- Pay stubs for the past 30 days
- Monthly or quarterly bank statements for all your financial accounts, including investments
- A profit and loss statement for self-employed applicants
- A signed copy of the real estate purchase agreement
If you currently don’t have a tenant but can provide proof of tax returns, your application should be fine. Otherwise, you’re probably going to need to calculate how much rental income you expect from your property.
However, note that a rough estimate won’t be sufficient for the lender. The lender will carefully examine your income and may order an appraisal. To estimate the rental income, the appraisal also considers other real estate comps in your neighborhood and their rental rates.
In addition, the lender might require a copy of the lease and copies of the most recent checks to determine whether the rent will be paid on time and consistently.
That said, know that your rental property’s income might be eligible to be reported as income. Before starting the mortgage application process, talk to the lender. Make sure to confirm which documents you’ll need to provide to support your application. This way, you’ll have everything ready and avoid wasting time looking for additional documents.
How to Determine Your Rental Income When Applying for a Mortgage
Basically, the documentation you provide will determine how your rental income will be calculated when you’re using rental income to qualify for a mortgage.
Let’s break down how mortgage lenders and loan officers calculate your rental income based on different documents.
Calculating Rental Income Based on Federal Tax Returns
When a borrower submits their federal tax returns when qualifying for the required rental income, the lender first determines the borrower’s cash flow. The lender then adds back any deductions for interest, depreciation, insurance, taxes, or HOA fees.
If the expenses were well documented, any nonrecurring property costs might be refunded.
The lender then averages the income over the number of months the borrower rented out the property over the tax year.
Calculating Rental Income Based on Leases and Appraisals
The lender uses a portion of the estimated rental income in their calculations based on leases and appraisals. Typically, they use 75% of it and leave 25% for foreseen vacancies.
Calculating Rental Income Based on DTI Ratio
As we mentioned, most mortgage lenders will take many factors into account when qualifying you for a mortgage. One of the factors is the debt-to-income (DTI) ratio. This ratio is calculated by adding all your total monthly income and dividing it by the total amount of your monthly debt.
The lower your DTI ratio, the better. Most lenders prefer a DTI ratio of 43% or less.
For example, let’s say your total monthly income is $5,500 and your monthly mortgage payment is $1,200. In addition, you’re repaying a student loan, car loan, and (minimum) credit card debt, which are $250 each. The calculations would appear like the following:
(1,200 + 250 + 250 + 250) / 5,500 = 35.45
In this case, your DTI ratio is 35% (rounded off).
However, you need to take more factors into account when carrying out the calculation, especially if the rental income you’re using to qualify for a mortgage comes from your primary property or different rental properties.
If the source of the calculated rental income, averaged over the number of months it was used as a rental in the previous tax year, is your primary residence, you should include it in your gross monthly income calculation. In the meantime, your monthly debts should include the full amount of your mortgage payment.
If the calculated rental income isn’t from your primary residence, it can only be considered if it exceeds your monthly mortgage payment when computing your gross monthly income.
Related: Debt to Income Ratio for a Mortgage: What Real Estate Investors Should Know
How to Calculate Your Rental Income to Qualify for a Mortgage
As you can see, estimating your monthly rental income is essential when using rental income to qualify for a mortgage. You need to carry out due diligence even when applying for a loan for property owned by LLC.
As you can already tell, manually conducting the calculations would be a time-consuming affair. You need to gather, organize, and analyze a lot of data. A simple error can make your entire analysis inaccurate. That’s why you need to use modern real estate tools.
Your best bet when it comes to estimating your rental income is Mashvisor. It is an online real estate platform that helps investors make smart business decisions by providing them with reliable and accurate data and analytics.
Mashvisor is a massive database with huge amounts of data that are regularly updated. It helps investors carry out analysis easily by making everything available with just the click of a button.
The platform offers a wide variety of tools to help you with your investment property analysis. For example, the investment property calculator will allow you to come up with accurate monthly rental income estimates. The numbers generated are accurate and realistic.
Our tools are interactive. If your research or experience on the ground shows that some numbers might be different, you can adjust them and see how the ROI will change.
If you want to get started with real estate investing and using rental income to qualify for a mortgage this year, we recommend using Mashvisor to ensure you get started on the right note. On top of the functions mentioned above, Mashvisor will also help you invest in the best market and rental property.
Sign up with Mashvisor today and start your 7-day free trial.
Many landlords who own and operate rental properties will be glad to know that using rental income to qualify for a mortgage is possible. Lenders will typically look at your debt-to-income ratio and income streams.
The process becomes way easier if you documented your rental income, and it’s verifiable. Using the estimated rental income you expect to receive from the investment property is a bit complicated. The lender will ask for an independent appraisal of the property to evaluate the market rental rate.
The lender may also use a signed lease agreement for occupied rental properties to determine the percentage of rent that will be used to qualify you for a mortgage.
Keep in mind that you will need to provide your lender with important supporting documents, such as bank statements, tax returns, profit and loss statements, and many more. The lender will also take into account the property’s expenses and cash flow when considering your application.
If you find it hard to calculate how much rental income you can expect from your property, use a reliable real estate tool such as Mashvisor. The real estate platform will help you calculate a property’s rental income and ROI. It will also assist you in choosing a profitable real estate market to invest in.
Schedule your demo today and see how Mashvisor’s tools can help you.
Frequently Asked Questions
Find out more using rental income when applying for a mortgage below:
What Percentage of Rental Income Can Be Used for Mortgage?
75%. Mortgage lenders only use 75% of the rental income to qualify borrowers for a mortgage since they have to account for the property expenses, vacancies, and any other losses that the landlord may inevitably face.
In short, 25% is to account for factors that may impact the gross rental income.
Can You Use Projected Rental Income for FHA?
Yes, it’s possible for a lender to consider the projected rental income from the investment property being financed for an FHA loan.
The FHA loan rules in HUD Handbook 4000.1 addresses the rental income issue, stating that “Rental income refers to income received or to be received from the subject property or other real estate holdings.”
However, you may need to consult your loan officer since lender standards may differ from the FHA loan rules.
Can You Use Potential Airbnb Rental Income to Qualify for a Mortgage?
Yes. If you’ve been renting out your property or part of it as an Airbnb rental, you can use that income to qualify for a mortgage.
Fannie Mae now allows conventional mortgage lenders to grant mortgage applications that account for projected short term rental income from property listings on vacation rental sites such as Airbnb and Vrbo.
Borrowers must show proof of a year’s worth of rental income from other properties they own. It means that accessing a mortgage using Airbnb rental income isn’t a suitable option for newbie investors without any track record of vacation rental success.
Can a Borrower Use Rental Income on a Primary Residence?
Yes, you can use rental income on a primary residence to secure a mortgage. The only condition is that you need to show a history of earning rental income from it or proof that you will continue earning from it.