Using Rental Income to Help Qualify

with David Reed 

There are times when the perfect home unexpectedly comes on the market … at the wrong time. The potential buyers are unprepared for the new listing, and if they don’t act fast their “perfect home” will be snatched up by someone else. However, with some creative financing on their side, they can nab the home of their dreams without the added pressure of another mortgage.

One of the biggest obstacles that buyers can face is having to qualify for a second mortgage while still paying their current mortgage. For example, if potential buyers have a current payment of $2,000 and their new home will require an additional $2,500 payment, then they will likely struggle to afford the new property. Still other buyers find a new property but don’t want to sell their current home. Maybe the market isn’t as good as they’d like and they don’t want to sell now, or perhaps it’s a wealth-building strategy to keep the asset in the family. Whatever their reasons, buyers can offset the second mortgage with a new renter—but only under certain circumstances.

Lenders can only allow rental income to be used to offset the old mortgage—they cannot use the rent from the new tenant as “income” to help qualify for the new (or second) mortgage. It sounds odd, but here’s how it works.

The renter must sign a minimum 12-month lease, provide a copy of a cancelled rent deposit check made out to the client and pay current market rent for the area. Current market rent is established independently using a third-party appraiser to perform a “rent survey.” Ultimately, it is this number – current market rent – that the lender will use as rental income, regardless of what the lease agreement says.

If the rent survey says that market rents are $2,800, then that’s the initial rent number the lender will use to help qualify the buyer for the new home. Next is what’s called the “vacancy factor,” which immediately reduces the market rent to 75 percent of its value. In this example, the $2,800 would be reduced to $2,100 for qualification purposes.

If the old principal, interest, tax and insurance payment (PITI) is $2,000, then the lender subtracts that $2,000 from the reduced market rent of $2,100 and gets $100. Now, the old mortgage has been offset by the adjusted market rent and the buyer can qualify for the new mortgage. It’s important to note that lenders won’t apply the net rental income ($100) to help buyers qualify. Seasoned landlords, or owners of real estate that collect rent from various tenants use a different method to calculate income and it’s taken from their tax returns.

But for the potential buyers who find a property and can’t qualify for two mortgages, this is an excellent method if followed correctly.
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