Discover how rental income impacts your mortgage approval

Rental income can significantly impact your mortgage application. Lenders typically allow you to count 75% of your rental income when calculating your debt-to-income ratio. For example, if you earn $2,000 a month in rent, they’d consider $1,500 of that income. This can help you qualify for a larger loan or a better interest rate.

Understanding How Rental Income Counts for Mortgage

When you’re applying for a mortgage, your income isn’t the only thing that lenders look at. They also consider any rental income you might have. But how exactly does that work? Let’s break it down.

What is Debt-to-Income Ratio?

Your debt-to-income (DTI) ratio is a measure of how much of your income goes toward paying debts. Lenders use this ratio to determine your ability to manage monthly payments and repay borrowed money. Generally, a DTI of 43% or lower is preferred by most lenders.

How Rental Income Fits into DTI

When calculating your DTI, lenders often allow you to include a portion of your rental income. If you rent out a property and receive $2,000 monthly, lenders typically consider 75% of that for qualifying purposes. So, in this case, they’d use $1,500 in your DTI calculation. This can significantly boost your borrowing power.

The 75% Rule Explained

The 75% rule is pretty straightforward. Lenders apply this rule because they account for potential vacancies and maintenance costs. If your rental property is empty for a month, you won’t receive that income. By using 75%, they’re being conservative to ensure you’re still capable of making mortgage payments.

Example Scenario: Sarah in Denver

Take Sarah, a 35-year-old teacher in Denver who rents out a basement unit for $2,000 per month. When she applies for a mortgage on her new home, her lender considers only $1,500 of that rental income. If her monthly debts total $3,000, her total income could then be calculated as $5,500 ($4,000 from her salary plus $1,500 from rent), giving her a DTI ratio of about 54%. This would make her less attractive to lenders, but it’s still possible to work with that.

Documenting Rental Income

You can’t just tell your lender you have rental income; you need to document it. This usually involves providing your tax returns for the last two years, showing consistent rental income. They’ll want to see your Schedule E form, which details your rental income and expenses.

Other Documentation Lenders May Require

• Lease agreements
• Bank statements showing rental deposits
• Evidence of property management, if applicable

Different Types of Rental Income

Not all rental income is the same. There are various types, like long-term rentals, short-term rentals (like Airbnb) and commercial rentals. Each type may be treated differently by lenders.

Long-Term Rentals

Long-term rentals are usually the easiest to qualify for since they’re stable and predictable. If you’ve been renting a property for several years, lenders will feel more confident in that income.

Short-Term Rentals

Short-term rentals can be a bit trickier. Lenders might want to see a history of income from platforms like Airbnb. They may require you to prove that you’ve been renting successfully for at least a year to consider this income.

Qualifying for a Mortgage with Rental Income

When you apply for a mortgage, your lender will want to know how rental income affects your financial profile. Let’s look at a few factors they consider.

Your Credit Score

Your credit score is a big factor in your mortgage application. Generally, a score of 620 or above is required for a conventional loan. If you have a strong credit score, lenders may be more willing to work with you, even if your DTI is slightly higher due to rental income.

Employment Stability

Lenders will also look at how stable your job is. If you’re a full-time employee with a steady income and have been renting for a while, that helps your case. Consistent income over time reassures lenders that you can handle your mortgage payments.

Real-World Example: Mike’s Story

Let’s consider Mike, a 40-year-old software engineer in Austin. He owns a rental property that brings in $2,500 in monthly income. Here’s how it looks for him:

• Salary: $7,000/month
• Rental Income Considered: $1,875 (75% of $2,500)
• Total Monthly Income: $8,875
• Current Debt Payments: $3,500/month

Mike’s DTI ratio would be about 39%, which is appealing to lenders. He’s likely to qualify for a larger mortgage amount because of his rental income, making it easier for him to buy his next investment property.

Factors Influencing How Much Rental Income Counts

Not all lenders treat rental income the same way. Some might be stricter than others and this can affect how much of your rental income they’ll count.

Lender Policies

Each lender has its policies regarding rental income. Some may allow for a higher percentage to be counted, while others stick strictly to 75%. It’s worth shopping around to find a lender that’s comfortable with your situation.

Area of Rental Property

The location of your rental property can also influence how lenders view your income. Properties in high-demand areas may provide more consistent income, which could lead lenders to be more lenient in their calculations.

FAQs About Rental Income and Mortgages

1. Can I use rental income to qualify for a new mortgage?

Yes, you can use rental income to help qualify for a mortgage. Lenders typically allow you to count 75% of your rental income, helping you improve your debt-to-income ratio.

2. Do I need to show proof of rental income?

Yes, you’ll need to provide documentation to prove your rental income. This usually includes tax returns, lease agreements and bank statements showing rental deposits.

3. What if my rental property is vacant?

If your rental property is vacant, lenders might be cautious. They typically count only 75% of your rental income to account for potential vacancies, so having a history of consistent rentals is important.

4. How long do I need to have rental income?

Most lenders prefer to see at least 12 months of consistent rental income. If you’re new to renting out a property, having a solid lease agreement can help.

5. Will rental income affect my interest rate?

While rental income can improve your chances of qualifying for a mortgage, it doesn’t directly affect your interest rate. However, a better debt-to-income ratio may lead to more favorable loan terms.

Conclusion

If you’re looking to buy a home and have rental income, make sure you understand how it counts for your mortgage application. Gather the necessary documentation and get familiar with your lender’s policies. Each lender can treat rental income differently, so it’s wise to shop around. If you can, work with a mortgage professional who can guide you through the process and help you maximize your borrowing power.

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