You found the perfect new home, but the thought of selling your current one doesn’t feel right. Maybe it was your first house, or maybe you see its potential as a long-term investment. The idea of becoming a landlord is exciting, but it also brings a wave of questions. How will a lender view your future rental income? Can you even qualify for a second mortgage? This is a common scenario, and the good news is that it’s entirely possible with the right plan. The key is to understand the process from a lender’s perspective. We’ll explain the new lending rules when renting out your home to buy another, covering everything from insurance changes to DTI calculations.
Key Takeaways
- Your rental income gets a 25% haircut: Lenders will only consider 75% of your gross monthly rent when qualifying you for a new loan. This buffer accounts for landlord realities like vacancies and repairs, ensuring you can truly afford both properties.
- Prove your property’s potential with official documents: You’ll need a signed lease agreement or a formal rent appraisal (Fannie Mae Form 1007) to verify your income. Lenders won’t just take your word for it, so have your paperwork ready from the start.
- Prepare your entire financial picture for two homes: Qualifying involves more than just rental income. Lenders will also assess your cash reserves, credit score, and require you to switch to landlord insurance to prove you’re a low-risk borrower.
How Do Lenders View Your Rental Income?
When you decide to turn your current home into a rental property to buy a new one, lenders don’t just add the rent you’ll collect to your annual salary. They have a specific and cautious way of looking at this new income stream. Their main goal is to confirm that you have a stable financial footing and can comfortably manage two properties, even if you hit a few bumps along the way, like a month or two of vacancy.
Understanding how lenders will assess your rental income is the first step to a smooth application process. It helps you set realistic expectations and gather the right paperwork from the start. Lenders will want to see proof of the income, and they’ll apply certain rules to calculate exactly how much of that rent can be used to help you qualify for your new loan. Let’s break down what they look for and the formulas they use.
What Lenders Look For
First and foremost, lenders want to see that you can afford both homes. The simplest path forward is if you can qualify for the new mortgage based on your existing income alone, without factoring in any future rent. This shows the lender you have a strong financial buffer. However, many people need to use their future rental income to meet the debt-to-income (DTI) requirements for the new loan, and that’s perfectly fine. If you fall into this category, be prepared for a bit more scrutiny. Your lender will need to verify the potential income your property can generate, which is where specific documentation comes into play.
The 75% Rule Explained
You might have a lease agreement for $2,000 a month, but a lender won’t count that full amount toward your income. Instead, they typically use what’s known as the “75% rule.” This means they will only consider 75% of the gross monthly rent—in this case, $1,500—as qualifying income. Why the 25% haircut? Lenders use this buffer to account for the realities of being a landlord, such as vacancies, maintenance costs, and property management fees. By using only 75% of the rent, they get a more conservative and realistic picture of your net rental income and your ability to make your mortgage payments.
What is Fannie Mae Form 1007?
If you don’t have a history of renting out the property and need the future rent to qualify, your lender will likely require a Single-Family Comparable Rent Schedule, also known as Fannie Mae Form 1007. This isn’t something you fill out yourself. Instead, a licensed appraiser completes the form. The appraiser analyzes similar rental properties in your area to determine a fair market rent for your home. This independent assessment gives the lender a reliable, third-party estimate of your property’s income potential, which they can then use in their calculations (applying the 75% rule, of course).
How Long Do You Need a Rental History?
Lender requirements for rental history can vary quite a bit. Some of the more traditional banks might want to see that you have experience as a landlord. They may ask for one to two years of rental income reported on your tax returns (specifically, on a Schedule E form). However, many lenders, especially in today’s market, are more flexible. If you have a strong financial profile—meaning a good credit score, stable employment, and cash reserves—they may be willing to approve your loan with just a signed lease agreement for your departing residence. This is where working with a knowledgeable loan officer can make all the difference in finding a loan program that fits your specific situation.
How Rental Income Affects Your DTI Ratio
When you’re ready to buy a new home but want to keep your current one as a rental, your biggest hurdle is often proving you can handle both mortgages. This is where your future rental income becomes your superpower. Lenders look closely at your debt-to-income (DTI) ratio to gauge your financial stability. While your existing mortgage adds to the “debt” side of the calculation, the rent you’ll collect can be added to the “income” side, creating a much more balanced picture for your lender. Understanding exactly how this works is the key to a smooth and successful application process.
