Calculate net rental income to improve mortgage approval chances

To calculate net rental income for a mortgage, start by determining your gross rental income. For example, if you collect $1,800 per month in rent, that totals $21,600 annually. Next, subtract allowable expenses like property management fees (let’s say $1,200), maintenance costs ($800), property taxes ($2,000) and insurance ($1,000). In this case, your total expenses would be $5,000. So, your net rental income would be $21,600 - $5,000 = $16,600 annually. Lenders typically use about 75% of your net rental income to assess your mortgage application. Maybe you’re considering buying a home and want to know how rental income factors into how much mortgage you can afford.

Understanding Net Rental Income

Calculating your net rental income is vital when applying for a mortgage, particularly if you plan to buy an investment property. Lenders want to know if the rental income will cover your mortgage and other expenses. Here’s a breakdown of how to get to that number and what factors play a role.

What Counts as Gross Rental Income?

Gross rental income is the total amount you earn from renting out your property before any deductions. This includes:

• Monthly Rent: The amount tenants pay each month.
• Parking Fees: If you charge for parking, include that.
• Laundry Income: If you have laundry facilities and charge tenants, add that income.
• Other Fees: Any additional fees like pet fees, storage rentals, or maintenance fees.

Example: Take Sarah, a 35-year-old teacher in Denver. She rents out a 2-bedroom apartment for $1,800 a month. That gives her an annual gross rental income of $21,600 ($1,800 x 12 months).

Identifying Allowable Expenses

Next, you need to consider the expenses associated with owning and renting out your property. These can significantly affect your net rental income. Here are common allowable expenses:

• Property Management Fees: If you hire a property manager, this fee usually ranges from 8% to 12% of the monthly rent. For Sarah, if she pays 10%, that’s $180 monthly or $2,160 annually.
• Maintenance and Repairs: Set aside money for regular maintenance and unexpected repairs. A good rule of thumb is to budget 1% of the property’s value each year. If Sarah’s property is worth $300,000, she should budget around $3,000 annually for maintenance.
• Property Taxes: Check your local rates. Sarah pays $2,000 in property taxes each year.
• Insurance: Landlord insurance can cost between $500 and $1,500 annually, depending on the location and property type. Let’s say it’s $1,000 for Sarah’s property.
• Utilities: If you cover utilities, include those costs too.

Total Expenses Calculation: For Sarah:

• Property Management: $2,160
• Maintenance: $3,000
• Property Taxes: $2,000
• Insurance: $1,000
• Total Expenses: $8,160

Calculating the Net Rental Income

Now that you have your gross rental income and allowable expenses, calculating your net rental income becomes straightforward.

1. Start with Gross Rental Income: $21,600
2. Subtract Total Expenses: $8,160
3. Net Rental Income: $21,600 - $8,160 = $13,440 annually

How Lenders Use Net Rental Income

When you apply for a mortgage, lenders generally use a portion of your net rental income to evaluate your ability to repay the loan. Your debt-to-income ratio plays a key role here. Most lenders will consider about 75% of your net rental income, factoring in potential vacancies and other risks.

Example: For Sarah, lenders would use:

• Net Rental Income: $13,440
• Amount Considered by lender: $10,080 ($13,440 x 75%)

This will be added to her other income sources to determine her eligibility for a mortgage.

Real-World Example: Mark’s Investment Property

Let’s look at another example. Mark, a 40-year-old engineer in Austin, owns a duplex. He rents out each unit for $1,500 per month.

1. Gross Rental Income:

• $1,500 x 2 units x 12 months = $36,000 annually.

2. Allowable Expenses:

• Property Management: 10% of gross rental = $3,600
• Maintenance: 1% of property value ($400,000) = $4,000
• Property Taxes: $3,500
• Insurance: $1,200
• Total Expenses: $12,300

3. Net Rental Income Calculation:

• $36,000 (Gross) - $12,300 (Expenses) = $23,700
• Lender’s Consideration: $23,700 x 75% = $17,775

Lenders will factor this into Mark’s mortgage application, considering his overall income.

The Bottom Line: Why Accurate Calculations Matter

Understanding how to calculate your net rental income is essential for successfully applying for a mortgage. It impacts how much a lender believes you can afford to borrow. If you’re off in your calculations, it could limit your buying power. Always keep accurate records and consult with a tax advisor if you’re unsure about what counts as deductible expenses.

Frequently Asked Questions

1. What if my rental property is vacant for a few months?

If your property is vacant, you won’t have any rental income during that time. Lenders usually account for vacancies by only considering 75% of your net rental income, so they’ll factor in the risk of vacancy when assessing your application. It’s wise to budget for these periods.

2. Are there any other deductions I can claim?

Yes, besides standard expenses, you can potentially deduct depreciation on the property, mortgage interest and some travel expenses related to managing the property. Always consult a tax professional to ensure you’re maximizing your deductions.

3. Can I use future rental income for a mortgage application?

Lenders typically look at historical rental income, but if you’re purchasing a property that’s currently vacant, you might be able to use projected rental income. You’ll need to provide evidence, like a rental agreement or market analysis, to support your projections.

4. How do I prepare for a mortgage application?

Gather documents like your tax returns, profit-and-loss statements for your rental properties and any lease agreements. Ensure you have a clear understanding of your net rental income, as it will be a key component of your application.

5. What if my expenses exceed my rental income?

If your expenses exceed your rental income, you’ll have a negative cash flow. While this can complicate your mortgage application, it doesn’t automatically disqualify you. Lenders will consider your other income sources, so it may still be possible to secure financing.

Conclusion

Calculating net rental income is a straightforward but critical part of securing a mortgage for an investment property. By knowing how to accurately assess your gross rental income and allowable expenses, you can present a strong case to lenders. If you’re planning to invest in rental properties, keep track of your numbers and consult professionals when needed. Start the process by gathering necessary documents and calculating your net rental income to see how it fits into your overall financial picture. Happy investing!

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