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Use future rental income from your current property to buy a new home.
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You're planning to buy a new home and rent out the house you're departing.
With careful planning, you can use the rental income you'll collect from the current place to offset your costs and give yourself the financial flexibility to get a mortgage to buy your new home.
I'll explain how in this article, including a step-by-step at the end.
What is future rental income?
"Future rental income" refers to the money you expect to receive from a house you rent out rather than living in.
It's a term we use in the mortgage business to represent the estimated income a rented property will bring in, and we use this number as part of our calculations when we qualify you for a home loan.
This term applies to all sorts of properties; whether you're buying a dedicated investment property, a multi-unit property, or, in this case, you want to rent out your old home and buy a new one.
Most buyers can't afford multiple mortgages without the additional cash flow from tenants, but your future rental income can—and often does—help you qualify for another mortgage.
That said, you won't get to claim 100% of your future rental income as you apply for another home loan.
Rental income can be interrupted by property maintenance or renovations, nonpayment, or even periods of vacancy between tenants. To account for this, the mortgage lender will calculate your future rental income as 75% of the total expected rent you receive for the property.
In other words, you'll be able to offset your mortgage costs with the rental income from your leased property, but only up to 75% of the total rent to be collected.
How do I calculate future rental income?
The good news is that you can use future rental income to offset the costs and qualify for another mortgage. But you will use less than 100% of the total rent collected as part of your qualifying calculations.
Accounting for routine maintenance missed rent, and possible vacancies, your lender, NewCastle Home Loans, will calculate your future rental income amount as 75% of the rent to be collected each month.
To estimate the projected rental income, ask your real estate agent for a breakdown of the rental rates for similar homes in your area. This research will help you understand market rent for your neighborhood and reasonably expect to collect from tenants each month.
As part of the qualifying process, your lender will calculate your future rental income, adjusting for maintenance, vacancies, or other issues that may arise. This number—75% of the rent you expect to receive each month—is then used to offset your monthly mortgage costs for your previous home and its mortgage.
Sound confusing? I'll explain.
Let’s say you bought a home in 2018 that’s now too small for your family. You love the home and aren’t ready to put it on the market, but you can’t afford to pay for two mortgages outright, given your current income. You decide to rent your current home and based on the local rental market, will collect $2,000 in rent each month. When a lender qualifies you for your new mortgage, they’ll consider your adjusted monthly rental income to be 75% of that $2,000, or $1,500 per month. This $1,500 will be used to offset your current mortgage debt, which can help you qualify for another mortgage on a new home.
It can be tricky knowing how to gauge or plan for income based on a market rental rate or to make sure that your rental income will be enough to qualify you for a new home. In cases like this, it's best to chat with one of our mortgage experts and get pre-approved for the mortgage.
With NewCastle's same-day pre-approval, you receive a verified pre-approval letter showing sellers we approved your home loan. As a result, you can stay ahead of the home-buying process at every stage, from shopping for a new home to making an offer and getting under contract.
Check out our Sales Contract Explainer here.
How will future rental income help me afford a new home?
Finding a renter for your current home helps offset the mortgage debt. By converting your existing home to a rental property, you can use the future rental income to offset the cost of your current mortgage, then qualify for another mortgage based on your adjusted debt-to-income ratio.
Jessica, who recently got married, wants to rent out her current condo to buy a single-family home, she’ll need to do a little math first. Her current monthly housing cost is $1,832. This payment accounts for all her associated mortgage costs—including the principal and interest payments, mortgage insurance, and property taxes—along with her homeowner's insurance payment and her condo’s homeowners association dues.
Jessica and her spouse want to buy a home priced at $560,000. Based on their down payment amount and interest rate, this would mean their new home comes with a monthly housing payment of $3,082. Their combined annual gross income is $132,000, or $11,000 per month, and their additional monthly debt comes out to $1,100, including one car payment and two student loan payments.
If we look at Jessica’s debt-to-income ratio with both mortgages factored in, she wouldn’t qualify for the mortgage on the new single-family home:
With $6,014 in monthly debts and $11,000 in monthly income, this puts Jessica’s DTI at 55%. ($6,014 / 11,000 = 0.5467 or 54.67%)
Without a renter for her condo, a 55% debt-to-income ratio is too high for a lender to qualify her for both mortgages.
