The calculation of rental income from a departure property can have more of an impact on a borrower’s mortgage eligibility than you may realize. While you may not encounter this scenario often, it’s wise to know where GSE guidelines differ for a rental property scenario to help you and your team find the best solution for your borrower.
First, let’s make sure we all agree on the definition of a departure property. A departure property is the home that is currently owned and occupied by the borrower. If the borrower chooses to convert that home to an investment property, this is referred to as primary conversion.
Now, if the current primary residence is converted to an investment property what are the qualifying implications? We will address the differences between the Fannie Mae and Freddie Mac guidelines below and help you see how one set of guidelines might be better for your given situation.
Freddie Mac Primary Conversion Guidelines – Rental Income on a Departure Property
If you’re working on a file using Freddie Mac guidelines, there are several nuances and caveats to be mindful of.
First, let’s cover documentation requirements. Here’s what you need in your file:
- A lease must be used to determine the net rental income; and
- Form 72 or 1000 supporting the income reflected on the lease; or Documentation (ex. bank statements evidencing deposit or electronic transfer of rental payments, canceled rent checks) supporting two months of receipt of rental income. Freddie Mac will allow proof of security deposit and the first month rent.
- Leases must be current and fully executed, with a minimum original term of one year.
Next, let’s review the method to calculate the income. When current lease agreements are used, you must calculate the rental income by multiplying the gross monthly rent(s) by 75%. There are a few caveats to keep in mind during your calculation, though:
- When the borrower’s current primary residence is being converted to a rental property, net rental income can only offset the full monthly payment of that primary residence.
- If the net rental income exceeds the full monthly payment of the new rental property or the converted primary residence, as applicable, the excess rental income cannot be added to the borrower’s gross monthly income to qualify unless the file documentation demonstrates the borrower has a minimum of one-year investment property management experience.
Finally, let’s cover the treatment of the income (or loss).
For positive amounts: If you have a scenario where the monthly qualifying rental income minus the full housing expense is positive, add it to the stable monthly income. Remember, a positive figure cannot be added to the income unless the borrower has a minimum of one-year investment property management experience. Without management experience rental income can only offset the full housing payment.
For negative amounts: If the monthly qualifying rental income minus the full housing expense is negative, add it to the monthly liabilities.
Fannie Mae Primary Conversion Guidelines – Rental Income on a Departure Property
Fannie Mae’s guidelines are straight forward and less nuanced than Freddie’s. Fannie Mae allows 75% of the documented rents as reported on the lease to be used. Fannie Mae does not limit the usable income to an offset or require property management experience.
For your documentation, you’ll just need a fully executed lease agreement to determine the gross rental income to be used in the net rental income (or loss) calculation.
Next, to calculate the income, calculate the rental income by multiplying the gross monthly rent(s) by 75%.
Last, let’s see how you’ll treat the income or loss.
For positive amounts: If the monthly qualifying rental income minus the full PITIA is positive, it must be added to the borrowers’ monthly income.
For negative amounts: If the monthly qualifying rental income minus the full PITIA is negative, the monthly net rental loss must be added to the borrowers’ total monthly obligations.
Differences in Calculating Rental Income from a Departure Property and Borrower Impacts
To summarize, Freddie Mac limits rental income to an offset unless the borrower has a one-year history of managing rental properties, while Fannie Mae allows positive income to be utilized without the rental management requirement.
Overall, what does this mean for you and your borrowers? In cases where the borrower(s) has ratio sensitivities, being able to utilize verifiable positive rental income may be a determining factor in qualifying.
If you have more questions about calculating rental income from a departure property or related scenarios, feel free to reach out to the Enact Regional Underwriting Managers at 800-444-5664, Option 2.
Robert Grolemund is a Regional Underwriting Manager for Enact. He’s a Certified Residential Underwriter with over 27 years in the MI industry.