If you’re purchasing or refinancing an income-generating property, you likely plan to use the rent amount to boost your loan application. However, the rules for using rental income from the subject property with a conventional loan can be tricky to decipher.
To clarify things, weve compiled a guide to how lenders calculate rental income, including from a couple of non-traditional sources, for primary residences, secondary homes, and investment properties.
Owning investment properties and earning rental income can be a great way to diversify your assets. But when it comes time to buy or refinance your own primary residence, can you actually use the rent you collect to help qualify for the mortgage?
The short answer is yes, rental income can be applied toward loan qualification with both government-backed and conventional mortgage programs. However, there are specific requirements and calculations for documenting rent and determining how much can be counted as income.
In this comprehensive guide. we’ll explain everything you need to know about using rental income when applying for a mortgage. including
- What types of properties generate eligible rental income
- How lenders calculate and verify rental income
- Limits on the amount of rent that can be applied
- Using rental income for primary residences, second homes, and investment properties
- Impacts on debt-to-income (DTI) ratios
- Frequently asked questions
What Properties Produce Eligible Rental Income?
The first step is understanding what types of real estate investments produce rental income that mortgage lenders will actually count toward your loan qualification Here are the main categories
Investment Properties: This refers to properties or units that are not your primary residence and that you rent out to generate ongoing income. Most commonly this includes single-family rentals, duplexes, triplexes, fourplexes, and small apartment buildings.
Two- to Four-Unit Primary Residences: While lenders have tightened up on this, you may still be able to use rent from units you’re not living in if your primary residence is a two- to four-unit building.
Accessory Dwelling Units (ADUs): Also known as granny flats or in-law suites, ADUs are independent living spaces typically added to the existing footprint of a single-family home. Income from an ADU can potentially be used in certain situations.
Boarding Income: Some lending programs may allow rental income from longer-term roommates or boarders who live with you in your primary residence.
In contrast, short-term or vacation rental income is generally not eligible to be used for loan qualification purposes. The same goes for sporadic or inconsistent rent from irregular arrangements.
How Do Lenders Calculate and Verify Rental Income?
The amount of rental income lenders will apply toward your debt-to-income ratio is based on a calculation of your net monthly rents. There are two primary methods lenders use:
1. Schedule E From Tax Returns
For properties you’ve owned for at least one year, lenders will look at Schedule E from your recent federal tax return. They’ll take your annual gross rents minus total expenses, then divide by 12 to get monthly net rental income.
Certain expenses get added back in, like mortgage interest, property taxes, homeowners insurance, HOA fees, and depreciation. Non-recurring losses may also be excluded.
2. Current Lease Agreements
If you don’t have at least a year of rental income reported on your taxes yet, such as with a newly-purchased investment property, the lender will evaluate your current lease agreements.
They’ll look at the monthly gross rent amount, then deduct a 25% vacancy factor to account for months when the unit may be empty between tenants or repairs. This results in the net monthly rental income amount.
To confirm these rental amounts provided on your application, lenders will request documentation such as:
- Two years of tax returns showing rental income and expenses
- Current executed lease agreements
- Bank statements or canceled checks showing deposit of rent payments
Limits on the Amount of Rental Income Applied
When underwriting your loan, lenders will cap the amount of net rental income that can be counted toward your qualifying income:
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For primary residence purchases using a conventional loan, rental income is limited to 30% of total income.
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With FHA, VA, and USDA loans, net rent cannot exceed the mortgage payment (PITI) on the primary residence.
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For investment property loans, net rental income is capped at the amount of PITI on that property specifically.
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On a second home purchase, rental income generally cannot be used at all.
There are additional stipulations if you don’t have at least one year of documented landlord experience. For instance, Fannie Mae and Freddie Mac limit rental income to just the PITI amount on the subject property.
Using Rental Income for a Primary Residence Purchase or Refinance
The eligibility guidelines for applying rental income toward a primary residence loan depend on whether it’s a single-family home or a multi-unit property:
Single-Family Home
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FHA, VA, and USDA programs do not allow rental income from single-unit primary residences.
