Calculating rental income for a mortgage loan is a crucial step in the loan approval process, especially if you plan to use the rental property to generate income that can help cover the mortgage payments. Lenders consider rental income to determine your ability to repay the mortgage. Here’s how you can calculate rental income for a mortgage loan:
Gross Rental Income:
Begin by calculating your property’s gross rental income. This is the total income you expect to receive from renting out the property annually. It includes the rent collected from tenants, any parking fees, and income from any additional services or amenities offered by the property.
To account for potential vacancies or periods when the property may not be fully rented, you should apply a vacancy rate. Lenders often suggest using a conservative estimate, such as 5-10%, to calculate the potential rental income loss due to vacancies.
Deduct the property’s operating expenses from the gross rental income. These expenses include property management fees, property taxes, insurance, maintenance costs, and other costs related to property upkeep. The remaining amount is your net rental income.
Lenders may consider your property’s debt service, which includes the mortgage principal and interest, in the calculation. Subtract your annual mortgage principal and interest payments from the net rental income.
The result of the previous step will give you your property’s cash flow, which is the profit or loss generated by the rental property after all expenses are accounted for. A positive cash flow indicates that the property generates more income than it costs to operate, which is a positive sign for loan approval.
Lenders often look at your debt-to-income (DTI) ratio to assess your ability to manage your mortgage payment along with other financial obligations. To calculate your DTI ratio, they consider your monthly debts, including the projected mortgage payment, as a percentage of your monthly gross income. A lower DTI ratio is generally more favorable for loan approval.
Rental Agreement and Lease:
Lenders may require you to provide a copy of the rental agreement or lease for the property to verify the terms of the rental income, as well as any security deposits or prepaid rent. These documents serve as evidence of your rental income.
Seasoned Rental Income:
Some lenders may require that your rental income is “seasoned,” meaning you have a history of receiving rental income from the property for a specific period, often at least one year. Seasoned income demonstrates the property’s ability to generate consistent rental income.
Rental Market Analysis:
In some cases, lenders may conduct a rental market analysis to assess the property’s rental income potential. This analysis evaluates the property’s location, market demand, and rental rates to determine its income-generating capacity.