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How to calculate future rental income from a departing residence
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With careful planning, you can use the future rental income you'll collect from your departing residence to get approved for a mortgage to buy a new home.
I'll explain how in this article, including a step-by-step.
What is a departing residence?
A departing residence refers to a property you previously used as your primary residence but have now decided to vacate or leave. It is the home that you are moving out of.
Some people sell their current home before buying a new one. Selling typically frees up equity for the down payment on the new place. Others choose to keep their existing home and rent it out for additional income, especially when it has good rental potential.
Recently, more home buyers are choosing to keep their departing residence as an investment property. They expect high rents will offset their low mortgage rate payments and even yield profits. Additionally, they believe in the long-term appreciation of real estate, viewing their departing residence as a valuable investment that may increase in value over time.
Matt is in the process of purchasing a new home. After careful consideration, he decided to keep his departing residence instead of selling it.
The main reason is the low interest rate and monthly mortgage payment, allowing him to maintain ownership while taking on a new mortgage for the new home.
Additionally, the property is in a high-demand rental area, and Matt anticipates charging enough rent to offset the housing payment.
Furthermore, Matt believes that the property's value will appreciate over time. He sees it as a long-term investment that could provide him with substantial returns in the future.
What is future rental income?
Future rental income refers to the revenue you expect from leasing a property rather than living in it.
If you plan to rent out your departing residence, the future rental income would be the cash you anticipate collecting from tenants in the months ahead based on the terms of the lease agreement.
Most homebuyers can't afford multiple mortgages, but 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.
- How future rental income can help you buy an investment property
- How can future rental income help me buy a 2-to-4-unit property?
How do lenders calculate future rental income from a departing residence?
The good news is that you can use a portion of the future rental income from your departing residence to offset the costs when qualifying for another mortgage. Here's how it works:
First, lenders start with a lease agreement and may order a Comparable Rent Schedule to determine the rental income for your departing residence.
Determine the rental income for the departing residence.
- Lease Agreement: Provide the lender with a complete copy of your signed lease agreement, including the rent and terms.
- Comparable Rent Schedule: The lender may order a third-party appraiser's opinion of the market rent and use the rent from the lease or the Comparable Rent Schedule, whichever is less.
Next, lenders subtract a portion of the rental income, accounting for maintenance and vacancies, to get the net rental income.
Use 75% of the rent, subtracting 25% for maintenance and vacancies.
- +$3,000 Monthly rent, departing residence
- -$750 Subtract 25% for maintenance and vacancy
- =$2,250 Monthly net rental income
Subtract the net rental income from the housing expense
- -$2,250 Monthly housing expense, including principal & interest, taxes, and insurance (PITI)
- +$2,250 Monthly net rental income
- =$0 Monthly housing expense after subtracting the net rental income
Let's break down how Matt can use his future rental income to offset his mortgage payment and improve his debt-to-income (DTI) ratio:
- Matt's monthly housing payment (PITI) for his departing residence is $2,250.
- He will receive $3,000 monthly in rental income from his departing residence.
- Matt's lender will subtract 75% of the rental income from the housing expense when qualifying for a new mortgage.
By using 75% of the future rental income to offset his mortgage payment, Matt effectively eliminates his housing expense from the DTI calculation, making it easier for him to qualify for a new mortgage on a different property.
Other lenders may calculate future rental income differently or require property management experience. Discuss your specific situation with a mortgage professional to get an accurate understanding of how much rental income you can count.
Can I count any rent from the departing residence as income?
Depending on your situation, you might be about to add a portion of the future rental income from the departing residence to your overall qualifying income.
With a higher qualifying income, you may be eligible for a larger mortgage loan, enabling you to afford a more expensive or desirable new home.
To add rental income from a departing residence to your qualifying income, you must meet two conditions.
- The net rental income must exceed the total housing expense (PITI)
- You must have at least one year of property management experience.
In the last section, I showed you how rental income offsets the costs associated with your departing residence. If your net rental income exceeds your housing expense, you'll have some leftover rental income.
In this case, you can add the excess rent to your qualifying income if you have at least one year of property management experience. Property management experience refers to a history of owning and receiving rental income on a property.
The lender will ask you to provide a copy of your federal income tax return to prove your property management experience.
Let's say Matt's monthly housing payment (PITI) is $2,000, and his lease on his departing residence is $3,000.
- -$2,000 Housing expense
- +$2,250 Rental income minus 25%
- =$250 Positive cash flow
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 and then qualify for another mortgage.
Matt wants to rent out his departing residence and buy a new home.
His monthly housing expense is $2,250, including the principal and interest, property taxes, homeowner's insurance, and mortgage insurance.
Matt's payment for the new house will be $3,500, his other monthly debts are $500, and his monthly income before taxes is $9,000.
Looking at Matt's debt-to-income ratio with both mortgages factored in, he wouldn't qualify for the mortgage on the new house.
With $6,250 in monthly debts and $9,000 in monthly income, Matt's debt-to-income ratio is too high at 69%.
But based on the current rental market in his area, he could rent his departing residence for $3,000. After subtracting 25% for maintenance and vacancy, Matt can use the net rental income of $2,250 to offset the departing residence housing expense.
Matt used the future rental income from his departing residence to lower his debt-to-income ratio to 44%. Thus, he can get approved for a mortgage to buy a new house.
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. 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 protection if 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 mortgage pre-approval process, and we can help you transition 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 verified pre-approval letter on the same day to 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. To improve your likelihood of winning the deal, including the pre-approval letter from NewCastle Home Loans. 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 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.
- Fannie Mae: Rental income
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Freddie Mac: Rental income
- Loan Estimate Explainer
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