Using Rental Income to Qualify for a Mortgage

Key Takeaways: 

• Rental income from both long-term leases and short-term vacation rentals like Airbnb can be considered when qualifying for a mortgage.
• The process for using rental income to qualify for a mortgage varies depending on the type of property being purchased and lenders will assess the stability and consistency of the rental income.
• Lenders consider two types of rental income - actual income and subject income - when determining mortgage eligibility and market research and data are crucial when evaluating short-term rentals for mortgage qualification.

Are you eyeing that perfect home and wondering if your Airbnb revenue might help you secure it?

You're not alone. Many savvy investors and homeowners are turning to rental income from both long-term leases and short-term vacation rentals to unlock better mortgage options. Though factoring rental income into your financing equation can get complicated, it can also be well worth it. 

Whether you’re managing a cozy studio or looking to scale your property investments, understanding how lenders view your income can transform your financial strategy. Here’s what you need to know about using rental income to qualify for a mortgage and the documents you’ll need to do it. 

Can I Use Rental Income to Qualify for a Mortgage?

You must show proof of income to qualify for a mortgage to buy any type of property. Though using employment income is most common, rental income—whether from long-term leases or short-term rentals like Airbnb—can also be a significant source of revenue that’s persuasive to lenders.

In other words, yes, you can use rental income to qualify for a mortgage. However, it’s not as easy as signing on the dotted line. 

Requirements for Using Rental Income for Mortgage Qualification 

Though you can use rental income, the process for using rental income to qualify for a mortgage varies depending on whether you’re looking to purchase a primary residence, secondary home, or investment property. 

• Primary Residence Purchase: If you're buying your primary residence, rental income from a property you currently own or plan to rent out can sometimes be considered part of your income stream, and lenders will evaluate its stability and consistency. This type of rental income is typically assessed alongside your employment income and other financial factors to determine your overall mortgage eligibility.
• Secondary or Vacation Home Purchase: Lenders may also consider individual rental income from second homes or vacation properties. Similar to primary residences, stability and consistency are key factors. However, since these properties are often used part-time or seasonally, lenders may take additional precautions to calculate qualifying rental income.
• Investment Property Purchase: When purchasing an investment property specifically for rental income, lenders will closely examine the property's income potential. This includes assessing the rental income’s stability, documentation such as tax returns and rental agreements, and predicted rental income analysis using tools like AirDNA or Zillow. Unlike primary or secondary homes, investment properties are primarily intended for generating rental income, and lenders may have stricter criteria for evaluating their financial viability.

Actual Income vs. Subject Income 

You should also know that lenders consider two types of rental income when determining whether you qualify for a mortgage: actual income and subject income. 

• Actual Income: This refers to the documented rental revenue consistently received and recorded on tax returns. A loan officer can calculate and verify your actual business rental income to help you qualify for a mortgage. It provides a tangible record of your rental earnings, demonstrating your ability to generate consistent income from the property.
• Subject Income: Subject income represents the anticipated rental earnings projected from the property you intend to purchase with financing. Lenders treat subject rental income distinctively from actual rental income, considering it an estimated figure rather than documented revenue. Understanding these distinctions can significantly impact your mortgage qualification process because it changes how rental income factors into your overall financial picture.

Special Considerations for Short-Term Rentals

Short-term rental income can be variable, which is why data is a critical tool to prove exactly how much you earn or expect to earn. Lenders often consider additional metrics when using short-term rental income to qualify for a mortgage, including: 

• ADR Analysis: Lenders examine the Average Daily Rate (ADR) alongside occupancy rates to gauge earning capability. A higher ADR indicates a stronger income potential, which can bolster your mortgage application.
• Market Research: As the applicant, understanding and conveying the market dynamics for vacation rentals within your target area is crucial. Providing detailed market analysis and data can help lenders assess the viability and profitability of the rental property as part of their risk evaluation process. 

Airbnb loans, however, may be easier to get than you’d think. Read more on why Airbnb loans may be a great option to enter the short-term rental market. 

In general, lenders assess the sustainability of the rental income primarily by examining historical data and adjusting for practical realities. They meticulously review past performance through tax returns and other financial documents to verify the consistency and amount of the actual income reported. 

