Rental income can be a valuable tool when qualifying for an FHA mortgage, potentially strengthening your application by demonstrating additional income streams. But there are certain rules and requirements you need to know about.
5 Key Points Covered in This Guide
- FHA allows rental income from multiple sources: You can use rental income from the property you’re purchasing (if it’s a 2-4 unit, has an ADU, or is an investment property) and from other properties you already own to help qualify for your mortgage.
- Documentation depends on your rental history: If you’ve been receiving rental income since your last tax filing, you’ll provide tax returns with Schedule E. Without that history, you’ll need appraisals showing fair market rent and any existing lease agreements.
- The 75% rule protects against vacancy: For properties without established rental history, FHA only counts 75% of the projected rent (either fair market rent or lease amount, whichever is lower) to account for vacancies and collection issues.
- Different calculations for subject property vs. other properties: Rental income from the property you’re buying gets added to your gross income. Rental income from other properties must have the existing mortgage payment (PITI) subtracted first, so only positive cash flow counts.
- Special restrictions apply to certain situations: ADU rental income cannot exceed 30% of your total qualifying income, and if you’re converting your current home to a rental, you must be moving at least 100 miles away and have a one-year lease in place.
This guide breaks down the key rules, requirements, and procedures you need to know about when using rental income for FHA loan qualification.
What Counts as ‘Rental Income’ for FHA Loans?
According to FHA guidelines, rental income refers to income you receive or will receive from either the property you’re purchasing (the subject property) or from other real estate you own.
This can include income from various property types, but there are important distinctions in how each is treated.
It’s crucial to note that commercial rental income cannot be included in your qualification calculations. FHA rental income provisions apply only to residential properties.
Rental Income from the Subject Property
When you’re purchasing a property that will generate rental income, FHA allows you to count that income toward your qualification under specific circumstances.
Eligible Property Types
You can use rental income from the subject property when purchasing one of the following:
- Single-family homes with an accessory dwelling unit (ADU). An ADU is a secondary living space on your property, such as a basement apartment, converted garage, or guest house with its own kitchen and bathroom facilities.
- Two- to four-unit properties. These are small multi-family dwellings where you’ll occupy one unit and rent out the others.
- Investment properties (one to four units). In limited cases where FHA allows investment property financing, rental income from all units may be considered.
Documentation Requirements: Two Scenarios
How you document rental income from the subject property depends entirely on your ownership history with that specific property.
Scenario 1: Limited or No Rental History
If you don’t have a documented history of receiving rental income from the subject property since your last tax filing, you’ll need to provide projected rental income documentation.
For two- to four-unit properties, lenders must obtain a Small Residential Income Property Appraisal Report that shows fair market rent for the units. If you already have lease agreements in place with prospective tenants, these should also be provided.
For single-family homes (with or without an ADU), the documentation requires a standard appraisal along with a Single Family Comparable Rent Schedule that demonstrates what similar properties rent for in your area. Again, any existing lease agreements strengthen your application.
The appraisal’s fair market rent analysis is critical because it provides an objective, professional assessment of realistic rental rates for your property based on comparable properties in the local market.
Scenario 2: Established Rental History
If you’ve been receiving rental income from the subject property since your previous tax filing, the documentation process is different and relies on historical data rather than projections.
Your lender will need your tax returns from the previous two years, specifically including Schedule E, which is where rental income and expenses are reported to the IRS. This provides verifiable proof of your actual rental income track record.
For properties you’ve owned less than two years, you’ll also need to provide documentation showing when you acquired the property.
Acceptable documents include the property deed, your closing disclosure from when you purchased it, or similar legal documents that establish the purchase date. This allows the lender to properly calculate your rental income history relative to the ownership period.
How Rental Income is Calculated
The calculation method differs significantly depending on whether you have a rental history.
For Properties Without Rental History
When there’s no established rental history, FHA takes a conservative approach by using only 75% of the rental amount. This built-in buffer accounts for potential vacancies, late payments, and the learning curve of new landlords.
The calculation uses 75% of whichever is less: the fair market rent determined by the appraiser, or the actual rent specified in your lease agreement. This ensures that overly optimistic rent projections don’t inflate your qualifying income.
Special rule for accessory dwelling units: If you’re buying a single-family home with an ADU, there’s an additional restriction. The rental income from the ADU cannot exceed 30% of your total monthly effective income used for qualification. This cap ensures that your financial stability doesn’t rely too heavily on rental income from a secondary unit.
For Properties With Rental History
When you have an established rental history documented on Schedule E, lenders calculate your rental income by averaging the amounts shown on those tax returns over the documented period.
Here’s where understanding Schedule E becomes important. This tax form shows not just your rental income, but also all your expenses related to the property: depreciation, mortgage interest, property taxes, insurance, and homeowners association dues.
For FHA qualification purposes, certain expenses can be “added back” to your net income or loss.
Specifically, depreciation (a non-cash expense), mortgage interest, taxes, insurance, and HOA dues shown on Schedule E may be added back to your bottom line. This is because these expenses will be accounted for separately in your new loan qualification, so counting them twice would unfairly penalize you.
