Buying a rental property may or may not help you qualify for financing. Here’s what you need to know to get the most amount of bang for your buckwhen buying a rental.
Fannie Mae and Freddie Mac have a formula that they take into consideration including depreciation, mortgage interest paid to banks, taxes, insurance etc. which go into a formula making your scenario on a rental property worse unless you’re financing that property. In other words, if you’re financing another property and you have mortgaged rental property on your schedule E, your rental may count as being a monthly loss.
75 percent rents- When you buy property as a rental the lender will allow you to use 75 percent of the fair market rents to qualify to offset the mortgage payment. That means if you’re generating $3,000 a month of rent on a property the lender would give you $2,300 of net income on paper to offset the mortgage payment. Here is an example-if the mortgage payment is $2,800 a month that obligation now is $500 a month instead of per month improving your borrowing power.
Timing is the other factor. If you bought the property in the last 12 months when the tax return is not due, then the same 75 percent rule applies. This allows you to offset the mortgage payment because your federal tax return is not yet due which means it doesn’t go on your federal income tax return under schedule E making your scenario worse as described above.
If you purchase a property at any point during the year you have until Oct. of the following year to use 75 percent of the rents to offset the mortgage payment with an IRS extension form.
When purchasing the property, it also needs not be tenant-occupied as well. You heard that right. Property can be vacant and because it’s your desire to purchase the property as a rental you can use the rents to offset the mortgage payment. You want to make sure however, when factoring the net numbers at the beginning to be conservative. Here is why a lender will also require a rental property appraisal and operating income analysis and rental market survey to make sure that the rents used are in line with what the market supports.
Where people can sometimes get into trouble is when they are financing a rental property that has been a year or two old that is on the schedule of the tax return and the lender is forced to use that formula to qualify. If, however your financing a property that’s on your schedule E then generally speaking the refinance of that property can positively influence your net numbers improving your ability to qualify. It’s when your purchasing other property that the schedule E factor with rental properties can become problematic.
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Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com.