how do banks calculate income for an existing rental

Question

I understand that for a Fannie Mae conventional loan, if you don't have tax returns for a rental, most lenders will count 75% of your rent as income and the full PITI as your debt.  The part where I'm not clear on is for an existing rental where tax returns are available.

I know that Principal, Interest, and taxes are all included as debt.  Depreciation is not counted as an expense.  What about one time repairs like fixing a leaky roof?  How about expenditures that are depreciated over 7 years like a new fridge?

Chris Mason · Answer

I blame the mortgage goblins for eating my response. Just when you think you've got them under control...

Chris Mason · Answer

@Gloria Mirza didn't you ask a very similar question like 3 days ago or am I going crazy?

We will use actual rent and actual expenses according to your tax returns, if you've had the properties long enough for them to show up on tax returns, and from there we will do some VERY wonky calculations. (There are actually three entirely different sets of wonky calculations, depending on the exact situation, that I will not bore you with.)

What you need to know, however, is that if [rent * 75% - PITI] works and yields a positive number, and if the home actually makes money, and if you haven't lied on your tax returns, then the wonky calculations that we do will not throw you off - and in all likelihood will actually improve your DTI.

> What about one time repairs like fixing a leaky roof?

Your lender should know how to exclude those from the arithmetic, and what documentation from you is required to justify it.

> How about expenditures that are depreciated over 7 years like a new fridge?

Depreciation can be added back in almost all cases.

Albert Bui · Answer

HI Gloria,

- yes 75% of gross - PITIA can be used when no tax returns exist like many have said above, however there are ways to "elect," to use this method of calculation even if  income/expense data is showing on the tax return. Using the 75% of gross income over tax return calculation method can be elected if the file is strategically put together as there are certain criteria underwriters look for to lean towards one side versus the other. Often times the 75% of gross income method yields a higher positive income number when dealing with rental income calculation. This is mostly true with older buildings where typical operating expenses are higher than newer properties and by using a limited 25% deduction for operating expenses (75% method) you will often show better net rental calculations than if you used actual. The documentation to get one calculation over the other is more an art than a science.

- one time expenses can be removed as long the correct documentation is provided so make sure to keep all your invoices and capital expenses not just for us but for your accountant as well so they can create your depreciation schedule during tax time

- The 7 year Fridge if depreciated, can get added back, however sometimes new equipment can be expensed completely as bonus depreciation depending on the tax incentives during the year so check with your accountant on what the options are. I personally like the long term depreciation play since it shields rental income.

Max Matrin · Answer

The American banks likewise have been ordered to tighten their mortgage regulations and underwriting criteria quite a bit, similar to the stress testing Karl describes. The old rule of thumb was that a prospective borrower could get a mortgage of about three times (2.8-3.6) times gross household income at interest rates in the 6-8% range. That makes a 180K loan on a 35K gross income completely unrealistic.

Gloria Mirza · Answer

@Chris M. this post was from Dec 5 and I didn't receive any responses until today :-).  Thanks for responding again though :-)

Joe Impagliazzo · Answer

@Gloria Mirza

75% of the rental income is only used if the property was recently purchased, for example you bought the rental home in 2015, but since tax returns are not due until April there would be nothing to show for it.  If the home has been owned since the previous tax season, and it is not on your tax returns unfortunately no income can be used.  There are some exceptions, but that is the general rule.  Otherwise rental income depends on what is claimed on the Sch. E of your tax returns.

Chris Martin · Answer

See page 357, section B3-3.1-08, Rental Income of the Fannie Mae Selling Guide for details.

For your second paragraph, I assume you are personally obligated on mortgage debt for property owned and reported through a partnership or S corporation. That's on page 363 of the selling guide under 'Offsetting Monthly Obligations for Rental Property Reported through a Partnership or an S Corporation'

how do banks calculate income for an existing rental

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