How Lenders View Rental Income
Income is income, right? Of course it is. There’s really no other way to describe money coming from an employer and deposited into a bank account. Or, the income that comes from a business or from investments and dividends. Interest is another form of income and as we approach income tax time any variety of income sources will be reported to the IRS. But as it relates to qualifying for a mortgage, not all income is the same, and this includes income from rental properties. Income is the same as it relates to inflating a bank balance but when applying for a mortgage it can be treated differently.
Income from an employer is the most common type of income. Income is verified by viewing copies of recent pay check stubs covering a 30 day period showing gross monthly income and a year-to-date amount. Self-employed borrowers prove income to a mortgage lender by providing copies of their most recent federal income tax returns for the past two years. Interest income from a bank account or from the sale of an asset can also be used when qualifying, as long as there is a consistent, two year history of receiving it. You notice a pattern here, right? Lenders can use most any form of income as long as there is a two year history of receiving it and there is a reasonable expectation the income will continue into the future.
When borrowers apply for a mortgage loan and there is rental income listed on the loan application, the very same two year rule applies. Rental income can be used if there is a two year history of receiving it. Okay, but what about an application to buy and finance a rental property that’s currently rented, can that rental income be counted? Real estate investors buy rental properties because their tenants essentially pay their mortgage for them plus some extra monthly profit. A rental property with rent coming in essentially “wipes out” the mortgage liability. But there does have to be a two year history of being a landlord on another property. If there is no such history, while the income is certainly there it can’t be counted. Instead, buyers have to qualify without the benefit of the rental income.
For those with two years of landlord experience and can provide evidence of receiving rental income, lending guidelines won’t necessarily use the amount listed in the rental agreement but will refer to the amount indicated by the appraiser. The appraiser will perform what is called a market rent analysis and determine the amount of rent the property is expected to generate. Loan guidelines also take into consideration vacancies, utilities and maintenance. In general, 75 percent of listed rental income will be used instead of 100 percent in light of these vacancy and maintenance factors.
In short, if you’ve got two years of successful landlord experience the income from the future purchase can be used to offset part or all of your mortgage payment. But until that time, real estate investors must qualify on their own without the benefit of future rental income.