How to Calculate “Rental Income” for Mortgage Loan?

Rental income is an excellent way to generate additional income for property owners. However, when applying for a mortgage loan, lenders may consider rental income as a source of income to qualify for the loan.

The rental income’s inclusion in the calculation depends on the lender’s guidelines and the type of mortgage loan. In this article, we will discuss how to calculate rental income for mortgage loans, the different methods used by lenders, and how to maximize rental income for mortgage loan qualification.

Requirements for Rental Income:

To use rental income to qualify for a mortgage loan, you must meet certain requirements. Here are a few things to keep in mind:

1. You must have a signed lease agreement with your tenant(s).
2. You must have a history of receiving rental income for at least two years.
3. The property must be in good condition and meet all local zoning and building codes.

When applying for a mortgage loan, lenders consider various factors such as credit score, debt-to-income ratio, and down payment. Rental income can also be used to qualify for the mortgage loan.

It’s important to note that not all lenders include rental income in the qualification process. However, if rental income is included, it can significantly increase the borrower’s qualifying income, which can lead to larger mortgage loan amounts.

Gross Scheduled Rental Income

The Gross Scheduled Rental Income (GSI) is the total rent that a property could earn if it were fully rented and there were no vacancies. Lenders use this method to calculate rental income for mortgage loan qualification. To calculate GSI, multiply the monthly rent by 12 to get the annual rent. For example, if the monthly rent is $1,000, the annual GSI is $12,000.

Effective Gross Income

Effective Gross Income (EGI) is the Gross Scheduled Rental Income minus any losses due to vacancies, concessions, and collections. Lenders also use this method to calculate rental income for mortgage loan qualification.

To calculate EGI, subtract the losses from the GSI. For example, if the annual GSI is $12,000, and the total losses are $2,000, the EGI is $10,000.

Debt Coverage Ratio

The Debt Coverage Ratio (DCR) is the ratio of the property’s Net Operating Income (NOI) to the mortgage loan’s debt service. Lenders use this method to determine whether the rental income is sufficient to cover the mortgage loan payments.

The DCR is calculated by dividing the NOI by the debt service. A DCR of 1 or more indicates that the rental income is sufficient to cover the mortgage loan payments. For example, if the NOI is $20,000, and the debt service is $15,000, the DCR is 1.33.

Loan-to-Value Ratio

The Loan-to-Value Ratio (LTV) is the ratio of the mortgage loan amount to the property’s appraised value. Lenders use this method to determine the risk associated with the mortgage loan.

A higher LTV indicates a higher risk for the lender. If the rental income is included in the calculation, it can increase the borrower’s qualifying income, which can lead to a lower LTV. For example, if the property’s appraised value is $200,000, and the mortgage loan amount is $150,000, the LTV is 75%.

Using Rental Income to Qualify for Mortgage Loan

To use rental income to qualify for a mortgage loan, the borrower must provide documentation of the rental income, such as lease agreements and tax returns.

The lender may also require a signed statement from the borrower indicating the rental income amount. The lender will then use one of the methods discussed above to calculate the rental income and include it in the borrower’s qualifying income.

Maximizing Rental Income for Mortgage Loan Qualification

To maximize rental income for mortgage loan qualification, property owners can take several steps to increase their rental income. The first step is to increase the property’s occupancy rate by finding and keeping reliable tenants. A high occupancy rate will increase the property’s GSI and EGI, which can increase the borrower’s qualifying income.

The second step is to increase the rental income by raising the rent. However, property owners should be cautious when raising the rent, as it could lead to tenant turnover and vacancies. Before raising the rent, property owners should research the local rental market to determine if the rent increase is reasonable and competitive.

Another way to increase rental income is by offering additional services or amenities to tenants, such as laundry facilities, parking spaces, or pet-friendly accommodations. Offering these amenities can increase the property’s appeal to potential tenants and increase the rental income.

Finally, property owners can consider using short-term rental platforms like Airbnb or Vrbo to generate additional rental income. However, property owners should be aware of local regulations and restrictions on short-term rentals, as they vary by city and state.

Here is an example of how to calculate rental income for a mortgage loan:

Assumptions:

• Rental property monthly income: $2,500
• Vacancy rate: 5% (i.e., the property is vacant for one month out of the year)
• Operating expenses: $1,000 per month
• Mortgage payment: $1,200 per month

The calculations are as follows:

1. Gross Rental Income: This is the total monthly rental income received from the property, which is $2,500 in this example.
2. Vacancy Rate: This is the percentage of time the property is vacant. In this case, the vacancy rate is 5%.
3. Vacancy Loss: This is the amount of rental income lost due to the property being vacant. To calculate the vacancy loss, we multiply the gross rental income by the vacancy rate. In this case, the vacancy loss is $125.
4. Effective Rental Income: This is the rental income received after accounting for the vacancy loss. To calculate the effective rental income, we subtract the vacancy loss from the gross rental income. In this case, the effective rental income is $2,375 ($2,500 – $125).
5. Operating Expenses: These are the expenses associated with operating the rental property, such as maintenance, repairs, property management fees, etc. In this example, the operating expenses are $1,000 per month.
6. Net Operating Income (NOI): This is the effective rental income minus the operating expenses. In this example, the NOI is $1,375 ($2,375 – $1,000).
7. Annual Mortgage Payment: This is the total amount of principal and interest paid on the mortgage each year. In this example, the annual mortgage payment is $14,400 ($1,200 per month x 12 months).
8. Debt Service Coverage Ratio (DSCR): This is the ratio of net operating income to annual mortgage payment. Lenders typically require a minimum DSCR of 1.1 or higher to approve a mortgage loan. In this example, the DSCR is 1.1 ($1,375 / $14,400).

Conclusion

Rental income can be a valuable source of income for property owners and can be used to qualify for a mortgage loan. Lenders use different methods to calculate rental income, such as GSI, EGI, DCR, and LTV.

Property owners can maximize their rental income by increasing occupancy rates, raising rents, offering additional amenities, and using short-term rental platforms. By taking these steps, property owners can increase their qualifying income and potentially secure larger mortgage loan amounts.

Rental Income for Mortgage loan FAQs

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