4. Rental Income

Introduction

This topic contains information on analyzing rental income, including

•	analyzing the stability of rental income

•	rental income from borrower-occupied property

•	income from roommates

•	documentation required to verify rental income

•	analyzing IRS Form 1040 Schedule E

•	using current leases to analyze rental income

•	the exclusion of rental income from a property being vacated by the borrower, and

•	the policy exceptions to the exclusion of rental income from a principal residence being vacated by a borrower.

Change Date

May 10, 2009

4155.1 4.E.4.a Analyzing the Stability of Rental Income

Rent received for properties owned by the borrower is acceptable as long as the lender can document the stability of the rental income through

•	a current lease

•	an agreement to lease, or

•	a rental history over the previous 24 months that is free of unexplained gaps greater that three months (such gaps could be explained by student, seasonal, or military renters, or property rehabilitation).

A separate schedule of real estate is not required for rental properties as long as all properties are documented on the URLA.

Note: The underwriting analysis may not consider rental income from any property being vacated by the borrower, except under the circumstances described in HUD 4155.1 4.E.4.h.

4155.1 4.E.4.b Rental Income From Borrower Occupied Property

The rent for multiple unit property where the borrower resides in one or more units and charges rent to tenants of other units may be used for qualifying purposes.

Projected rent for the tenant-occupied units only may

•	be considered gross income, only after deducting the HOC's vacancy and maintenance factor, and

•	not be used as a direct offset to the mortgage payment.

Reference: For information about the HOC vacancy and maintenance factor, see the HOC Reference Guide at www.hud.gov/offices/hsg/sfh/ref/hsgrcont.cfm.

4155.1 4.E.4.c Income from Roommates in a Single Family Property

Income from roommates in a single family property occupied as the borrower's primary residence is not acceptable. Rental income from boarders however, is acceptable, if the boarders are related by blood, marriage, or law.

The rental income may be considered effective, if shown on the borrower's tax return. If not on the tax return, rental income paid by the boarder

•	may be considered a compensating factor, and

•	must be adequately documented by the lender.

4155.1 4.E.4.d Documentation Required to Verify Rental Income

Analysis of the following required documentation is necessary to verify all borrower rental income:

•	IRS Form 1040 Schedule E, as described in HUD 4155.1 4.D.5.b, and

•	current leases/rental agreements, as described in HUD 4155.1 4.E.4.f.

4155.1 4.E.4.e Analyzing IRS Form 1040 Schedule E

The IRS Form 1040 Schedule E is required to verify all rental income. Depreciation shown on Schedule E may be added back to the net income or loss.

Positive rental income is considered gross income for qualifying purposes, while negative income must be treated as a recurring liability.

The lender must confirm that the borrower still owns each property listed, by comparing Schedule E with the real estate owned section of the URLA. If the borrower owns six or more units in the same general area, a map must be provided disclosing the locations of the units as evidence of compliance with FHA's seven-unit limitation.

Reference: For information about the FHA seven unit rental limitation, see HUD 4155.1 4.B.4.d.

4155.1 4.E.4.f Using Current Leases to Analyze Rental Income

The borrower can provide a current signed lease or other rental agreement for a property that was acquired since the last income tax filing, and is not shown on Schedule E.

In order to calculate the rental income

•	reduce the gross rental amount by 25 percent (or the percentage developed by the jurisdictional HOC) for vacancies and maintenance

•	subtract PITI and any homeowners' association dues, and

•	apply the resulting amount to
	–	income, if positive, or
	–	recurring debts, if negative.

4155.1 4.E.4.g Exclusion of Rental Income From Property Being Vacated by the Borrower

Underwriters may not consider any rental income from a borrower's principal residence that is being vacated in favor of another principal residence, except under the conditions described in HUD 4155.1 4.E.4.h

Notes:

•	This policy assures that a borrower either has sufficient income to make both mortgage payments without any rental income, or has an equity position not likely to result in defaulting on the mortgage on the property being vacated.

•	This applies solely to a principal residence being vacated in favor of another principal residence. It does not apply to existing rental properties disclosed on the loan application and confirmed by tax returns (Schedule E of form IRS 1040).

4155.1 4.E.4.h Policy Exceptions Regarding the Exclusion of Rental Income From a Principal Residence Being Vacated by a Borrower

When a borrower vacates a principal residence in favor of another principal residence, the rental income, reduced by the appropriate vacancy factor as determined by the jurisdictional FHA HOC, may be considered in the underwriting analysis under the circumstances listed in the table below.

Reference: For information on jurisdictional HOC vacancy factors, see http://www.hud.gov/offices/hsg/sfh/ref/sfh2-21u.cfm.

Exception	Description
Relocations	The borrower is relocating with a new employer, or being transferred by the current employer to an area not within reasonable and locally-recognized commuting distance. A properly executed lease agreement (that is, a lease signed by the borrower and the lessee) of at least one year's duration after the loan is closed is required. Note: FHA recommends that underwriters also obtain evidence of the security deposit and/or evidence the first month's rent was paid to the homeowner.
Sufficient Equity in Vacated Property	The borrower has a loan-to-value ratio of 75% percent or less, as determined either by
	•	a current (no more than six months old) residential appraisal, or
	•	comparing the unpaid principal balance to the original sales price of the property.
	Note: The appraisal, in addition to using forms Fannie Mae1004/Freddie Mac 70, may be an exterior-only appraisal using form Fannie Mae/Freddie Mac 2055, and for condominium units, form Fannie Mae1075/Freddie Mac 466.