Before the liquidity crisis that began in 2007, if investment properties showed a loss on your taxes, lenders deducted that amount from your income. That’s fair. Somewhere along the way, they decided to count those losses as Debt.
Why is that a problem? The standard DTI lenders use is 43%. I explain that calculation the article titled “If you pay alimony or child support, will that kill your ability to get a home loan?”
For our purpose here, know that you need income of about 2 ½ times the amount of the debt to simply overcome the debt. Then the rest of your income qualifies you for the loan.
That is why it is important that your investment property shows a profit by lending standards. If your investment property income is negative, it counts as a debt.
Here is the standard calculation. There is a calculator on my website that does this for you www.HollyGustlin.com
Minus total expenses
Add back Mortgage Interest, Property Tax and Insurance (and HOA if applicable)
Add back Depreciation
Deduct the Principal portion of the mortgage payment (this is the kicker that often causes the calculation to go negative)
They use that number as the monthly rental income, not your actual rental income. The rental income they calculate offsets your current monthly payment (or future monthly payment if you are refinancing that property).
Here is an example. One of my clients charges less than market rent because the tenant is a family friend. We had to count debt of $856.17 when qualifying him to refinance his primary residence. We needed $1,998 in additional income to overcome the investment property debt (over and above the income we needed to qualify for the home loan).
I was able to overcome the obstacle and get his loan approved; but I offer this example so that you can determine how your rental property income and expenses can affect your DTI calculation when you apply for a home loan.
If you or your accountant do this calculation on your Schedule E rental properties and the result is a negative number, then lenders will count that as debt. You may be better served to rethink deducting some expenses.
If you have questions or want help assessing your situation, you can contact me at 877-728-2008; Holly@HollyGustlin.com