Calculating DTI on Rental Mortgages

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Calculating DTI on Rental Mortgages

Will Johnston
Investor · Washington, DC · Member since 2014 · 107 posts · 25 votes

I've found different lenders calculate DTI ratio when it comes to rental income differently.

Some lenders take rental income (or a percentage thereof), subtract the mortgage amount, and then add the result to either the debt or the income.

Others add the rental income (or a percentage thereof) to income and the monthly mortgage payment to debt.

So, let's say a place rents for $4000, the mortgage is $2000, I make $5000/month, and I've got other debt of $2500/month.

So, my DTI without the rental is 50%.

Under the first scenario, . Adding the additional mortgage makes my DTI 35.7%. (2500 debt/(5000 income + 4000 rental income - 2000 rental mortgage)) In other words, I easily qualify for the mortgage.

Under the second scenario, adding the additional mortgage doesn't change my DTI from 50%, and I wouldn't qualify. ((2500 debt + 2000 rental mortgage)/(5000 income + 4000 rental income))

So, two questions:

Is there some name for these different ways of calculating DTI such that I can easily reference them and ask lenders?

Does anyone know of any low-cost lenders that calculate DTI the first way? Maybe one of the CostCo lenders? I refinanced a place using a lender that calculates it the second way and barely qualified for the mortgage because of my DTI.

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Albert Bui
Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
11y
Originally posted by @Brie Schmidt:

@Will Johnston -  I have never heard of a lender calculating it the first way.  I believe Fannie/Freddie underwriting guidelines require it to be calculated the second way.  @Albert Bui is a lender and may be able to shed more insight.  

My local lender sent me a rental income calculator I can share with you if you PM me your email

This is a great segway example on the complications and different methods used to calculate DTI.

1) Generally its 75% of gross rents - PITIA = net rental income added to "income," if its a negative number its added as a "liability," that you'll have to qualify for in your ratios. This is pretty simple but its only if you dont have any information filed on your tax returns yet. If the property is a currently owned property then the info on your schedule E or 1065 partnership return (if LLC, LP, or general partnership) is used to calculate income. This method basically nets the income against the expense and adds the net to either income or expenses. This method is used on investment/non owner/rental properties 1-4 units residential finance.

2) There is another method where a percentage of gross income is added to "income," and monthly expenses/mortgage is added to "liability," but this method is only used when the borrower is also "occupying," the space as their primary residence on 1-4 units residential. This method separates the income and expense calculation which gives you less of a qualifying effect as method #1.

Which method is more effective for the borrower qualifying wise? #1 method is however its important that the lender on the file knows the difference of which method to use in the specific scenario so that there are no issues when qualifying for these income property/house hacking property strategies.

method #2 above is used in FHA and conventional and VA, but there are some additional hurdles used in FHA and VA such as the 100% coverage rule in FHA, and for veterans they need to have enough disposable income depending on the family size, but with conventional its pretty straight forward.

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  • Brie SchmidtBusiness Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
    11y

    @Will Johnston -  I have never heard of a lender calculating it the first way.  I believe Fannie/Freddie underwriting guidelines require it to be calculated the second way.  @Albert Bui is a lender and may be able to shed more insight.  

    My local lender sent me a rental income calculator I can share with you if you PM me your email

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    2Reply
  • Albert Bui
    Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
    11y
    Originally posted by @Brie Schmidt:

    @Will Johnston -  I have never heard of a lender calculating it the first way.  I believe Fannie/Freddie underwriting guidelines require it to be calculated the second way.  @Albert Bui is a lender and may be able to shed more insight.  

    My local lender sent me a rental income calculator I can share with you if you PM me your email

    This is a great segway example on the complications and different methods used to calculate DTI.

    1) Generally its 75% of gross rents - PITIA = net rental income added to "income," if its a negative number its added as a "liability," that you'll have to qualify for in your ratios. This is pretty simple but its only if you dont have any information filed on your tax returns yet. If the property is a currently owned property then the info on your schedule E or 1065 partnership return (if LLC, LP, or general partnership) is used to calculate income. This method basically nets the income against the expense and adds the net to either income or expenses. This method is used on investment/non owner/rental properties 1-4 units residential finance.

    2) There is another method where a percentage of gross income is added to "income," and monthly expenses/mortgage is added to "liability," but this method is only used when the borrower is also "occupying," the space as their primary residence on 1-4 units residential. This method separates the income and expense calculation which gives you less of a qualifying effect as method #1.

    Which method is more effective for the borrower qualifying wise? #1 method is however its important that the lender on the file knows the difference of which method to use in the specific scenario so that there are no issues when qualifying for these income property/house hacking property strategies.

    method #2 above is used in FHA and conventional and VA, but there are some additional hurdles used in FHA and VA such as the 100% coverage rule in FHA, and for veterans they need to have enough disposable income depending on the family size, but with conventional its pretty straight forward.

    4Reply
  • Will Johnston
    OP
    Investor · Washington, DC · Member since 2014 · 107 posts · 25 votes
    11y

    @Brie Schmidt & @Albert Bui , thanks, guys! That is very helpful. I've only got one rental right now, and the lender I used on the purchase calculated with the first method, but the lender I used on the refinance calculated with the second (even though a non-OO)

    Greatly appreciate the insights.

    0Reply
  • Albert Bui
    Lender · Bellevue WA & Orange County, CA · Member since 2013 · 2k+ posts · 1k+ votes
    11y
    Originally posted by @Will Johnston:

    @Brie Schmidt & @Albert Bui , thanks, guys! That is very helpful. I've only got one rental right now, and the lender I used on the purchase calculated with the first method, but the lender I used on the refinance calculated with the second (even though a non-OO)

    Greatly appreciate the insights.

     Good to Know Will the above response I made was how its typically done by guideline however some banks have "overlays," which are their own specific formula's and methods they like best. They use overlays to create their own risk analysis on their loans.

    So if you said they used the second method on a non owner property that would tell me that that bank is very conservative because they are making it harder to qualify for a borrower buying non owner/investment properties. Perhaps they like the primary occupancy market better?

    Banks use overlays to reduce their exposure to certain markets or segments they are either not familiar with or have unfavorable experiences (loss money) in the past.

    Hope that helps.

    1Reply
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