We’ll be honest, we’re going to “keep it simple” and not go too far into the weeds on how the Qualifying Income for rental income is calculated. That said, we can provide the concept and a good rule-of-thumb if you’re trying to use the Debt To Income Calculator to determine how much you can afford.
To truly calculate the net rental income and expense from each rental property owned we start with the gross revenue and the subtract the total expenses – then we add back anything relating to the actual mortgage as well as “paper losses”. Example: we can add-back mortgage interest, homeowners insurance, property taxes, HOA dues, and depreciation & depletion. We can do add-backs for one-time big expenses BUT that has to be properly documented.
On the Schedule E we basically want to determine what the expenses that are outside of the mortgage. We will ultimately count the full PITI (principal interest, taxes, and insurance, and association dues) payment of each property in the total monthly debts and then apply the income (or loss) from the Schedule E.
Once you have figured out the Schedule E income calculation for each property you then have to determine the qualifying income. For conventional loans you can use the most recent tax year’s figure, for government loans (like FHA, VA, USDA) you have to take a two-year average OR use the most recent tax year’s income if that amount is less than the previous year’s figure.
Be Careful – Check Your Taxes
On a number of occasions we’ll see it where the rents received from rental properties aren’t be reported correctly (or at all). While that may help with the amount of taxes owed to Uncle Sam, it’s technically not kosher with IRS and won’t help your debt to income ratios when getting a loan. The mortgage industry can’t use unreported rental income for qualifying and we’ll be left to just counting the debts against you. Be sure to check your tax returns before you sign and file them.
The Easy Way
The simplest and easiest way to get an estimate of what to use for qualifying income is to use 75% of the rental payments. This 75% is determined by Fannie Mae and Freddie Mac and exists to account for future maintenance and potential vacancies. While this won’t be perfect it’s a good rule of thumb and should get you close. As always, call us if you want it done right and we’ll be happy to calculate your qualifying income.
As an FYI, most often the mortgage industry can’t and won’t use royalties as a viable income source. In the case of oil and gas royalties, it’s difficult (i.e. impossible) to provide documentation that those income streams will continue at a consistent level for the next three years. Royalties from other sources (such as authoring a book) can be considered but will need proper documentation.
Loan Officer, NMLS # 729612