The Investment That Could Kill Your Mortgage
Do you own a rental property? If yes, and you’re looking to get a new mortgage, your gain or loss identified by your tax returns may help or hinder your chances.
Lenders can use up to 75% of the rent generated on your rental property as income to help you qualify for a mortgage. However, if there is a history of rental losses, those losses may limit your borrowing power.
Here’s what you should pay attention to if you have a mortgaged rental property and want to buy another home.
Know Your Schedule E
The schedule E of your Form 1040 is the area of your personal income tax return where you report rental property. If, at the end of the calendar year, you have a net loss on your property for your tax return, you could face a tough time qualifying for a mortgage because the loss is counted as a liability, much like a minimum payment is on a car loan, credit card or other consumer debt.
Lenders will usually average a two-year history for each rental property owned. An averaged gain or loss from the Schedule E will determine if you cut the mustard for qualifying.
How a Lender Sees Your Rental
For each rental property, it’s not as simple as using gross income to offset a mortgage payment (comprised of lender payment + taxes +insurance; here’s a good way to figure out what your monthly housing budget should be). The other factors that come into play for carrying a rental property include maintenance expenses as well as depreciation, which is required on rental properties. This is especially important if the rental property was your primary residence at one point and has now been converted into a rental property. The depreciation schedule will specifically delineate at what point in time the property became a rental, which is crucial for the lender to consider income generated.
Here is the special formula lenders use to determine if your rental property is a liability against your income, using the annualized figures from Schedule E on your 1040: Gross rents + taxes + plus mortgage interest + insurance + depreciation + homeowner’s association dues (if applicable) – total expenses divided by 12 = net gain or loss
The lender will look at these numbers for the past 24 months and this formula will be performed for each rental property you have whether or not there is a mortgage on that particular property.
Mortgage Tip: If any rental property is free and clear of any mortgages, there is almost always a net gain – resulting in more useable income for the loan.
How Your Rental Could Hurt You
The debt-to-income ratio (DTI) is an anchor component in determining whether you’ll get approved for a mortgage and how much you’ll be able to borrow. Essentially, DTI is the amount of your gross monthly income that goes to a total mortgage payment including taxes and insurance minus any minimum payment obligations you may have on other debts like credit cards, car loans, personal loans, student loans, child support, etc. The larger percentage of liabilities against your income, the less borrowing ability you have as a mortgage applicant.
The Essentials for Rental Property Owners
There are a few important facts that all rental property owners should know when applying for a mortgage:
75% of gross rents are used for calculating income, since the lender must account for vacancies.
Own more than four financed properties? Some lenders may not be willing to lend to you, and others may charge a pricing premium.
The rule of averaging the rents is reduced if one of the rentals is the subject property being refinanced for payment reduction.
A lender will require a copy of the lease agreement for each rental.
If there is a new rental agreement in place with higher rent than what the tax returns support, lender will use the tax returns for rental income as that is the only sufficient supporting documentation for income history.
It’s important to keep in mind that debt-to-income ratio isn’t the only hurdle homebuyers will encounter when trying to qualify for a mortgage. Your credit score is also an incredibly important factor in determining whether you can qualify for a mortgage. If you want to see where you stand, you can check two of your credit scores for free every month on Credit.com.
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