What do FHA loan rules say about using rental income to qualify for an FHA home loan? Is it possible to use rental income according to the FHA loan handbook, HUD 4000.1?
The short answer is that it depends on whether or not the rental income meets FHA loan minimum standards. When processing your home loan application, your participating FHA lender will request copies (never originals) of the relevant paperwork associated with your employment and income, including tax documents, W2 forms, pay stubs, etc.
If your income is derived in whole or in part by rent payments, the lender will need to see documentation for that, too. FHA loan rules in HUD 4000.1 address this on page 202, starting with the definition of what is considered rental income under the FHA loan program:
“Rental Income refers to income received or to be received from the subject Property or other real estate holdings.” This definition is likely intended for several reasons including the prevention of “grey areas” where rental earnings are concerned.
HUD 4000.1 also instructs the lender, “The Mortgagee may consider Rental Income from existing and prospective tenants if documented in accordance with the following requirements. Rental Income from the subject Property may be considered Effective Income when the Property is a two- to four-unit dwelling, or an acceptable one- to four-unit Investment Property.”
As mentioned above, supporting documentation is required, but another factor in the lender’s decision whether to approve such income? Whether or not the borrower has previous experience as a landlord and whether the applicant has a record of rental income from tax documents submitted with the loan application. Those who do not have a history of being a landlord will need to understand FHA loan requirements for rental income under such circumstances:
“Where the Borrower does not have a history of Rental Income from the subject since the previous tax filing:
Two- to Four-Units
The Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and, if available, the prospective leases.
The Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report; Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule; and Fannie Mae Form 216/Freddie Mac Form 998, Operating Income Statement, showing fair market rent and, if available, the prospective lease.”
To calculate a borrower’s effective income from rental property in cases like these, HUD 4000.1 states:
“To calculate the Effective Income from the subject Property where the Borrower does not have a history of Rental Income from the subject Property since the previous tax filing, the Mortgagee must use the lesser of:
–the monthly operating income reported on Freddie Mac Form 998; or
–75 percent of the lesser of:
–fair market rent reported by the Appraiser; or
–the rent reflected in the lease or other rental agreement.”
In cases where the borrower does have experience as a landlord, the rules are different. HUD 4000.1 has these instructions for the lender in such cases:
“Where the Borrower has a history of Rental Income from the subject since the previous tax filing, the Mortgagee must verify and document the existing Rental Income by obtaining the Borrowers most recent tax returns, including Schedule E, from the previous two years.
For Properties with less than two years of Rental Income history, the Mortgagee must document the date of acquisition by providing the deed, Settlement Statement or similar legal document.
(c) Calculation of Effective Income
The Mortgagee must add the net subject property Rental Income to the Borrowers gross income. The Mortgagee may not reduce the Borrowers total Mortgage Payment by the net subject property Rental Income.”
HUD 4000.1 adds, “The Mortgagee must calculate the Rental Income by averaging the amount shown on Schedule E. Depreciation, mortgage interest, taxes, insurance and any HOA dues shown on Schedule E may be added back to the net income or loss. If the Property has been owned for less than two years, the Mortgagee must annualize the Rental Income for the length of time the Property has been owned.”