Investing in real estate can be a lucrative venture, and for many, it involves generating rental income. When it comes to obtaining a mortgage, understanding how rental income is assessed is crucial. In this blog post, we will delve into the details of eligible and ineligible properties, general requirements for documenting rental income, and the various methods for calculating and reporting rental income.
Eligible and Ineligible Properties
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Eligible Properties:
- Two- to four-unit principal residence properties with the borrower occupying one unit.
- One- to four-unit investment properties.
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Ineligible Properties:
- Rental income from the borrower's principal residence or second home generally cannot be used for qualification.
- Exceptions for Boarder Income and properties with accessory units.
Documenting Rental Income:
- Rental income for subject and non-subject properties is typically reported on IRS Form 1040, Schedule E.
- If tax returns don't accurately represent income, a fully executed current lease agreement can be used.
- Examples justifying lease agreement use include purchase or refinance transactions with existing leases, significant rental interruptions, or when rental income is used to qualify for a property placed in service in the current year.
- Fannie Mae requires specific forms when qualifying with rental income:
- For ONE-Unit Properties: Single-Family Comparable Rent Schedule (Form 1007).
- For TWO to FOUR-Unit Properties: Small Residential Income Property Appraisal Report (Form 1025)
| SUBJECT PROPERTY |
NON-SUBJECT PROPERTY |
- Use Form 1007 or Form 1025 and provide either the borrower’s recent federal tax returns or copies of current lease agreements.
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- Document monthly gross rental income using the borrower’s signed federal income tax return or current lease agreements.
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- Specific documentation requirements based on borrower history and transaction type.
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Reconciling Partial or No Rental History:
- Use alternative methods for calculating qualifying income when there is a partial or no rental history.
- Consideration of property acquisition, renovation, or other specific situations.
Mortgage Finance and Qualification Strategies
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Calculating Monthly Qualifying Rental Income:
- Scenarios and Guidelines: Different scenarios based on the borrower’s housing status and property ownership history.
- Qualification Strategies: Guidelines for using rental income based on property type and ownership duration.
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Offsetting Monthly Obligations:
- Aggregate Income or Loss: Consideration of total income or loss for borrowers with multiple rental properties.
- Tax Strategies: Business tax returns as a tool to offset PITIA for properties reported through partnerships or S corporations.
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Rental Income Calculation Worksheets:
- Tool Utilization: Optional worksheets provided by Fannie Mae for calculating rental income from various property types.
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Reporting of Gross Monthly Rent:
- Mandatory Reporting: Requirement for reporting eligible rents on subject properties.
- Transparency in Process: Ensuring accuracy in the mortgage process through transparent reporting.
Conclusion:
Understanding the intricacies of rental income qualification is essential for both borrowers and lenders. This comprehensive guide provides a roadmap for navigating the documentation and calculation processes, ensuring that rental income is appropriately considered when seeking a mortgage. Whether you're a potential homebuyer or a lending professional, this knowledge will empower you to make informed decisions regarding rental income qualification.