Leveraging Rental Income for Your Mortgage Applications

The process of applying for a traditional mortgage requires careful consideration of your debt-to-income (DTI) ratio. This is essentially the comparison of your total monthly debt payments (not including utility bills, groceries, etc.) to your total monthly income before tax. A lower DTI implies less financial stress and more reliability in the eyes of lenders.

For instance, if you have a monthly income of $6000 and your total debt payments come to $2000 per month, your DTI ratio is 33% ($2000 is 33% of $6000). Lenders typically want a DTI ratio of 45% or less, though there might be flexibility up to 50% in some circumstances, depending on the borrower's overall financial situation. It's important to remember, however, that your assets are not included in the DTI calculation; they're primarily used to cover out-of-pocket expenses and to meet reserve requirements.

We're here today to explore how to incorporate your rental income into your mortgage application. There are two prevalent methods used to calculate how much rental income can be considered in your mortgage application.

The older method consists of taking 75% of your monthly rental income and setting aside the remaining 25% for potential repairs or property-related expenses. For example, if you collect $2000 each month from a rental property, $1500 (75% of $2000) is counted towards your income for mortgage application purposes.

The newer method offers a more accurate approach by analyzing your Schedule E tax form, which displays your annual profit or loss from rental properties. By examining your rental history, lenders can determine a more precise rental income to include in your mortgage application.

Lenders often require this newer method, utilizing a specific spreadsheet for calculations. Yet, the old method can serve as a rough estimate, particularly if the property is new with no rental history.

Investing in rental properties requires strategic planning and understanding of factors that will influence your investment strategy. You need to identify the type of properties offering the best returns and the level of cash flow you desire. Investment objectives differ, so it's crucial to define your budget and goals clearly.

Think long-term: the number of properties you wish to acquire and how this aligns with your investment approach. Seeking professional advice from accountants and lawyers can help structure your investment strategy for future growth, especially if you plan to operate it as a business. By considering these aspects, you're well-positioned to make informed decisions and optimize your rental property investments.

A special note on traditional individual mortgages: Fannie Mae and Freddie Mac limit the financing to 10 individual units per person. If you reach this limit and the properties are financed under your name, you'll need to explore alternative options. One possibility is partnering with a different investor or brokering the loan to someone who can finance more than 10 units. While this might result in a slightly higher interest rate, it gives investors the chance to expand their portfolio beyond the conventional loan limits set by Fannie Mae and Freddie Mac.

Join Delmarva REI Facebook group to learn more and get connected with other like minded individuals.

This article was inspired from an interview about Debt-to-Income ratio and other mortgage related items with Shawn Hunt at CMG Home Loans.