Does Rental Income Count as Income for a Mortgage?

The question of how rental income fits into a mortgage application can be somewhat nuanced, and the answer often depends on the specific circumstances and the policies of the lender.

Understanding Rental Income in Mortgage Applications

Rental income is generally considered a form of 'ordinary income' that can contribute to a successful mortgage application. However, it's important to understand the limitations and correct ways to include this income. Here’s a detailed breakdown:

General Considerations

Direct rental income is counted as part of your income, but it doesn't automatically qualify you. Lenders typically consider a portion of the rental income, usually around three-quarters or more, depending on the lender's policies and the nature of the property.

Net Rental Income

When applying for a mortgage to buy a property specifically for rental, banks often calculate the net rental income. The net rental income is defined as the rental income minus all associated expenses, including mortgage payments, repairs, maintenance, and other relevant costs.

Here's the standard process:

Calculate the total annual rental income. Subtract all expenses, including mortgage payments, repairs, and maintenance, to determine the net income. Apply 70% of the net income to your primary income to assess your eligibility for the mortgage.

Income and Expenses

For rental income to be considered valid and significant, it must be properly documented. This includes accounting for all business-related expenses. Common expenses may include:

Mortgage insurance payments Repairs and maintenance Utilities and property management fees Any necessary advertising or marketing expenses

It's crucial to keep detailed records of all business-related financial transactions, and this information is often required by the lender during the application process.

Documentation and Taxes

Lenders will likely request a detailed record of the rental income over the past two years. This can include:

Tax filings for the last two years, showing the rental income and expenses. Copies of rent receipts or bank statements for the past two years. Documentation of any lease agreements, including copies of active and expired leases.

Properly documenting and substantiating the rental income for at least two years is key in demonstrating the stability and potential for future income.

Common Mistakes and Considerations

One common mistake is including items that don't effectively impact the net cash flow or the loan applicant's ability to repay the mortgage. For instance, depreciation is often treated separately as it does not require a cash outlay and doesn't directly affect the net income from the property. In some cases, this could result in a net loss after applying all expenses.

Another important aspect is the tax status of the rental income. For landlords who are in the business of renting real estate, the income earned from these properties is treated as ordinary income. This makes it easier to include in the mortgage application.

It's advisable to consult a financial advisor or a tax professional to ensure that all aspects of rental income and expenses are correctly reported and included in the mortgage application process.

Conclusion

While rental income can indeed count as part of your income for a mortgage application, it's important to understand the specific requirements and limitations. Proper documentation, accurate financial reporting, and a solid understanding of the mortgage application process can greatly improve your chances of a successful application.