Adding Rental Income to Your DTI
Your debt-to-income (DTI) ratio is simply a comparison of your total monthly debts to your total monthly income. When you apply for a new loan, lenders will count your current mortgage payment as a debt, which can make your DTI look high. However, the rent you plan to collect can be added to your income, which helps lower your DTI and strengthens your application. Think of it as a balancing act: the new income from your rental property helps counteract the debt of your existing mortgage, making you a more attractive borrower for various loan programs.
How Rental Income Can Offset Your Mortgage
The money you expect to earn from renting out your home can directly offset its mortgage payment in the eyes of a lender. This is often called “departing residence income.” Instead of just seeing two large mortgage payments on your file, the lender can use the projected rent to cancel out most, or all, of the payment on your departing home. This strategy is a complete game-changer because it keeps your DTI ratio in a healthy range, making it much easier to get approved for the loan on your new primary residence.
Using Income from Your Departing Home
Lenders won’t just take your word for how much rent you’ll get. They typically count about 75% of the projected gross monthly rent toward your income. That 25% buffer is set aside to account for potential vacancies and maintenance costs, which is a standard industry practice. To verify the rental potential, your lender will likely require a special appraisal, sometimes called a Fannie Mae Form 1007 or a Small Residential Income Property Appraisal Report. This report, completed by a licensed appraiser, provides a professional estimate of your property’s fair market rent, giving the lender a reliable figure to use in their calculations. When you’re ready to see how this could work for you, you can apply now to get started.
What Paperwork Do You Need for Your Rental?
When you ask a lender to count your rental income, they’ll want to see the receipts. It’s not enough to just say you have a tenant or that the property could rent for a certain amount. You need to provide clear, official documentation that proves your property is a reliable source of income. Getting your paperwork in order ahead of time is one of the smartest things you can do to ensure a smooth loan process. Think of it as building a case for your financial strength. The more organized you are, the more confident your lender will be. Here’s a checklist of the key documents you’ll likely need to gather.
Lease Agreements and Rental History
A signed lease agreement is your golden ticket. This legal document proves to the lender that you have a tenant, specifies the monthly rent you’re collecting, and defines the income period. If you already have a tenant in place, your lender will want to see a copy of the current, fully executed lease. To make your case even stronger, provide proof that you’ve received the security deposit and the first month’s rent. This shows the agreement is active and your tenant is financially committed. For new landlords, having a solid lease agreement is the first step to proving your property’s income potential to a lender.
Tax Returns and Schedule E
If you’ve been a landlord for at least a year, get ready to share your tax returns. Lenders will specifically look for Schedule E, the part of your tax return where you report income and expenses from rental properties. This form gives them a detailed history of your property’s financial performance, showing not just the gross rent collected but also your expenses like insurance, repairs, and property taxes. A history of positive net income on your Schedule E demonstrates that you can run a profitable rental. You can view the form directly on the IRS website to see exactly what information is required.
The Rent Schedule Appraisal
What if you don’t have a tenant yet? This is where a rent schedule comes in. As part of the appraisal on your current home, a lender can request a Comparable Rent Schedule (Fannie Mae Form 1007). This is an official report from a licensed appraiser that estimates the fair market rent for your property. The appraiser analyzes similar rental properties in your area—considering location, size, and amenities—to determine a realistic potential monthly income. This document is crucial because it gives the lender a credible, third-party validation of your projected rental income, which they can then use in their calculations for your new loan application.
Bank Statements and Rental Deposits
Lenders need to see that you have enough cash on hand to manage two properties. They’ll ask for recent bank statements to verify your savings and check for consistent income. This is all about confirming you have a financial cushion, often called cash reserves, to cover both mortgages during a potential vacancy or for an unexpected repair. If you have a new tenant, showing their security deposit and first rent payment clearing your account is another powerful piece of evidence. It directly links your bank statements to your lease agreement, proving the rental income has started to flow and reinforcing your financial stability.
