Rental Income Treatment For FHA

If you are vacating your current principal residence and wish to use rental income from it to qualify for a new loan, you generally must be relocating to an area more than 100 miles away. You must obtain a lease agreement for a duration of at least one year that commences after the new mortgage closes. Additionally, you must provide evidence of the payment of the security deposit or the first month’s rent. If you have no history of rental income from this property, the lender will calculate income based on 75 percent of the lesser of fair market rent or the lease amount, minus the PITI.

The specific forms depend on the property type. For two- to four-unit properties, the lender utilizes the Small Residential Income Property Appraisal Report (Fannie Mae Form 1025/Freddie Mac Form 72). For one-unit properties or properties with an Accessory Dwelling Unit (ADU), the lender requires the Uniform Residential Appraisal Report (Fannie Mae Form 1004/Freddie Mac Form 70) alongside a Single Family Comparable Rent Schedule (Fannie Mae Form 1007/Freddie Mac Form 1000). These forms provide the fair market rent estimates necessary for the lender to calculate the rental income that can be used for qualification.

Income from boarders renting space within your single-family dwelling can only be used as effective income if you have a documented two-year history of receiving such income. This must be evidenced by your tax returns showing the boarder income. Additionally, you must be currently receiving this income. For purchase transactions, you must provide a copy of an executed written agreement documenting the boarder’s intent to continue living with you. The effective income is calculated by using the lesser of the two-year average derived from your tax returns or the amount specified in the current lease.

For other real estate holdings where you have a history of rental income, the lender uses your recent tax returns, specifically Schedule E. The net rental income is calculated by averaging the amounts shown on Schedule E. The lender adds back expenses such as depreciation, mortgage interest, taxes, insurance, and HOA dues to the net income or loss listed. If the result is positive, it is added to your total effective income. If the resulting net rental income is negative, it is treated as a monthly debt or liability in your debt-to-income ratio.

If you own other investment properties but do not have a history of rental income from them since the previous tax filing, the lender must verify potential income. This usually requires an appraisal evidencing market rent and confirming that you have at least 25 percent equity in the property. To calculate the effective net rental income, the lender deducts the Principal, Interest, Taxes, and Insurance (PITI) from 75 percent of the lesser of the fair market rent reported by the appraiser or the rent reflected in a valid lease or rental agreement.

Net Self-Sufficiency Rental Income is calculated using the appraiser’s estimate of fair market rent for all units in the property, including the unit the borrower intends to occupy. From this total gross rent potential, the lender subtracts a vacancy and maintenance factor. This factor is the greater of the appraiser’s specific estimate for vacancies and maintenance or a standard 25 percent of the fair market rent. The resulting figure represents the Net Self-Sufficiency Rental Income, which is then compared against the monthly principal, interest, taxes, and insurance (PITI) to determine if the property is self-sufficient.

The Self-Sufficiency Rental Income test is a mandatory requirement for three- to four-unit properties to ensure the property can generate enough income to cover its own expenses. To pass this test, the Net Self-Sufficiency Rental Income must cover 100 percent of the total monthly mortgage payment, including principal, interest, taxes, and insurance (PITI). This means the PITI divided by the Net Self-Sufficiency Rental Income cannot exceed 100 percent. This calculation ensures that the property is financially sustainable and does not rely on the borrower’s other income to cover its monthly housing obligations.

Yes, rental income from an Accessory Dwelling Unit (ADU) can be used as effective income to qualify for a mortgage. To verify this, the lender requires an appraisal (Form 1004) and a Single Family Comparable Rent Schedule (Form 1007) showing the fair market rent. If available, prospective leases should also be provided. However, there is a specific cap on how much ADU income can be used: the amount of rental income from the ADU included in the borrower’s effective income calculation must not exceed 30 percent of the total monthly effective income used to qualify the borrower.

When there is limited or no history of rental income for the subject property since the previous tax filing, such as with a new purchase, the lender verifies potential income using an appraisal. For two- to four-unit properties, an appraisal reporting fair market rent (Fannie Mae Form 1025) is required. For one-unit properties, the lender requires a Single Family Comparable Rent Schedule (Form 1007). The effective income is calculated using 75 percent of the lesser of the fair market rent reported by the appraiser or the rent reflected in specific prospective leases, if available.

If you have a history of receiving rental income from the subject property since the previous tax filing, the lender will verify this using your most recent tax returns, specifically Schedule E, covering the past two years. The lender calculates the income by averaging the amount shown on Schedule E. They will add back non-cash deductions such as depreciation, as well as expenses like mortgage interest, taxes, insurance, and homeowners’ association dues shown on the schedule. If you have owned the property for less than two years, the income will be annualized for the length of ownership, documented by the deed or closing disclosure.