Eleven Days From Closing: The Rental Income Rule That Almost Cost Alexandra Her Edisto Beach Purchase
Alexandra was eleven days from closing on a house near Edisto Beach when she learned the rental income from her other property had never been calculated the way FHA actually requires, putting her entire deal at risk.
A Common Mistake With a New Tenant
A situation that comes up often: a buyer already owns a second property, a separate rental cottage, and recently leased it to a new tenant. There is no rental history on that property yet, so it feels natural to just hand the lender the lease and assume that monthly amount becomes income on the new purchase. For Alexandra, that assumption sat quietly in her file until just before closing, when the math was reviewed and found incomplete.
What FHA Actually Requires
FHA guidance under HUD 4000.1 is specific about properties without rental history. Here it is verbatim:
"Rental Income from other real estate holdings may be considered Effective Income. For properties without rental history, the Mortgagee must deduct PITI from 75 percent of the lesser of fair market rent reported by the Appraiser or the rent reflected in the lease. Positive net Rental Income must be added to the Borrower's Effective Income. Negative net Rental Income must be included as a debt/liability. If the Borrower is vacating a property, the Borrower must be relocating to an area more than 100 miles from the current Principal Residence."
That is a very different calculation than simply counting the lease amount. The lender takes 75 percent of whichever figure is lower, the appraiser's fair market rent estimate or the actual lease amount, and then subtracts the full PITI, principal, interest, taxes, and insurance, on that rental property. Whatever remains either adds to the borrower's effective income if it's positive, or gets counted as a debt against them if it's negative.
Why This Nearly Derailed Alexandra's Deal
In Alexandra's case, the original file had used the lease amount directly without running it through this formula. Once the correct calculation was applied, pulling the appraiser's fair market rent figure and comparing it against the lease, then subtracting the full PITI, the net rental income came out positive. That figure was added to her effective income, which kept her approval on track and her closing date intact.
Had the number landed negative instead, it would have been added as a liability, which changes a borrower's debt-to-income ratio in the opposite direction. Either way, the calculation has to be done correctly, and it has to be done with the right documents.
One Thing You Can Do Today
If you already own a rental or second property that you recently leased, and you're working toward a new purchase, ask your loan officer directly: did you deduct the full PITI from 75 percent of the lesser of the appraiser's fair market rent or my lease amount, and if the result was negative, did you add it to my debts? Then ask to see the appraiser's rent schedule, Form 1007, sitting next to your signed lease. Those two documents together are what substantiates the calculation.
Get Ahead of It Before Your Closing Date
The guideline is not complicated once you know it exists, but it's easy to miss if nobody checks. I'm Jason Sharon, a licensed mortgage broker at Home Loans Inc in Charleston, SC, and I find the path through guidelines like this one before they become a problem at the closing table. If you own a rental property with a new tenant and you're planning your next purchase, call 843-LOW-RATE and let's run your numbers correctly from the start.
Home Loans Inc - Jason Sharon, Mortgage Broker. Company NMLS #1728740, Jason Sharon NMLS #1281448. Equal Housing Opportunity.
Learn more about this loan program: Eleven Days From Closing