Property Management Agreements
If you’ve hired a professional to manage your rental, your lender will want to see that agreement. This document details the services provided and, most importantly, the management fee—typically a percentage of the monthly rent. The lender will subtract this fee from your gross rental income to determine the net income they can use for qualifying. While it represents an expense, having a property management agreement can actually strengthen your application. It shows the lender you have a professional plan in place, which can be especially reassuring if you’re a first-time landlord or won’t be living near your rental property.
Can You Use Projected Rental Income to Qualify?
Yes, you absolutely can use the potential rent from your current home to help you qualify for a new mortgage. It’s a smart strategy many homeowners use to transition into their next property without having to sell the first one. However, lenders won’t just take your word for it. They need to see solid proof that your home can realistically generate the income you’re projecting. This is all about ensuring you can comfortably afford both mortgages and aren’t overextending yourself. It’s a common misconception that you need a long history as a landlord to make this work, but that’s not always the case.
The process involves specific documentation and professional assessments to verify your property’s rental value. While it might sound like a few extra hoops to jump through, it’s a standard procedure designed to protect everyone involved. Think of it as creating a business plan for your new rental property—your lender just wants to see that the numbers add up. Understanding these requirements upfront will make the entire process smoother and help you confidently move forward with your homebuying plans. Different loan programs may have slightly different guidelines, so it’s always a good idea to discuss your specific situation with your loan officer to find the best fit for your financial goals.
Proving Market Rent
So, how do you prove what your home will rent for? The most straightforward way is with a signed lease agreement. If you’ve already found a tenant and have a lease in hand, that’s the gold standard for lenders. It shows a clear, contractual income stream that’s ready to go.
But don’t worry if you haven’t found a tenant yet—that’s a very common scenario. In this case, your lender will likely order a Fannie Mae Form 1007, also known as a Single-Family Comparable Rent Schedule. This is simply a report completed by a professional appraiser who assesses your property and the local market to determine a fair market rent. It provides an official, unbiased estimate of your home’s rental potential, giving your lender the verified data they need.
How Appraisals Affect Projected Income
An appraisal is always a key step in the mortgage process, but it takes on an expanded role when you’re converting your home into a rental. Your lender will often request that the appraisal on your departing home includes a “rent schedule.” This is a detailed analysis where the appraiser researches similar rental properties in your neighborhood to establish a credible market rent for your specific home.
This isn’t just a quick guess. The appraiser looks at comparable properties—considering size, location, condition, and amenities—to provide a professional opinion on its income-generating potential. This objective report is incredibly important because it gives your lender a reliable figure to work with. It removes the guesswork and forms the foundation for how much rental income you can use when you apply for your new loan.
Common Lender Rules for Projected Income
Once the fair market rent for your property has been established, lenders apply a standard rule of thumb: they typically only count 75% of that gross monthly rent toward your qualifying income. It might seem like a steep cut, but there’s a good reason for it. This practice is known as using a “vacancy factor.”
That 25% buffer is a safety net that accounts for the real-world costs of being a landlord. It covers potential vacancies between tenants, funds for unexpected repairs, property management fees, and other maintenance expenses. For example, if your home is projected to rent for $2,400 per month, your lender will likely add $1,800 to your monthly income for qualification purposes. This conservative approach ensures you have the financial cushion to handle landlord duties without jeopardizing your ability to pay both mortgages.
What Are the Financial Requirements for Your New Home?
Once you understand how lenders will view your rental income, the next step is to get a clear picture of the financial qualifications for your new home loan. Lenders will look at your complete financial profile, including your down payment source, cash reserves, credit score, and overall income. Each of these pieces helps them determine your ability to manage two properties successfully.
Down Payments and Cash Reserves
Coming up with a down payment for a second home can feel like a big hurdle, but you have options. Lenders often allow you to borrow up to 85% of your current home’s value, which can be a great source for your down payment funds. Beyond the down payment, you’ll also need cash reserves—money set aside in a savings account. This shows lenders you can handle unexpected costs. The amount you need depends on how many mortgaged properties you have. For one to four properties, you’ll typically need 2% of the total unpaid mortgage balances in reserves. This requirement increases as you acquire more properties.
