Solving Rental Income Challenges
As a mortgage lender, you've likely experienced the frustration of dealing with loan defects and the financial risk they bring. The miscalculation of rental income and rental loss continues to be a top issue in random loan quality reviews, and recently, the lack of proper documentation has become a significant defect driver. To avoid common pitfalls and ensure your loans are processed smoothly, it's crucial to understand the requirements and take the following steps when using rental income to qualify borrowers:
- Determine if the rental income is eligible to use as an income source and if it is limited to offsetting the mortgage payment.
- Determine what documentation is required to calculate the income correctly.
- Calculate the income using the methodology described in Selling Guide B3-3.1-08, Rental Income.
To avoid common pitfalls and ensure your loans are processed smoothly, it's crucial to understand the Selling Guide requirements when using rental income to qualify borrowers.
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Top rental income defect drivers:
| Issue | Requirements |
|---|---|
| Including rental income in the underwriting assessment when it is ineligible because the borrower does not have a housing expense, or the housing expense is not supported. | To include rental income to qualify the borrower, confirm that the borrower owns a principal residence or has a current housing expense. (The loan file must contain documentation of the housing expense.) If the borrower does not have either, then remove the rental income. |
| Including positive net rental income in the underwriting assessment when it can only be used to offset the housing expenses. | To use positive rental income to qualify the borrower, confirm that the borrower meets these two conditions:
If converting the departure residence to a rental property: the borrower must have a one-year history of receiving rental income from other properties. Otherwise, the rental income can only offset the housing expenses. The loan file must contain documentation to support the history of property management. |
| Using a lease, instead of a tax return, to calculate the rental income when the property was owned by the borrower in the previous tax year. | If the borrower owned the property in the most recent tax year, document rental income with tax returns that include Schedules 1 & E and use this information to calculate the rental income or loss. Otherwise, document a qualifying exception:
|
| Using a lease on a departure residence when the departure residence was listed for rent or sale after closing. | The documentation in the loan file must be authentic and support the borrower’s financial picture and the borrower’s intended use or occupancy of the property. |
| Using rental income on a departure residence and not documenting it properly. | Rental income from a non-subject property must be documented with either tax returns or a copy of the lease. When a lease is used to document the rental income, the following are required to support the terms of the lease:
|
| Incorrect calculation of Principal, Interest, Taxes, Insurance, and Association fees (PITIA) of the rental property | Confirm that all components of the property’s housing expense are current and accurate. |
Other Considerations
Use the Income Calculator to ensure the accuracy of rental income calculations from Schedule E, Part 1, Income or Loss From Rental Real Estate and Royalties.
Use one of Fannie Mae’s rental income tools to accurately calculate the income:
- Rental Income Worksheet – Principal Residence, 2– to 4–unit Property (Form 1037)
- Rental Income Worksheet – Individual Rental Income from Investment Property(s) (up to 4 properties) (Form 1038),
- Rental Income Worksheet – Individual Rental Income from Investment Property(s) (up to 10 properties) (Form 1038A), and
- Rental Income Worksheet – Business Rental Income from Investment Property(s) (Form 1039).
Take a Step Back
Assess the loan file and ask yourself: Does the occupancy scenario make sense and does all the information appear correct?
We have observed the following:
- misrepresentation of rental income due to a falsified lease.
- misrepresentation of primary occupancy when the borrower purchases a new subject property, retains the “departure residence” as a rental, and then remains in the departure residence while offering the subject property for rent.
