Mastering the DTI Calculation: A Landlord’s Guide to Including Rental Income

Calculating your Debt-to-Income ratio (DTI) is a crucial step in securing a mortgage, particularly if you’re a landlord aiming to leverage rental income. Here’s the core of the matter: To calculate DTI with rental income, first determine your total gross monthly income and your total monthly debt obligations. Then, calculate your net rental income (typically a percentage of gross rents, often 75%, to account for vacancy and expenses). Add your net rental income to your gross monthly income. Finally, divide your total monthly debt obligations by your adjusted gross monthly income (including rental income) to get your DTI.

Unveiling the Nuances of DTI with Rental Income

Understanding the interplay between rental income and DTI is paramount for real estate investors. Lenders want assurance that you can comfortably manage your existing debt alongside any new mortgage. Rental income, when factored correctly, can significantly bolster your financial profile and improve your chances of loan approval. However, the devil is in the details – how that income is calculated and treated varies depending on the lender and loan type. Let’s delve into the complexities.

The Core Components: Income and Debt

Before we get lost in the world of rental properties, let’s solidify the fundamentals of DTI. It’s a ratio that compares your monthly debt payments to your gross monthly income. Lenders use it to assess your ability to repay a loan.

• Gross Monthly Income: This is your total income before taxes and other deductions. It includes salary, wages, self-employment income, and – importantly for our discussion – rental income.
• Monthly Debt Obligations: These are recurring monthly payments like credit card bills, student loans, car loans, and, crucially, existing mortgage payments (including principal, interest, taxes, and insurance – PITI). Note: rent is not considered a debt in your DTI calculation.

The Rental Income Factor: Finding the Net

This is where things get interesting. Lenders don’t simply add your gross rental income to your total income. Why? Because being a landlord involves expenses: maintenance, property taxes, insurance, potential vacancies, and more. To account for these, lenders typically use a percentage of the gross rental income as your net rental income.

The magic number is often 75%. This means that the lender will consider 75% of your gross rental income as income they can use in the DTI calculation. The other 25% is reserved for accounting for the expenses mentioned above.

Example: You receive $2,000 per month in gross rental income. The lender will likely use $1,500 (75% of $2,000) in your DTI calculation.

Note: This 75% rule isn’t universal. Some lenders might use a different percentage, while others might require you to provide detailed documentation of your rental property expenses to determine a more precise net rental income.

The Calculation in Action: A Step-by-Step Guide

Let’s break down the DTI calculation with rental income using a hypothetical scenario:

Scenario:

• Gross Monthly Income (Salary): $6,000
• Gross Monthly Rental Income: $2,000
• Monthly Debt Obligations: $2,500

Step 1: Calculate Net Rental Income:

• $2,000 (Gross Rental Income) * 0.75 = $1,500 (Net Rental Income)

Step 2: Calculate Total Gross Monthly Income (Including Rental):

• $6,000 (Salary) + $1,500 (Net Rental Income) = $7,500 (Total Gross Monthly Income)

Step 3: Calculate DTI:

• $2,500 (Monthly Debt Obligations) / $7,500 (Total Gross Monthly Income) = 0.33 or 33%

In this scenario, your DTI is 33%. Lenders generally prefer a DTI of 43% or lower, so this borrower is in a good position.

Documentation is Key: Show Me the Money (and Expenses)

Lenders will require documentation to verify both your gross rental income and the expenses associated with your rental property. Common documents include:

• Schedule E (Form 1040): This IRS form reports income and expenses from rental real estate.
• Lease Agreements: These provide proof of current rental income.
• Bank Statements: These confirm the receipt of rental payments.
• Property Management Agreements: If you use a property manager, this document outlines the fees and expenses associated with their services.

Frequently Asked Questions (FAQs)

Here are some commonly asked questions to further clarify the process of calculating DTI with rental income:

FAQ 1: What if my rental property is currently vacant?

A vacant property poses a challenge. Lenders typically won’t count potential rental income for vacant properties unless you can demonstrate a strong history of rental income and have a signed lease agreement with a future tenant. The lender needs reliable, verifiable income.

FAQ 2: Can I use future rental income from a new property I’m buying to qualify?

Generally, no. Lenders want to see a track record of rental income before including it in your DTI calculation. They need to see that the property is actually generating the income you anticipate. Some lenders might make exceptions if you have extensive experience as a landlord, but it’s rare.

FAQ 3: How does the type of loan (conventional, FHA, VA) affect DTI calculation with rental income?

The specific guidelines vary depending on the loan type. FHA loans often have more lenient DTI requirements than conventional loans, but they also have stricter property standards. VA loans can be very favorable for eligible veterans, and they consider residual income (income left over after paying debts and expenses) in addition to DTI. Always consult with a lender specializing in the loan type you’re pursuing.

FAQ 4: What if I have multiple rental properties? How does that impact the calculation?

The lender will typically look at the combined net rental income from all your properties. This means they’ll likely apply the 75% rule (or a similar method) to each property’s gross rental income and then sum the resulting net incomes.

FAQ 5: Are there any expenses I can specifically deduct to increase my net rental income for DTI purposes?

While you can’t “specifically deduct” expenses in the DTI calculation beyond what’s already factored into the 75% rule, accurately reporting all deductible rental expenses on your Schedule E can improve your overall financial picture and make you a more attractive borrower.

FAQ 6: What DTI is considered “good” when applying for a mortgage?

Generally, a DTI of 43% or lower is considered good. However, lenders have different risk tolerances. Some might be comfortable with a higher DTI, especially with a strong credit score and significant assets. Lower is always better.

FAQ 7: How does self-employment income from real estate management affect the DTI calculation?

If you actively manage your rental properties and receive a salary or fees for your services, this income can be included in your gross monthly income. However, you’ll need to provide documentation to verify your income, such as tax returns and profit and loss statements.

FAQ 8: Can I use projected rental income if I’m renovating a property?

Similar to vacant properties, projected rental income from a renovation project is usually not considered until the property is actually rented and generating income. Lenders need verifiable income, not potential income.

FAQ 9: What if I co-own a rental property? How is the income and debt handled?

Your share of the rental income and your share of any mortgage debt associated with the property will be included in your DTI calculation. The lender will typically require documentation showing your ownership percentage.

FAQ 10: Does my credit score affect how lenders view my DTI?

Absolutely. A strong credit score can offset a slightly higher DTI, as it demonstrates a history of responsible borrowing. Conversely, a low credit score can make it difficult to get approved, even with a low DTI.

FAQ 11: What if I have short-term rentals (e.g., Airbnb)? How is that income handled?

Short-term rental income can be trickier to qualify for. Lenders will typically require a detailed history of rental income, often spanning two years or more, to demonstrate consistency. They may also require documentation of occupancy rates and expenses.

FAQ 12: Can I improve my DTI before applying for a mortgage?

Yes! Here are some strategies:

• Pay down debt: Reducing your monthly debt obligations is the most direct way to lower your DTI.
• Increase your income: While this is often easier said than done, consider taking on a side hustle or negotiating a raise.
• Refinance existing debt: Lowering the interest rate on your existing loans can reduce your monthly payments and improve your DTI.

By understanding how rental income factors into your DTI and taking steps to optimize your financial profile, you can significantly increase your chances of securing the mortgage you need to expand your real estate portfolio. Remember, consulting with a mortgage professional is always recommended to receive personalized advice based on your specific circumstances.