The Credit Score and Income You’ll Need
Your credit score is always important, but when you’re managing multiple properties, lenders pay special attention to your debt-to-income (DTI) ratio. This number compares your total monthly debt payments to your gross monthly income. It’s one of the most critical factors lenders consider. While every situation is unique, a good rule of thumb is to aim for a DTI of 36% or less. A lower DTI demonstrates that you have enough income to comfortably cover your existing debts plus a new mortgage payment. Maintaining a strong credit score alongside a healthy DTI will put you in the best position to get approved.
Conventional Loan Rules for Investment Properties
If you’re using a conventional loan, there are specific rules to follow when turning your primary residence into a rental. For instance, if you need the future rental income to qualify for your new loan, your lender will likely require a special appraisal report, Fannie Mae Form 1007, to estimate the property’s market rent. Another key rule involves occupancy. If your current mortgage is for an “owner-occupied” home, most lenders expect you to have lived there for at least 12 months before you can convert it into a rental property. This helps prevent mortgage fraud and ensures you’ve met the original terms of your loan.
Exploring Portfolio Lender Options
Not every lender approaches investment properties the same way. Some may require a full year of rental income documented on your tax returns, while others are more flexible and will accept a signed lease agreement as proof of income. This is where working with an experienced loan officer becomes invaluable. They have access to a wide range of loan programs and understand the nuances of different lenders. A knowledgeable partner can connect you with a portfolio lender or a bank whose guidelines fit your specific financial situation, making the entire process smoother and more straightforward.
What to Know About Your Current Mortgage Agreement
Before you start listing your home for rent and shopping for a new one, there’s a critical first step: digging into the paperwork for your current mortgage. It might not be the most exciting part of the process, but understanding the rules your current lender has in place can save you from major headaches down the road. Many mortgage agreements, especially for primary residences, include specific terms about how you use the property. Simply deciding to rent it out without checking these terms could put you in violation of your loan agreement.
Think of it as a partnership with your lender—they have a significant financial stake in your property, so they get a say in how it’s used. Some lenders are perfectly fine with you turning your home into an investment property, while others have stricter rules. The only way to know for sure is to review your documents or have a direct conversation with them. Taking this step ensures you can move forward with your plans confidently and without risking penalties or legal trouble. It’s all about being prepared and making sure your financial foundation is solid before you build on it.
Check Your Current Mortgage Terms
Your first move is to locate your original mortgage agreement. Buried in that stack of papers is a section that outlines your responsibilities as the homeowner, often called an “occupancy clause.” This clause typically states that you must live in the home as your primary residence for a certain period, usually at least one year. If you plan to rent out the property, you need to be sure you’re not violating this agreement. If reading through legal documents makes your eyes glaze over, don’t hesitate to call your lender directly. A quick phone call can clarify their specific policies on renting and save you the trouble of deciphering the fine print on your own.
Do You Need Your Lender’s Permission?
In many cases, yes, you will need to get your lender’s official permission before you can bring in tenants. Simply moving out and renting the property without telling them could trigger a “due-on-sale” clause, which means they could demand you pay the entire mortgage balance immediately. If your current lender isn’t on board with your rental plans, it’s not the end of the road. This is often a good time to consider refinancing into a new loan that’s better suited for an investment property. Exploring different loan programs can help you find a lender with more flexible terms that align with your new goals as a landlord.
Avoiding Penalties and Violations
Being transparent with your lender is always the best policy. Attempting to rent out your home without their knowledge can lead to serious consequences, including accusations of mortgage fraud. To keep the process smooth and penalty-free, it’s wise to ensure you can qualify for your new mortgage without depending on the potential rental income from your current home. Lenders want to see that you have the financial stability to handle two properties, especially during the transition. This proactive approach not only simplifies your application for the new home but also demonstrates that you’re a responsible borrower, which is always a plus.
How to Adjust Your Homeowner’s Insurance
Once you decide to rent out your home, one of the most important calls you’ll make is to your insurance agent. Your standard homeowner’s policy is designed for a home you live in, and the moment a tenant moves in, the risks associated with your property change completely. Continuing with your old policy could mean that if something goes wrong—a fire, a break-in, or an injury—your claim could be denied, leaving you to cover the costs out of pocket.
This isn’t just a minor detail; it’s a critical step in protecting your investment. You’re not just a homeowner anymore; you’re a business owner, and your property is your biggest asset. Adjusting your insurance ensures that your asset is properly protected against the unique risks that come with being a landlord. It’s a non-negotiable part of the process that provides peace of mind and a crucial financial safety net as you step into your new role. Let’s break down what you need to do.
