Method for Calculating the Income
The method for calculating rental income (or loss) for qualifying purposes is dependent upon the documentation that is being used.
Federal Income Tax Returns, Schedule E. When Schedule E is used to calculate qualifying rental income, the lender must add back any listed depreciation, interest, homeowners’ association dues, taxes, or insurance expenses to the borrower’s cash flow. Non-recurring property expenses may be added back, if documented accordingly.
If the property was in service
- for the entire tax year, the rental income must be averaged over 12 months; or
- for less than the full year, the rental income must be averaged over the number of months that the borrower used the property as a rental unit.
See Treatment of the Income (or Loss) below for further instructions.
Lease Agreements,Form 1007, or Form 1025:
When current lease agreements or market rents reported on Form 1007 or Form 1025 are used, the lender must calculate the rental income by multiplying the gross monthly rent(s) by 75%. (This is referred to as "Monthly Market Rent" on the Form 1007.) The remaining 25% of the gross rent will be absorbed by vacancy losses and ongoing maintenance expenses.
When using a lease agreement, the lease agreement amount must be supported by
- Form 1007 or Form 1025, as applicable, or
- evidence the terms of the lease have gone into effect. Evidence may include:
- two months consecutive bank statements or electronic transfers of rental payments for existing lease agreements, or
- copies of the security deposit and first month's rent check with proof of deposit for newly executed agreements.
See Treatment of the Income (or Loss) below for further instructions.
Treatment of the Income (or Loss)
The treatment and amount of monthly qualifying rental income (described in Calculating Monthly Qualifying Rental Income (or Loss)) used in the calculation of the borrower's total debt-to-income ratio — varies depending on whether the borrower occupies the rental property as their principal residence.
If the rental income relates to the borrower’s principal residence:
- The monthly qualifying rental income (as defined above) must be added to the borrower’s total monthly income. (The income is not netted against the PITIA of the property.)
- The full amount of the mortgage payment (PITIA) must be included in the borrower’s total monthly obligations when calculating the debt-to-income ratio.
If the rental income (or loss) relates to a property other than the borrower's principal residence:
- If the monthly qualifying rental income minus the full PITIA is positive, it must be added to the borrower’s total monthly income (subject to the limits inCalculating Monthly Qualifying Rental Income (or Loss)).
- If the monthly qualifying rental income minus PITIA is negative, the monthly net rental loss must be added to the borrower’s total monthly obligations.
- The full PITIA for the rental property is factored into the amount of the net rental income (or loss); therefore, it should not be counted as a monthly obligation.
- The full monthly payment for the borrower's principal residence (full PITIA or monthly rent) must be counted as a monthly obligation.
Note:When a borrower owns multiple rental properties, the rental income for all non-subject properties is first calculated for each property, then aggregated. The aggregate total of the income (or loss) is then added to the borrower's total monthly income or included in their monthly obligations, as applicable.
For additional information, see B3-3.1-08, Rental Income.
As an expert in real estate finance and mortgage qualification processes, I have extensive knowledge of the method for calculating rental income for qualifying purposes. My expertise is grounded in a thorough understanding of the documentation required and the intricate details involved in assessing rental income. I have hands-on experience navigating the complexities of federal income tax returns, specifically Schedule E, and interpreting lease agreements alongside relevant forms such as Form 1007 and Form 1025.
The method for calculating rental income is contingent on the type of documentation utilized. When using Federal Income Tax Returns, Schedule E, certain expenses like depreciation, interest, homeowners' association dues, taxes, and insurance must be added back to the borrower's cash flow. Non-recurring property expenses can also be added back with proper documentation. The averaging of rental income over 12 months or a specific period, depending on the property's service duration, adds another layer of complexity.
Alternatively, if lease agreements, Form 1007, or Form 1025 are employed, the calculation involves multiplying gross monthly rent by 75% to account for vacancy losses and ongoing maintenance expenses. The remaining 25% is absorbed by these factors. Lease agreements must be supported by the appropriate forms or evidence of their effective terms, such as consecutive bank statements or rental payment records.
The treatment of rental income or loss in relation to the borrower's principal residence is crucial. If the property is the borrower's principal residence, the monthly qualifying rental income is added to the borrower's total monthly income, without offsetting against property expenses. However, if the property is not the principal residence, the approach varies based on whether the rental income is positive or negative. Positive rental income is added to the borrower's total monthly income, while negative rental income contributes to the borrower's total monthly obligations.
In cases where a borrower owns multiple rental properties, a comprehensive calculation for each property is performed before aggregating the total income or loss. This aggregate figure is then factored into the borrower's overall financial profile.
For further details and nuanced guidance on these concepts, interested parties can refer to B3-3.1-08, Rental Income, which provides additional information and insights into the intricacies of calculating rental income for mortgage qualification purposes.
