How future rental income can help you buy an investment property

When buying an investment property, you can use a portion of the future rental income to help you get approved for the mortgage.

However, only some real estate investors can use the property's rental income to offset the mortgage payment.

In this article, I'll explain how to calculate future rental income and when you can use it to buy an investment property.   

 

What is an investment property's future rental income?

Future rental income is the rent you expect to earn from tenants after purchasing an investment property. Lenders may allow you to use a portion of this anticipated income to help qualify for a mortgage, making it easier to meet debt-to-income requirements and secure financing.

 

Why It Matters

Incorporating future rental income into your mortgage application can:

• Lower Your Debt-to-Income Ratio: By offsetting your mortgage payment with anticipated rental income, you present a stronger financial profile to lenders.
• Increase Your Purchasing Power: Qualifying for a larger loan becomes more attainable when future rental income is factored into the equation.

How Lenders Evaluate Future Rental Income

Lenders assess several factors to determine how much future rental income can be considered:

• Property Appraisal: An appraiser provides a market rent estimate based on comparable properties in the area.
• Vacancy and Maintenance Adjustments: Typically, lenders use 75% of the estimated market rent to account for potential vacancies and maintenance costs.
• Your Experience: Having prior property management experience can positively influence the lender's assessment.

A Note on Mortgage Rates

Keep in mind that mortgage rates for investment properties are generally higher than those for primary residences. Check current rates to understand the potential costs involved.

 

 

How do lenders determine rental income for an investment property? 

Lenders assess rental income by reviewing current lease agreements and conducting a property appraisal to estimate market rent.

 

Lease Agreements

If the property you're purchasing has existing tenants, lenders will examine the current lease agreements. These documents provide insight into the actual rent being collected, which helps establish the property's income-generating potential.

 

Property Appraisal

In addition to lease agreements, lenders require a property appraisal. A licensed appraiser evaluates the property and provides an estimate of its fair market rent. This estimate is based on comparable rental properties in the area and reflects what the property could reasonably earn in the current market.

The appraiser's rental estimate is documented in a standardized form, such as the Single-Family Comparable Rent Schedule. Lenders use this information to determine the property's gross rental income.

 

Calculating Qualifying Rental Income

To account for potential vacancies and maintenance costs, lenders typically consider 75% of the property's gross rental income as qualifying income. This adjustment ensures a conservative estimate of the income that can be used to support your mortgage application.

 

If the appraiser estimates a monthly market rent of $2,000:

• Gross Rental Income: $2,000

• Qualifying Rental Income: $2,000 × 75% = $1,500

This $1,500 would be the amount considered by the lender when evaluating your mortgage application. 

• How to calculate future rental income from a departing residence

Understanding these steps can help you prepare for the mortgage approval process and set realistic expectations for the income potential of your investment property. If you have questions, schedule a time to talk with a mortgage professional at NewCastle Home Loan.

 

 

How to calculate rental income for an investment property

Lenders calculate qualifying rental income by taking 75% of the property's gross monthly rent into account, which accounts for potential vacancies and maintenance costs.

This adjusted figure helps determine how much of the rental income can be used to support your mortgage application.

 

Step-by-Step Calculation

 

1. Start with the Gross Monthly Rent

Obtain the estimated market rent from the property's appraisal report. This figure represents the expected monthly income if the property were rented under typical market conditions.

Example: 
If the appraiser estimates the market rent at $3,000 per month.

 

2. Apply the Vacancy and Maintenance Adjustment

Multiply the gross monthly rent by 25% to estimate potential losses due to vacancies and maintenance expenses.

Calculation:

$3,000 × 25% = $750

 

3. Determine the Adjusted Monthly Rent

Subtract the estimated vacancy and maintenance costs from the gross monthly rent to find the qualifying rental income.

Calculation:

$3,000 − $750 = $2,250

This $2,250 is the amount the lender will consider as income when evaluating your mortgage application.

 

Why Use 75%?

Lenders use 75% of the gross rental income to conservatively estimate the property's income potential, taking into account periods when the property may be vacant or require maintenance. 

Understanding how rental income is calculated can help you determine whether an investment property is affordable and likely to provide a good financial return.

If you're considering purchasing an investment property, you should get pre-approved for a mortgage by a local lender like NewCastle Home Loans.  

 

 

How rental income can help you buy an investment property

Rental income can offset your mortgage payment, reducing your debt-to-income (DTI) ratio and making it easier to qualify for a loan.

When you apply for a mortgage on an investment property, lenders consider both your income and your debts. By including a portion of the expected rental income, you can lower your DTI ratio, which is a key factor in loan approval.

 

Understanding the Impact

Lenders typically use 75% of the property's projected rental income to account for potential vacancies and maintenance costs. This adjusted rental income is then compared to your monthly mortgage payment, which includes principal, interest, taxes, and insurance (PITI).

 

 

Key Takeaway

Using future rental income can make an investment property more affordable by lowering the debt burden considered in your mortgage application. This strategy enhances your purchasing power and can be a valuable tool in building your real estate portfolio.

 

 

Who can use rental income when qualifying for a mortgage?

You can use rental income to qualify for a mortgage if you have a current housing expense and at least one year of property management experience.

 

Current Housing Expense

Lenders require that you either own a home or pay rent to consider rental income in your mortgage application. This demonstrates your ability to manage ongoing housing payments.

• If you live rent-free (e.g., with family), you typically cannot use future rental income to qualify.

 

Property Management Experience

Having at least one year of experience managing rental properties strengthens your application. This experience can be demonstrated through:

• Tax returns showing rental income (Schedule E).

• Lease agreements from properties you've managed.

Without this experience, lenders may limit the amount of rental income they consider.

 

 

Summary

To use rental income when qualifying for a mortgage:

• Maintain a current housing expense (owning or renting).

• Have at least one year of property management experience.

Meeting these criteria can enhance your borrowing power by including rental income in your mortgage application.

 

Mortgage rules for rental income

The following sources outline the general rental income eligibility requirements for conventional conforming mortgages. 

• How to calculate future rental income from a departing residence
• Down payment for investment properties
• Fannie Mae rental income
• Freddie Mac rental income
• Calculating rental income
• Rental income calculation worksheets