Switching to Landlord Insurance
First things first: you need to switch from a homeowner’s policy to a landlord insurance policy. These policies, sometimes called dwelling fire policies, are specifically designed for non-owner-occupied properties. A standard homeowner’s policy won’t cover rental properties, which can leave you vulnerable to significant financial loss. Landlord insurance typically covers the physical structure of the home, any other structures on the property (like a shed or detached garage), and your financial interest in the property. It’s important to note that it does not cover your tenant’s personal belongings; they will need to secure their own renter’s insurance for that.
Understanding Liability Coverage
As a landlord, you are responsible for providing a safe living environment for your tenants. If a tenant or their guest is injured on your property due to your negligence—for example, tripping on a broken step you failed to fix—you could be held liable. This is where liability coverage becomes essential. It helps protect you from the financial fallout of potential lawsuits or claims, covering legal fees and medical payments up to your policy limit. Don’t underestimate the importance of this protection; review your liability limits carefully to ensure you have enough coverage to protect your personal assets.
Options for Extra Protection
A basic landlord policy is a great start, but you might want to consider additional coverage to further protect your investment. Many insurers offer endorsements, or add-ons, that you can add to your policy for more comprehensive protection. For instance, you can often add coverage for loss of rental income. This helps replace the rent you would have collected if your property becomes uninhabitable due to a covered event, like a storm or fire. You might also consider coverage for damages caused by tenants or even protection for the appliances you leave in the unit. Talk to your insurance agent about these options to tailor a policy that fits your specific needs.
The Financial Risks and Rewards of Renting
Turning your first home into a rental property is a huge financial step, and it’s smart to walk in with your eyes wide open. Becoming a landlord can be an incredible way to build wealth, but it also comes with its own set of challenges and responsibilities. It’s not just about collecting a rent check every month; it’s about managing another significant asset. Let’s break down the financial realities—both the exciting rewards and the potential risks—so you can decide if this path is the right one for you.
Juggling Two Mortgages and Potential Vacancies
The biggest financial hurdle is making sure you can comfortably handle two mortgage payments. Even with rental income on the horizon, lenders will want to see that you have strong finances to cover both properties, especially during the transition. You also need to plan for vacancies. It’s rare for a new tenant to move in the day after the old one leaves. Having a month or two without rental income is a real possibility, and you’ll need a cash reserve to cover the mortgage, utilities, and other costs during that time without feeling squeezed. This financial cushion is key to managing two properties successfully.
Building Wealth with Monthly Cash Flow
Here’s where things get exciting. The rent you collect from tenants can cover your first home’s mortgage, property taxes, insurance, and repairs. If you have money left over after all those expenses are paid, that’s positive cash flow—and it goes directly into your pocket. This extra income can be a powerful tool, helping you pay for your new home or build long-term wealth. For many, becoming a landlord is a strategic move that makes purchasing a second home much more achievable and financially rewarding over time.
Taxes, Deductions, and Depreciation
Owning a rental property comes with some nice tax perks. You can subtract many of your operating costs—like repairs, insurance, property management fees, and even travel to the property—from your rental income. However, the tax rules for investment properties are more complex than for a primary residence. For example, if you eventually sell your rental home, you may have to pay capital gains taxes on the profit, which is treated differently than the sale of your main home. It’s a great idea to chat with a tax professional to understand all the implications and make sure you’re taking full advantage of the available deductions.
Handling Maintenance and Tenants
Being a landlord means you’re the go-to person for everything from a leaky faucet to a broken appliance. It involves finding and screening tenants, handling repairs, and managing the property to keep it in great shape. This can take up a significant amount of time and energy. If the hands-on approach isn’t for you, you can always hire a professional property management company. They’ll handle the day-to-day operations for a percentage of the rent, freeing you up to focus on your new home and other priorities while still reaping the financial benefits of your investment property.
How to Prepare Your Finances for the Transition
Turning your current home into a rental property while buying a new one is a major financial move. Before you even start looking at new homes or listing your current one for rent, it’s essential to get your financial house in order. Lenders will scrutinize your application more closely for this type of transaction, so solid preparation is your best strategy. Taking these steps will not only make the loan process smoother but will also set you up for success as a first-time landlord. Let’s walk through the key areas to focus on.
