In the wake of the national housing crash that began way back in 2007 as a result of lax mortgage lending standards, obtaining a mortgage has become much more difficult as lenders tightened their underwriting criteria.
Homebuyers and investors seeking to qualify for mortgages should be prepared for a deep dive into their earnings and debt-to-income ratio (DTI), which is a measure of how much you owe compared to earnings. Many types of income can help you qualify for a mortgage, and there’s no “minimum” income that will help you qualify.
Wages from employment typically must be stable and verifiable – good luck qualifying if your income is from self-employment and reported on Form 1099. You can use many different types of income, though, including income generated from rental properties.
Here’s an overview of how to use rental income to qualify for a mortgage.
Rental Income and Mortgages: What Lenders Look For
Proper documentation is crucial to obtaining a mortgage using rental income.
Rental income is generated from lease payments made by tenants. There are two types of rental income:
- Actual income. Actual income refers to documented rental income that’s been received on a steady basis and has been recorded on your tax returns. A loan officer can verify and calculate this income stream to help you qualify for a mortgage.
- Subject income. Subject income refers to projected income that will be generated from a rental property you wish to acquire through financing. This income stream is treated differently from other income generated from rental properties you may own.
With actual income, loan officers can simply review your tax returns – specifically, Form 1007: Single-Family Comparable Rent Schedule – to come up with an accurate number for rental income that can be used to help you meet lending criteria. Since there is no such history with subject income, lenders have to take a different approach.
With subject rental income, your loan officer will take the greater amount of 75 percent of a gross lease or 75 percent of predicted rent as reported by a certified appraiser. If you are seeking a mortgage to purchase a two to four-unit rental property, you’ll need to use Form 1025, Small Residential Income Property Appraisal Report. This report is completed by an appraiser and provides lenders with an unbiased opinion of market rental rates for subject properties.
If you plan on living in one of the units of your rental property, the Form 1025 breaks out rents by unit to help lenders come up with an accurate amount for rental income. Lenders only use 75 percent of predicted rental income to account for variables such as vacancy and expenses associated with maintenance and routine upkeep on the property.
Putting it all Together
If you own a rental property and want to use rental income to qualify for a mortgage on an additional property, lenders are going to take a hard look at your current debt-to-income ratio and your income streams. Rental income that’s been documented and is verifiable makes it slightly easier to tip the scales in your favor.
Using prospective rent from a property you hope to acquire can be a bit more complicated. Lenders will order an independent appraisal of the asset to assess market rental rates, or they will use a signed gross lease for occupied properties to come up with a percentage of rent that can be used to help you qualify for a loan. Lenders can only use 75 percent of subject rental income since variables such as vacancy and maintenance can impact gross rental proceeds.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.