But based on the current rental market in her area, Jessica could bring in $2,500 in rent each month if she were to lease her condo. Based on the rental adjustment rate of 75%, Jessica could use 75% of that $2,500 rental amount to offset her condo housing costs, or $1,875 each month.
Because this adjusted rental amount is more than her condo housing payment, it won’t factor into her monthly expenses. With a renter for her condo, we would qualify Jessica based on the following debt-to-income ratio instead:
With the adjusted rental income factored in, Jessica would easily qualify for her new home loan with a debt-to-income ratio of 38%. This would mean she can keep her condo, build equity, and ideally profit from the property over time.
Before converting the condo to an investment property, Jessica should also consider refinancing her current mortgage. Interest rates are lower today than when she bought her condo, and she has at least 20% equity in the property. With a new loan at a lower rate and no mortgage insurance, she'd lower her monthly payments and further reduce her debt-to-income ratio before buying a new home.
Whether you're ready to put in an offer on a new place or just weighing your options for the future, we've helped hundreds of borrowers buy new homes after converting their current homes to investment properties. So schedule some time to talk today.
When do I find a renter for my current home?
The mortgage contingency is the sweet spot for you to find your renter. You committed to buying the home, your mortgage process is underway, and the contingency clause offers a little protection - in case you can't find a renter in time. If you have trouble finding a tenant, you can still back out of the deal, and the seller will refund your earnest money.
And while it's true that 30 or so days seems like a strict deadline to meet, again—the real estate and rental markets move fast! During the contingency period, you'll have time to advertise and show your property to prospective tenants, then draw up a lease agreement for your renter(s) while your mortgage lender gets everything together to process and approve your loan.
If you don't qualify for both mortgages outright, you'll need to provide your lender with proof that you're renting out your current home before the contingency period expires.
Typically, the lender wants copies of the lease and the security deposit check. The check proves that you have a renter and the amount of the rent. We will process and approve the loan with these documents, and you'll be ready to close on your new home.
How to use future rental income to get an additional mortgage
At NewCastle Home Loans, we've perfected the process of pre-approval and transitioning your current residence into an investment property.
Much of the mortgage process is time-sensitive, and the timelines get even tighter when you need to find a renter before closing on your new property. However, we know from experience that meeting your tight approval deadlines often depends on the lender.
Our 100% online process gets you the loan you need faster. We've broken it down into four simple steps to get you approved for an additional mortgage on a new home:
1. Get pre-approved.
Get a strong pre-approval letter quickly, so you can take advantage of every opportunity to buy the perfect home. The loan decision-maker verifies your information, so you feel confident about making an offer because you know you're ready to buy.
With a pre-approval letter from NewCastle Home Loans as part of your offer, your real estate agent will be able to expedite the process with the seller and get the ball rolling on your formal loan approval as soon as possible.
2. Make an offer to buy.
Once you've found the perfect home to buy, it's time for you and your real estate agent to make an offer. Include the pre-approval letter from NewCastle Home Loans to improve the likelihood of winning the deal. A mortgage pre-approval letter signed by an underwriter enhances your negotiating power, especially when competing with other buyers.
Make sure that you have enough time to find a renter, too. Leave yourself time from the date of acceptance to the mortgage contingency date to find a renter and execute a valid lease.
3. Find a renter and execute a lease.
Research rent values, advertise your property, and find a renter to lease your property. You'll provide the lease and proof of the security deposit to the lender as part of qualifying for the new home loan.
Also, remember that you need to execute a lease and collect a security deposit before the mortgage contingency expires.
4. Receive final loan approval from your lender.
After we receive a copy of the lease and security deposit, we will issue your mortgage commitment. Then, you're ready to close on your new home!
At NewCastle Home Loans, we believe in simplifying the mortgage process and empowering our customers with the knowledge they need to buy a home confidently.
As daunting as this process may seem, we're committed to answering your questions and guiding you to homeownership.