Additionally, lenders typically account for potential vacancies and property management expenses by calculating up to 80% of the total rental income, although the exact percentage can vary depending on the lender. This adjusted figure ensures that the income is sufficient to cover the payments and interest and robust enough to handle associated costs effectively (Reminder: rental income is taxed, so that’s another expense for you to consider). 

Since every lender has different requirements for mortgage qualification, always consult with mortgage experts or a financial advisor who understands the nuances of the rental industry for tailored advice. For more insights, check out our guide to financing your vacation rental.

What Kinds of Rental Income Are Accepted for Mortgage Qualification? 

Lenders accept rental income from long-term residential leases and verified short-term rental agreements through platforms like Airbnb, provided there is a history of consistent occupancy and earnings. On the other hand, they generally don’t accept sporadic or one-time rental incomes because they aren’t a reliable indicator of whether you have the funds to uphold ongoing financial obligations. 

Qualifying with Investment Property Rental Income

Investment properties offer a unique avenue for bolstering mortgage qualification through rental income. Unlike primary residence purchases, these properties have distinct considerations for lenders and applicants alike.

1. Stability and Documentation: Lenders typically seek a documented rental income history, often spanning two years or more, to ensure stability. Comprehensive documentation, including federal tax returns and lease agreements—with sufficient market rent—is crucial for lenders to verify the actual income. 
2. Occupancy and Profitability: Consistent occupancy rates and a positive cash flow signal a property's profitability. Lenders scrutinize these factors to gauge the property's ability to sustain monthly mortgage payments and associated costs effectively.
3. Short-Term Rental Dynamics: Short-term rentals, like those on Airbnb, present unique challenges due to income variability. Lenders utilize metrics like ADR and market dynamics to assess the property's income potential and sustainability.
4. Adjustments and Calculations: Lenders adjust rental income calculations, often considering up to 80% of total monthly income, to account for vacancies and property-related expenses. This ensures the income is sufficient for mortgage payments and robust enough for ongoing property management.

Looking for more ideas on how to finance a short-term rental property? Check out AirDNA’s podcast episode on Acquiring Your STR Loan. 

How Lenders Calculate Qualifying Rental Income

Calculating rental income for a mortgage application is a crucial step in demonstrating your financial capability to lenders. This process involves a series of assessments and calculations to ensure that the actual income from your rental properties is stable, sustainable, and sufficient to cover new mortgage obligations. 

Here’s a breakdown of the most common ways lenders calculate rental income:

Federal Tax Returns

When assessing your application, lenders begin by examining Schedule E (Supplemental Income and Loss) from your federal income tax returns. This form provides detailed insights into the income and expenses associated with your rental properties.

It reports gross rental income received, along with expenses such as property management fees, repairs, and depreciation. This information helps lenders evaluate the profitability and sustainability of your rental income over the past tax year.

Leases and Appraisals

Signed lease agreements are critical as they provide documented proof of the rental income you're claiming. These agreements specify the monthly rental income, lease duration, and other terms that confirm the income's reliability and expected continuity.

Appraisals are conducted to estimate the current market value of the property and its rental income potential. This is especially important in situations where there isn’t an extensive rental history or if the property has been recently renovated or converted into a rental. Lenders use this information to gauge the feasibility and risk associated with the mortgage loan.

DTI Ratio

The debt-to-income ratio (DTI) is a key determinant in mortgage applications, measuring the proportion of a borrower's gross monthly income that goes towards paying debts. 

For mortgage qualification, lenders calculate this ratio by adding the proposed mortgage payments for the new property to any existing monthly debt payments, then dividing this total by your gross monthly income calculation. A lower DTI ratio signifies a better ability to take on additional debt, making you a more appealing candidate for lending.

DSCR Ratio

"The debt-service-coverage ratio (DSCR) is a popular alternative for lenders that do mortgage loans for short term rentals," says Robin Simon, partner at Easy Street Capital. "For these lenders, called DSCR Lenders, no DTI ratio or the borrower’s personal income is utilized. Instead, the DSCR ratio is used, which measures expected cash flow from the property. Its calculated by simply dividing expected rental revenue by property expenses."

