If you’ve ever wondered about buying a rental property as an owner who occupies, or you’re strictly looking for an investment, purchasing a rental property is a great way to build wealth and invest in your future.
For many, the goal of owning an investment property that pays for itself carries a big question—whether you’ll be able to finance it in the first place. Getting a mortgage based on rental income can help make your investment affordable.
You may be able to use projected market rental values to get a mortgage for your future income property. Depending on the lender, your future rental income can be factored against your mortgage rates, leaving you with smaller monthly payments. You may also be able to measure expected rental income against your debt-to-income ratio (DTI).
So, let’s dive in and learn what you should keep in mind when financing an income property.
How it works
Lenders use fair market value to determine the amount of rental income property will receive.
To determine a property’s fair market value, lenders conduct a rental property analysis. This process takes into account the home’s location, condition, associated expenses, insurance, any HOA fees, and, of course, the mortgage itself.
Once the home’s fair market value is determined, you can use projected rental income to lessen your monthly mortgage payment. You can do this for properties that you own and manage, as well as rental properties that serve as your primary address.
When seeking a mortgage for an income property, the net rental income is averaged with your other personal sources of income.
Let’s took a great example from Fannie Mae. Once your total income is added up, Fannie Mae allows borrowers to use 75% of your property’s market rent as a way to determine the property’s net cash flow.
For instance, if the market rent is $1,000, you would regard your property’s net cash flow as -$250. In this scenario, only $250 is used to calculate your DTI.
You can exclude the entire monthly mortgage payment when qualifying for a mortgage if the market rent is 25% higher than your mortgage payment.
We know this can be tricky to figure out, which is why it’s so crucial to partner with a knowledgeable Realtor® and mortgage broker. If you don’t have a local mortgage broker to turn to, chances are your Realtor® works with trusted professionals who can walk you through calculating your projected monthly payments.
This second point is especially important. Some borrowers may feel that their projected rental income will be able to overcome the fact that they may not earn high incomes. This is not always true.
It’s helpful to remember that the fair market value for the expected rents a property is projected to receive is only one component in determining your eligibility for a mortgage.
Even if one’s income is not ideal for the terms of a specific loan, there are ways to build your application, so you can get the investment property you want.
Let’s look at some other things to keep in mind when getting a mortgage based on rental income.
How you report expenses matter. So do taxes…
If you already own a property, the deductions you’ve taken on your Schedule E will affect your ability to borrow and can even change your DTI. This can potentially hurt your chances of getting approved for a mortgage.
It’s vital to report your monthly expenses accurately, so the mortgage company gets a clear picture of what kind of loan will work best for you. Besides, you want the best loan possible so that you can be successful in your real estate investment.
But even if you have losses, and also if your property shows losses, borrowing may still be possible.
Taxes! If your property shows losses over a number of years, there is an opportunity to claim those losses against your taxes. This lowers your overall tax burden, which can make getting a mortgage based on rental income a feasible investment move.
Be sure to speak to your accountant about tax strategies for your specific situation.
What about after I buy?
After you’ve worked with an expert Realtor® to purchase your investment property in a way that makes sense for your needs, there are some more things to consider when breaking down rental income.
- After you’ve owned your income property for a year, your expenses are averaged, and your DTI will be updated, which may impact your mortgage. It’s important to know how you will manage both personal and property-related expenses before you buy.
- Rental agreements can provide you with the opportunity to skip over being evaluated by standard averages used by mortgage companies. You can claim 75% of what the expected fair market rents will be, per rental agreement(s).
You’ll want to explore opportunities to manage your expense portfolio better if you’re looking to become an income property owner. Speak with a qualified real estate professional to get a better sense of your situation.
A few more things to consider…
Your FICO score is essential when getting a mortgage based on rental income. It’s excellent to project healthy incomes from your properties, but your credit score will still determine a lot of how your mortgage is structured, including the rates you’ll pay. Remember, your FICO score impacts your DTI, which in turn affects your ability to borrow.
Ask your Realtor® about getting connected with a loan officer. They often work with trusted professional partners who regularly provide their clients support. Click here to discover the trusted professionals we partner with every day.
Ready to make your move?
If you’re considering getting a mortgage based on rental income, we want you to know that it is possible. Sure, there are a few things to keep in mind, but if you balance the right concerns, the dreaming of owning an investment property can be yours.
Reach out to a qualified mortgage professional to get a better picture of your financial situation. This will help you realistically frame your search and will set you up for long-term success.
Once you and your lender have determined how to move forward, contact a Realtor® who can help you find the perfect investment for your goals. Your Realtor® will also connect you with trusted professionals, whom they know are qualified to provide you with the best service possible.
We’re always available to help you with your home search, no matter what questions you may have. Get in touch to speak with one of our real estate experts who can address your unique needs.
If you have any questions about how getting a mortgage based on rental income, we’re here to help guide you through your comprehensive property search.