Your income determines the size loan lenders will give you. They compare your total income to your debts. If your debt-to-income ratio is in line with program requirements, you may secure a loan. What if your income isn’t as straightforward as a paycheck? What if you receive rental payments? Will they count towards your income? We look at a few examples here.
Using Rental Income for Owner Occupied Mortgages
Owner occupied mortgages are those used to purchase the home you will live in. In this case, lenders consider rental income alternative income. They can’t verify it with paystubs or W-2s. Instead, they’ll need your tax returns and/or a lease agreement. Lenders do the following:
- If you have a lease and owned the property for less than 1 year – The lender uses 75% of the rent written in the lease
- If you have a lease and owned the property for more than 1 year – The lender uses Schedule E on your tax returns. They use the profit or loss you report. They do add back depreciation and certain household expenses, though.
If you owned the property for several years, lenders average your rental income over a 2-year period.
Using Rental Income for Investment Properties
If you purchase an investment property, the process is a little different. You can’t provide the lender with a rental history. You have future or projected rent. In this case, lenders ask the appraiser for the fair market rent for the area. The lender then uses 75% of that amount as your rental income. They take 75% to account for maintenance, insurance, and HOA expenses. It also accounts for depreciation.
Procedure for Using Rental Payments as Income
If you use existing rental payments for qualification, you must provide accurate proof of the payments. The following steps help make this happen:
- Always deposit the rent payments at the same time each month. It’s best if you have a separate bank account for the rental income. This way there’s no question regarding where the income originated.
- Have copies of the canceled rent checks along with the deposit tickets or bank statements. This shows proof of receipt of the income.
- Create and execute a lease. Some lenders allow rental income without one, but it’s not worth the chance. A lease protects your interests. Plus it shows lenders consistency with the payments. Without a lease, you don’t have legal recourse with a non-paying renter.
- Provide proof of all rental expenses. This includes expenses you write off on your taxes and those you don’t. Keep a running log and copies of the appropriate bills. This shows lenders the true cost of renting out your home.
- Claim the rental income on your tax returns. Many lenders won’t accept rental income if you don’t report it. The exception to the rule is rental income you received for less than 1 year. If you don’t report it, you’ll need a valid excuse for the lender.
- Have reasons for any losses you report on your tax returns regarding the rental property. It’s obvious you want to lower your tax liability. But, this could hurt your chances of using rental payments as income on your mortgage application.
Proving a Likelihood of Continuance
Lenders want to know your income will continue. They prefer continuance for at least 3 years. This helps offset any immediate risk. Rental income is no exception. This is why having a lease is so important when you apply for a mortgage. Tax returns show previously collected income. They don’t provide any assurance that you will receive the money in the future, though. The longer the lease period on your lease, the more stable your income.
As is the case with any loan program, the rules vary by lender. Conventional and FHA programs allow the use of rental payments. They require specific documentation, but you can use them. Certain lenders may add more restrictions, though. They may not accept just a lease as proof of income. They may make you wait until you file your taxes for the current year and report the income. This way they know the income is accurate.
Either way, rental payments may help you qualify for a loan. Both current and projected rental payments may help you. If you must use projected rent, you are at the mercy of the fair market value for rent in your area. Do your research and determine the best route for you. Either way, rental income may help you purchase an owner occupied or investment home soon.