Using Rental Income To Qualify for a Conventional Loan: Primary, Secondary, Investment Homes

If you’re purchasing or refinancing an income-generating property, you likely plan to use the rent amount to boost your loan application. However, the rules for using rental income from the subject property with a conventional loan can be tricky to decipher.

To clarify things, we've compiled a guide to how lenders calculate rental income, including from a couple of non-traditional sources, for primary residences, secondary homes, and investment properties.

How Is Rental Income Calculated?

There are two ways that conventional lenders can calculate rental income: past performance of the property or anticipated future rent. In most cases, the method used will depend on whether you’re applying for a purchase loan or refinance.

1. Actual or Market Rent If Rental Income Not on Tax Return

This method is used for purchase loans or refinances where the borrower bought the property during the current tax year (or otherwise doesn't have accurate tax filings). Lenders use signed lease agreements to calculate future income based on actual rent levels. They can instead estimate rent based on a local market analysis if no signed lease is in place.

Lenders then take the monthly gross rent, actual or market, and multiply the amount by 75% to account for vacancies, repairs, and other costs. This results in the net rental income that is eligible to be applied toward your loan application.

For example, if you’re purchasing a single-family investment property with a signed lease for $1,500/month, the net rental income would be $1,125 (75% of $1,500).

2. Schedule E (Form 1040) If Rental Income is on Tax Return

Lenders will calculate rental income using Schedule E from your latest federal tax returns for most refinances. From your tax filings, they'll take the actual rent received and subtract your total expenses.

From there, they'll add back several documented deductions, including:

• Mortgage interest

• Property taxes

• Insurance premiums

• Homeowners association fees

• Depreciation

• Non-recurring losses

This annual total is divided by 12 (or the number of months your rental was in service during the tax year) to calculate your net rental income.

Other Types of Rental Income

In addition to the standard rent generated from investment homes or multi-unit properties, a couple of other types of rental income can apply in certain situations.

Accessory Dwelling Units (ADUs)

Accessory dwelling units (ADUs) are independent living areas on the same property as an existing home. ADUs can be attached or detached quarters but must have their own kitchen, sleeping area, and bathroom with space for bathing.

Net rental income for an ADU is calculated at 75% of gross rent. Overall, rental income from an ADU can account for 30% of your total qualifying income when purchasing the home as your primary residence.

Boarder Income

Generally, boarder income – rent received from someone living with you in your primary residence – doesn't count. The main exception is for disabled borrowers who receive rent from a live-in personal caretaker or assistant. In this situation, the full rental income can be applied when qualifying for primary and second residence loans.

However, borrowers applying for HomeReady or Home Possible mortgages can use rental income from a roommate if the boarder:

• Is not party to the loan and will have no ownership interest in the home

• Has lived with the borrower for at least 12 months

• Has proof of residing at the borrower’s address, such as a driver’s license, utility bill, or bank statement

• Has paid rent, with evidence of payment, for at least nine of the past 12 months

In any situation, boarder income can only make up 30% of your total qualifying income.

Rental Income for a Primary Residence Purchase or Refinance

Conventional lending standards allow you to use rental income from your primary residence. Still, eligible sources of rent depend on the number of units in the home.

Single Unit

You can use rental income from a live-in caretaker. With HomeReady and Home Possible mortgages, you can use boarder income from a roommate who lives with you and will follow you to the new home. Fannie Mae's HomeReady program also allows you to apply ADU rental income on single-unit primary residences. In contrast, Freddie Mac guidelines allow ADU income on all single-unit primary loans.

2-4 Units

You can use rental income from units that you are not occupying in your multi-unit primary residence. This can include income from ADUs on two and three-unit properties with some lenders. But you must already own a primary residence (or otherwise have a current housing expense) to qualify using rental income. Even still, rental income can only be applied up to the amount of the property's mortgage cost (PITIA) unless you have a year of documental property management experience.

Rental Income for Second Home Purchase or Refinance

Only single-unit properties are eligible for second-home mortgages, and you generally can’t use rental income to qualify for a loan. The one exception is for disabled borrowers with boarding income from a live-in aid.

Still, you are allowed to refinance a property as a second home even if it's generated rent. That's because conventional loan guidelines allow second homes to be leased out for part of the year, typically via short-term rentals.

You must, however, live there for the greater of 14 days per year or 10% of the number of days it is rented for. For example, if you had a second home rented out for 180 days during the year, you'd be required to spend at least 18 days there yourself.

Rental Income for Investment Property Purchase or Refinance

Most conventional lending guidelines for investment property purchases and refinances apply to all properties with up to four units.

You can use standard rental income to qualify, as long as you own a primary residence or currently have a housing expense. However, rental income can only offset the property's mortgage cost (PITIA) unless you have at least a year of documented property management experience.

For Investment Properties up to 3 Units: While Fannie Mae prohibits it, Freddie Mac allows you to use income from an ADU for investment properties with up to three units. If your lender doesn’t work with Freddie Mac, get in touch with another mortgage professional who does.

How Does Rental Income Affect My Debt-to-Income Ratio (DTI)?

Conventional lenders will apply eligible rental income to your debt-to-income ratio (DTI) in one of two ways:

Primary Residences: Net rent is added to your qualifying income, while housing expenses (PITIA) are added to your debt obligations.

Investment Properties: If the net rental income exceeds the monthly housing expense, the difference is added to your qualifying income. If the rental income is less than the monthly housing expense, the difference is added to your debt obligations.

Frequently Asked Questions

Here are a few of the most frequently asked questions about using rental income to qualify for a primary residence, secondary home, or investment property:

Can I use rent from my roommate when buying a house?

You can generally use rental income from your roommate if you're applying for a HomeReady or Home Possible mortgage. However, they must have lived with you for at least 12 months, have proof of residency at your address, and have paid verifiable rent for nine of the past 12 months.

Can I qualify using rental income for a second home?

In most cases, no. Rental income can only be used when qualifying for a second home loan by disabled borrowers who receive rent from a live-in caretaker.

Can I use rental income from an ADU on an investment property?

With some lenders, yes. Fannie Mae guidelines restrict the use of ADU rent to HomeReady mortgages for single-unit primary residences. Freddie Mac, however, allows the income to be counted for investment properties with up to three units. If the lender you're working with can't apply ADU rental income for your investment property, shop around for other lenders who can.

Determining Eligible Rental Income for Your Purchase or Refinance

If you plan to purchase or refinance an income-generating property, talk with a lending expert to get an accurate idea of how much rental income you can use. Guidelines can vary immensely from case to case, and a qualified mortgage professional can give you a full assessment of how rental income can be applied to your loan application.