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For conventional loans, Fannie Mae allows ADU income while Freddie Mac permits both ADU and boarder income. But amounts are capped at 30% of total qualifying income.
Two- to Four-Unit Primary Residence
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Rental income from units you won’t occupy can be used to qualify for FHA, VA, USDA, and conventional loans.
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Income is limited to the PITI amount on the mortgage, unless you have one year of documented landlord experience.
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With Fannie Mae and Freddie Mac loans, lenders may also require that you have an existing housing payment or current primary residence.
Applying Rental Income for a Second Home Loan
In general, rental income cannot be used to qualify for a second home purchase or refinance. The only exception is for disabled borrowers who receive rental payments from a live-in caretaker.
Some lenders may allow you to refinance a current rental property or vacation home as a second home. But you’ll still need to use your primary income to qualify, not the rent you’ve been collecting.
Using Rental Income for Investment Property Loans
For both purchases and refinances, Fannie Mae and Freddie Mac allow rental income from investment properties with up to four units.
The net monthly rent calculated from your Schedule E or lease agreements can be applied toward your DTI. But as mentioned above, the amount is capped at the property’s PITI if you don’t have at least one year of landlord experience documented.
The requirements are similar for FHA, VA, and USDA investment property loans. Rental income is limited to the PITI amount on the subject property unless you have qualifying landlord experience.
Impacts on Your Debt-to-Income Ratio
When applied to your loan qualification, rental income affects your DTI in different ways depending on the type of property:
Primary Residence: Added to income and housing expenses (PITI) added to debts
Investment Property: If rent exceeds PITI, the difference is added as income. If PITI exceeds rent, the difference is added as a debt payment.
Second Home: No impact since rental income generally cannot be used.
Always consult with a mortgage professional to get an accurate assessment of how rental income will specifically impact your DTI and loan qualification.
Frequently Asked Questions
Can I use rent from my roommate to qualify for a mortgage?
Yes, Fannie Mae’s HomeReady and Freddie Mac’s Home Possible programs allow boarder income if you’ve lived together for at least 12 months and have proof of rental payments. The income is capped at 30% of total qualifying income.
What about rental income from a basement apartment or in-law suite?
You may be able to use ADU rental income toward a conventional primary residence loan, up to 30% of your total income. Guidelines vary between Fannie Mae and Freddie Mac and by property type.
Can I use my Airbnb or VRBO income to qualify for a mortgage?
No. Sporadic income from short-term vacation rentals is not eligible rental income for mortgage qualification purposes.
How much weight does rental income carry compared to W-2 or salary income?
Lenders will scrutinize rental income more closely than salaried income. Expect to provide ample documentation. Also, limitations on amounts applied to your DTI prevent rental income from carrying full weight in your qualification.
If my rent covers my entire mortgage payment, can I qualify with no income?
No, lenders still want to see you have adequate primary income sources, like W-2 wages or self-employment income. While rental income can supplement DTI qualification, it rarely eliminates the need for documented primary income.
The Bottom Line
Rental income can be a huge help improving mortgage eligibility, allowing you to qualify for a lower rate and more favorable loan terms. But guidelines are complex, so work with an experienced loan officer to leverage your real estate investments and rental properties to maximize buying power.
How Is Rental Income Calculated?
There are two ways that conventional lenders can calculate rental income: past performance of the property or anticipated future rent. In most cases, the method used will depend on whether you’re applying for a purchase loan or refinance.
Actual or Market Rent If Rental Income Not on Tax Return
This method is used for purchase loans or refinances where the borrower bought the property during the current tax year (or otherwise doesnt have accurate tax filings). Lenders use signed lease agreements to calculate future income based on actual rent levels. They can instead estimate rent based on a local market analysis if no signed lease is in place.
Lenders then take the monthly gross rent, actual or market, and multiply the amount by 75% to account for vacancies, repairs, and other costs. This results in the net rental income that is eligible to be applied toward your loan application.
For example, if you’re purchasing a single-family investment property with a signed lease for $1,500/month, the net rental income would be $1,125 (75% of $1,500).