Qualifying For An Investment Purchase Using Rental Income
Here are some general lending rules for rental properties.
- Projected rents may be used by most lenders to offset against the mortgage payment at up to 75% of projected fair market rents determined with an appraisal when buying a property.
- If you owned a rental property for the last 12 months, the lender will average your expenses, which may impact your income ratios and ultimately how much mortgage you can handle.
- If you bought a rental in the last year but have not yet filed your return, you can use 75% of projected fair market rents with a rental agreement, bypassing the rental averaging lenders use.
- Conventional loans are typically the only loans that can used for investment purchases.
- FHA Loans can be used to purchase investment properties if you owner occupy the property.
Tax return losses may hurt your mortgage chances
The schedule E of your Form 1040 is the area of your personal income tax return where you report rental property. If at the end of the calendar year, you have a net loss on your tax return, you could face a tough time qualifying for a mortgage because the loss is counted as a liability much like a minimum payment is on a car loan, credit card or other consumer debt.
Lenders will usually average a two year history for each rental property owned. An averaged gain or loss from the Schedule E will determine if you cut the mustard for qualifying.
How The Math Pencils
For each rental property, not as simple as using gross income to offset a mortgage payment (comprised of lender payment + taxes +insurance). The other factors that come into play include maintenance expenses as well as depreciation, which by the way is required on rental properties. This is especially important if a previous home was a primary residence and has been converted into a rental property. The depreciation schedule will specifically delineate at what point in time the property became a rental which is crucial for the lender to consider income generated.
Here is the special formula lenders use to determine if your rental property is a liability against your income
Using the annualized figures from the Schedule E:
The Calculation →gross rents + taxes+ plus mortgage interest + insurance+ depreciation+ HOA (homeowner’s association if applicable) -total expenses divided by 12 = net gain or loss
Knowing the lender into turning how you qualify will look at the most recent last 24 months, this formula will be performed for each rental property you have whether or not there is a mortgage on that particular property.
*Mortgage Tip: if any rental property is free and clear of any mortgages, there is almost always a gain -resulting in more useable income for the loan.
Scenario:
Consider this scenario, Borrower A with $10kper month in income, with a 500 per month car payment and two rental properties showing equal breakeven.
Consider the same scenario with Borrower B having $10k per month loss per property per year.
Each borrower is trying to qualify for a 450,000 mortgage assuming a 30 year fixed rate at 4.375%. Assuming taxes and insurance are $600 per month, principal and interest payment, is $2246.78 per month, so total payment is $2,846.
Borrower A
$10,000 monthly income x .45% as debt ratio (common ratio number lenders use to qualify borrowers) equals $4,500 per month, the maximum threshold for the total liability payments in relationship to the income. $4,500 – $500 car payment is a $4k Mortgage payment this person would easily qualify for the $2,846 or mortgage payment. This represents a healthy debt ratio of 33%.
Borrower B
$10,000 monthly income x .45% equals $4,500 less than $500 car payment is a $4k in total liabilities this consumer can take. $4k, less $2k in rental losses, less $2,846 per month as the target mortgage payment, leaving the borrower negative $846 per month, resulting in a 53% debt to ratio to income, causing a would be lender to deny such transaction or reduce the loan amount.
To apply this scenario to your own personal situation, you need to Talk to a qualified mortgage specialist. Then you can have your income calculated by a professional, they can look over your tax returns to identify any losses that may be an issue, and see what you truly qualify for with projected rental income.
. If you would like to see how you qualify for an investment purchase, please visit me here
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