Plan Your Emergency Fund and Cash Flow
First things first: your savings. You need strong finances to handle two mortgage payments and other costs, especially during the transition. Think of your emergency fund as a safety net for both properties. What if your new rental sits vacant for a month or two? What if the water heater breaks in the first week? Having at least six months of living expenses—including both mortgage payments—saved in an accessible account is a smart goal. This cash reserve shows lenders you’re a responsible borrower and gives you peace of mind to handle any unexpected bumps in the road without financial stress.
Fine-Tune Your Credit Score
Your credit score is a key factor in any mortgage application, and it’s even more critical when you’re juggling two properties. Lenders see this as a higher-risk loan, so a strong score can make all the difference in getting approved and securing a favorable interest rate. Improving or maintaining a good credit score involves consistent good habits, like timely payments and smart use of your available credit. Focus on paying all your bills on time, keeping your credit card balances low, and avoiding any new major credit applications in the months leading up to your mortgage application. You can learn more about how lenders view your financial health on our blog.
Research Your Local Rental Market
Before you can budget accurately, you need to become an expert on your local rental market. This research will help you determine a realistic monthly rent for your property. Start by looking at comparable rental listings in your neighborhood on sites like Zillow or Realtor.com. It’s also a great idea to talk to local professionals. Ask about the rental market in your area, how much rent you can charge, and what it’s like to be a landlord there. The real estate agents in our Elite Partner Program are fantastic resources for this kind of on-the-ground insight and can help you understand demand and pricing.
Create a Budget for Two Properties
Now it’s time to put all the numbers together. Create a detailed budget that accounts for every expense for both your new home and your rental property. For the rental, list all monthly expenses, including the mortgage, taxes, insurance, maintenance, and potential vacancy rates. Then, subtract those expenses from your projected rental income to see if you’ll have positive cash flow. Lenders will also calculate your debt-to-income ratio (DTI) to assess your ability to manage the debt. Aim for a DTI of 36% or less. Once you have a clear picture of your finances, you can confidently explore our exclusive loan programs and find the right fit for your goals.
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Frequently Asked Questions
Do I need to have a tenant and a signed lease before I can apply for my new mortgage? Not necessarily. While having a signed lease is the most straightforward way to prove your rental income, it’s not your only option. If you don’t have a tenant yet, your lender can order a special type of appraisal report that includes a Comparable Rent Schedule. A licensed appraiser will analyze your local market to determine a fair market rent for your property, giving the lender a reliable, third-party estimate of its income potential.
Why do lenders only use 75% of my rental income to help me qualify? It might seem like a steep cut, but lenders use this 25% buffer as a practical safety net. They know that being a landlord comes with costs beyond the mortgage payment, such as vacancies between tenants, unexpected repairs, and general maintenance. By using a more conservative income figure, they get a realistic picture of your finances and ensure you won’t be stretched too thin if you have a month without rent or need to fix a leaky roof.
How much money should I have in savings to do this? There isn’t a single magic number, but you’ll need a solid financial cushion. Lenders will want to see that you have cash reserves, which is typically a percentage of the total balance of both mortgages. Beyond that, it’s smart to have your own emergency fund that can cover at least six months of expenses for both properties. This shows the lender you’re financially prepared and gives you the peace of mind to handle a vacancy or an unexpected repair without stress.
Can I just rent out my house without telling my current mortgage lender? This is a risky move that you should absolutely avoid. Most mortgage agreements for a primary residence include an “occupancy clause” that requires you to live in the home for a specific period, usually at least a year. Renting it out without permission could violate your loan terms and potentially trigger a clause that requires you to pay the entire mortgage balance immediately. Always start by reviewing your current loan documents or calling your lender to understand their rules.
What’s the most important document I’ll need to get started? If you already have a tenant, the fully signed lease agreement is your golden ticket. It’s the clearest proof of your new income stream. If you don’t have a tenant yet, the most critical document will be the appraisal report that includes the Comparable Rent Schedule (Fannie Mae Form 1007). This independent assessment of your property’s rental value is what your lender will use as the foundation for all their income calculations.
