How Does Owning Rental Property Affect the DTI Calculation

When assessing a borrower’s income for a conventional loan, the calculation of qualifying rental income (the income added to the DTI denominator) follows a standard methodology, regardless of whether the loan is processed through the Automated Underwriting System (DU) or manual underwriting. To account for potential losses due to vacancy and maintenance, the qualifying rental income is determined by multiplying the gross monthly rent(s) by 75%. This standardized reduction ensures that the income figure used is stable and predictable for analyzing the borrower’s capacity to repay the debt by its final maturity. This strict calculation applies to all properties that are not the borrower’s principal residence or a second home.

Rental income from an Accessory Dwelling Unit (ADU) can be used for qualifying purposes for a conventional loan only if stringent conditions are met:
1. The property must be a one-unit, principal residence.
2. Rental income from only one ADU is permitted.
3. The transaction must be a purchase or a limited cash-out refinance.
4. Crucially, the qualifying rental income from the ADU cannot exceed 30% of the borrower’s total qualifying income.

A Jumbo Loan is a non-conforming conventional loan offered by Shining Star Funding that exceeds the size limits set by the FHFA. Because of the higher risk associated with the large loan size, the underwriting requirements—including DTI—are typically stricter than for a conforming loan. While conforming loans may allow a DTI of up to 50% with automated underwriting, a Jumbo Loan typically requires a DTI ratio that is 43% or lower, and ideally 36% or less. This stricter DTI threshold reinforces the need for strong income and low debt when financing large investment properties.

For a conventional loan secured by an investment property that is underwritten through the Automated Underwriting System (DU), the maximum allowable DTI ratio is generally 50%. DU is able to accept this higher ratio because it simultaneously analyzes compensating factors, such as the required six months of PITIA financial reserves for the investment property. If the DTI ratio exceeds this limit or if DU cannot find sufficient compensating factors, the loan may be subject to manual underwriting, where the DTI limits are significantly lower (36% standard, 45% maximum).

Conventional loans can finance multi-unit properties (two, three, or four units) if the borrower occupies one unit as their principal residence. While this situation affects the income side of the DTI calculation (as rental income from the other units can be used), it also affects the down payment requirement. The minimum down payment for purchasing a multi-unit property (e.g., a duplex or triplex) is higher than for a single-unit home, starting at 15%. All rental income used must still be calculated at 75% of gross rents to be applied toward the DTI.

No. If the property is designated as a Second Home, which is defined as a property occupied by the borrower for a portion of the year, any rental income from a second home cannot be used to qualify the borrower for the mortgage. This rule applies even if the borrower plans to rent the property occasionally. Because the income is deemed unstable for qualification purposes, the lender must ensure the borrower’s DTI ratio can accommodate the full housing payment (PITIA) for the Second Home without the aid of the rental income. A minimum of two months of PITIA reserves are also required for a Second Home.

If a borrower is financing a second home or an investment property and will have a total of seven to ten financed properties (including the new loan), the DTI eligibility is impacted by a significantly higher credit requirement. In this high-risk scenario, the mortgage loan must have a minimum representative credit score of 720. This is higher than the standard minimum of 620 required for most conventional loans. Although the DTI limit itself remains up to 50% (for DU), the higher required credit score acts as a compensating factor to mitigate the increased layered risk associated with high debt obligations relative to the number of properties owned.

If a borrower is financing an investment property and will own multiple financed properties (2 to 10 total, including the subject property), the conventional loan guidelines impose higher reserve requirements, calculated as a percentage of the aggregate Unpaid Principal Balance (UPB) of the other financed properties (excluding the borrower’s principal residence and the subject property).
• For 2 to 6 financed properties (total), the minimum reserves required are 4% of the aggregate UPB.
• For 7 to 10 financed properties (total), the minimum reserves required are 6% of the aggregate UPB. These reserves are critical because they serve as a compensating factor, which may be necessary to offset the risk of a higher DTI ratio or the inherent risk associated with managing multiple long-term liabilities.

Owning an investment property is considered a higher risk compared to a principal residence, which requires the borrower to maintain adequate liquid financial reserves. Reserves are measured in months of the full mortgage payment (PITIA). For a single investment property being financed with a conventional loan, the general reserve requirement, as determined by DU based on risk, is six months of PITIA (Principal, Interest, Taxes, Insurance, and Association dues). These reserves act as a crucial safety net for the lender, providing a cushion against temporary income disruption, as borrowers are more likely to default on non-essential investment properties during financial hardship.

When a borrower owns other rental properties (i.e., not the subject property being financed) and intends to use that income for qualifying for a conventional loan, the lender must carefully document the financial data. The required documentation includes the borrower’s most recent signed federal income tax return. Specifically, the lender must document the gross and net rental income using Schedule 1 and Schedule E from that return. Furthermore, if the rental properties are held through a business structure, such as a partnership or S Corporation, the corresponding business tax returns (like Form 8825) would also be required. This meticulous documentation ensures the stability and consistency of the income used in the DTI calculation.