Counting Rental Income on New Mortgage

Just like with many aspects in mortgage lending, the way an Arizona lender calculates and includes rental income on a new loan application for properties a borrower already owns has changed based on a new rule issued by mortgage giant Fannie Mae.  You may think that including rental income from existing rental properties owned by a borrower on a mortgage application is as simple as plugging in an amount equal to how much rent a borrower receives for a particular property based on a lease agreement.   Let’s see if that’s true.

Counting Rental Income was Easy

In the past, mortgage guidelines required that a Phoenix area lender look at a borrowers Schedule E from (located within the 1040/Federal Tax Return).  Mortgage lenders were required to look at the bottom line/overall income or loss from a property and then add back the depreciation expense to figure out what income or loss had to be associated with that particular property on the borrower’s new loan application.

For example:

Let’s assume a borrower’s schedule E shows a net overall loss of -$1500 for the year for a rental property and that the same sample property also showed $2,000 in depreciation expense for that same year.  The lender in this case would have taken the -$1500 and added back the $2,000 depreciation due to the fact that depreciation is a paper loss and not an actual incurred expense (-$1500 + $2,000 = $500).  The lender would have given this particular borrower credit/income for this sample property equal to $500/year OR $41.67 per month ($500/12) on their loan application for a new mortgage on a new property.  This calculation however is s no longer allowed.

Out With the Old – In with The New

As a lender, we abide by one major rule of thumb – as soon as we get used to something we expect it to change.   In order to not disappoint, Fannie Mae issued new guidance with regard to what they will allow a borrower to use for rental income for an existing rental property when applying for a new home loan on a new property.  This new Fannie Mae calculation will typically result in less income allowed on a new loan application for each rental property listed on a borrower’s schedule E when compared to the old method outlined above.  Now before grumbling, this new calculation is typically much more accurate than the old income/loss + depreciation method.  The new calculation looks like this:

Step 1:  Rental income/loss + depreciation + amortization + casualty loss + one-time expenses + insurance + mortgage interest + taxes = ADJUSTED RENTAL INCOME/LOSS

Step 2: ADJUSTED RENTAL INCOME/LOSS / months rental income received = AVERAGE MONTHLY INCOME/LOSS FOR PROPERTY

Step 3: AVERAGE MONTHLY INCOME/LOSS FOR PROPERTY – borrowers current monthly mortgage – monthly property taxes – monthly insurance – monthly hoa payment = MONTHLY NET RENTAL INCOME/LOSS FOR PROPERTY

Easy as 1..2..3 right?  This calculation is not something that a borrower needs to do themselves however it is helpful if they know how the mortgage world and more specifically their lender sees and computes rental income today.  If you have any questions on how rental income will factor into your home loan approval please call or email me.

By Jeremy House
Google

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