According to Robin, "DSCR Loans are a great option for short term rental investors. Lenders have the flexibility to qualify based on expected income, using AirDNA projected income or other tools to evaluate the loan, rather than personal qualification standards not connected to the property. These loans are typically used by borrowers that are looking to scale STR portfolios."

Net Cash Flow

To determine whether a borrower's rental income can support the financial demands of the property, lenders assess their net cash flow. Net cash flow is calculated by deducting all operational expenses associated with the property from the gross rental income. These expenses include property management fees, maintenance, insurance, and property taxes. 

The resulting income figure is what lenders consider as the borrower's effective net rental income from the property, which must be sufficient to cover the mortgage payments and any associated costs.

Fannie Mae Worksheets

For a more granular analysis of rental income, especially from short-term rentals like Airbnb or vacation homes, lenders may use Fannie Mae's underwriting worksheets, such as Form 1037. These tools help to estimate the projected rental income based on factors like historical occupancy rates and seasonal trends. 

These worksheets are particularly useful in cases where traditional income verification methods might not fully capture the property’s earning potential due to its non-traditional rental patterns.

Short-term Rental Calculators

The AirDNA Airbnb Calculator is an invaluable tool lenders use to estimate your rental income accurately. By comparing similar rental properties, our calculator makes extremely accurate assumptions on the earning potential for any address, anywhere in the world that lenders can use to complete your financial picture. As a result, you and your lender will know how much a property could earn if listed as a full-time short-term rental.

Documents You Need When Using Rental Income to Qualify for a Mortgage 

When applying for a mortgage that includes rental income as part of your financial portfolio, it's essential to provide comprehensive and accurate documentation. This documentation proves the stability and profitability of your rental activities, whether they involve long-term leases or short-term rentals like Airbnb. Here’s what you need to prepare:

Tax Returns: Lenders will typically request the last two years of your federal income tax returns. These returns must include Schedule E, which details your rental income, expenses, and the net profit derived from each rental property. This form helps lenders assess the consistency and reliability of the income you report.

Lease Agreements: For properties rented out on a long-term basis, you must provide current lease agreements. These documents should specify the rental amount, the duration of each lease, and any other pertinent terms that affirm the qualifying income's long-term stability.

Airbnb Analytics: For short-term rentals, provide income statements from your service provider, such as Airbnb, listing booked dates and corresponding rates. This documentation should closely align with your reported income and highlight the frequency and reliability of bookings.

Profit and Loss Statement: A comprehensive year-to-date profit and loss statement may also be required. This statement should reflect all revenues and expenses related to the property. For short-term rentals, it’s crucial to include details such as occupancy rates and specific fees associated with the rental activity (like cleaning and service fees).

Bank Statements: Recent bank statements that show the deposits from rental income are critical. These statements provide direct evidence of the income flow into your accounts, supporting the figures reported in other documents.

Pay Stubs: If you have employment income in addition to rental income, be prepared to provide recent pay stubs to verify your total monthly income.

Real Estate Purchase Agreements: If you're in the process of purchasing a new property that will generate rental income, include the real estate purchase agreement to demonstrate your investment intentions and the terms of the purchase.

By preparing this documentation, you ensure lenders can accurately evaluate your financial health and the income-generating potential of your rental properties, putting you one step closer to your next real estate purchase agreement. This detailed approach assists lenders in making informed decisions about your mortgage application, increasing the likelihood of approval based on your rental income.

Frequently Asked Questions

What documents are required to prove rental income for mortgage qualification?

Lenders typically require a Schedule E form from the previous year's tax return to verify rental income. For short-term rental income, they may also request 1099 forms, bank statements showing deposit history, and proof of rental property ownership.

Can projected rental income be included when applying for a mortgage loan?

Some lenders may consider predicted rental income for current or aspiring short-term rental property owners. However, they generally require a strong history of rental performance in the area, and the borrower must often provide a sound rental appraisal or existing rental agreements.

What proportion of my rental income is recognized by lenders when obtaining a mortgage?

Lenders typically count a percentage of rental income, with many considering 75% to account for vacancy rates and ongoing maintenance expenses. For short-term rentals, this percentage may vary based on the lender's evaluation of rental income stability and property location.