If you’ve owned the property for less than two years, the lender must annualize your rental income. For example, if you’ve owned it for six months, your income will be calculated on a per-year basis to provide a standardized measure.
Important Distinction: How Rental Income is Applied
There’s a critical point that catches many borrowers by surprise. While rental income from the subject property is added to your gross income for qualification purposes, it cannot be used to reduce your total mortgage payment calculation.
In other words, the rental income increases your income side of the debt-to-income ratio, but your full mortgage payment (including the payment on all units) still counts on the debt side.
What this means in practice is that FHA wants to see that you can afford the entire mortgage payment on your own, without relying on rent from the property you’re buying to cover that payment.
Even if the expected rental income would fully offset part of the mortgage in the real world, FHA still requires the full payment to be counted as a monthly debt, with the rental income helping only by increasing your qualifying income.
This approach reduces risk and helps ensure borrowers can handle the payment even if rental income is interrupted.
Rental Income from Other Properties You Own
FHA also allows you to use rental income from other properties you own to strengthen your qualification, though the requirements and calculations differ from subject property rental income.
When You Can Use It
Rental income from other real estate holdings can be counted as effective income, including from properties you’re vacating to buy your new home.
However, if you’re converting your current primary residence into a rental property, there’s a geographic requirement: you must be relocating to an area more than 100 miles away from your current home.
This distance requirement prevents borrowers from claiming they’re moving while actually maintaining easy access to their former residence, which could indicate they’re not truly treating it as a rental property.
When converting your primary residence to a rental, you must provide a lease agreement with at least one year’s duration that extends beyond your new mortgage closing date. You’ll also need to show evidence that the tenant has paid the security deposit or first month’s rent, demonstrating that this is a legitimate rental arrangement and not just a paper transaction.
Documentation Requirements
Like subject property rental income, the documentation depends on whether you have an established rental history.
Without Rental History
If you don’t have a history of rental income from the property since your previous tax filing, you’ll need an appraisal showing the market rent for the property.
Additionally, you must demonstrate that you have at least 25% equity in the property. This equity requirement provides assurance that the property has sufficient value and that you’re not over-leveraged on your real estate holdings.
The appraisal doesn’t need to be completed by an FHA roster appraiser, which provides more flexibility and potentially faster turnaround times.
For two- to four-unit properties, you’ll need the Small Residential Income Property Appraisal Report showing fair market rents, along with any existing leases.
For single-family homes (with or without an ADU), you’ll need a standard appraisal and a Single Family Comparable Rent Schedule showing market rents, plus any lease agreements you have in place.
With Rental History
If you have an established rental history, your lender will need your last two years’ tax returns with Schedule E attached. This documentation proves your track record of successfully generating rental income from the property.
Calculating Net Income From Other Properties
The calculation for rental income from other properties is more conservative than for the subject property because you must account for the existing mortgage and expenses on those properties.
For properties without rental history, you start by taking 75% of the lesser of the appraiser’s fair market rent or your actual lease amount (the same starting point as subject property).
However, you then must subtract the full PITI payment (Principal, Interest, Taxes, and Insurance) on that property. Only the remaining amount can be added to your effective income for qualification purposes.
For example, if a property’s fair market rent is $2,000 per month, you’d start with 75% of that amount: $1,500. If your PITI payment on that property is $1,200, your net rental income for qualification purposes would be $300 per month.
This conservative approach ensures that the rental income truly represents positive cash flow rather than just covering the existing property’s costs.
Key Considerations and Common Questions
Can I use projected rental income if I’ve never been a landlord?
Yes, but only in certain situations. FHA allows projected rental income for the property you’re buying and for other properties you already own, as long as you don’t have rental income reported since your last tax filing and you meet the applicable documentation and equity requirements. In these cases, lenders rely on an appraisal showing fair market rent and apply the 75% factor.
What if my Schedule E shows a loss?
This is common for rental properties due to depreciation and other expenses. During FHA qualification, certain expenses like depreciation, mortgage interest, taxes, insurance, and HOA fees can be added back to your net income or loss, potentially converting a paper loss into qualifying income.
How does the ADU income cap work?
If you’re purchasing a home with an accessory dwelling unit, the rental income from that ADU cannot represent more than 30% of your total monthly effective income. This ensures you’re not overly dependent on the ADU for qualification.
What counts as adequate rental history?
Rental history means documented income since your previous tax filing. If you purchased a property in June 2024 and are applying for a new mortgage in December 2024, you would not yet have a tax return showing that rental income, so you’d follow the “no rental history” documentation path.
Why the 100-mile requirement for converted residences?
FHA wants to ensure that when you claim you’re converting your primary residence to a rental, you’re genuinely relocating rather than maintaining it as a second home or attempting to manipulate the qualification process. The distance requirement, combined with the lease documentation, provides reasonable assurance of legitimate intent.
Conclusion
Using rental income for FHA mortgage qualification can significantly improve your borrowing power, but it requires careful documentation and understanding of the specific rules.
The key factors are whether you have established rental history, what type of property is generating the income, and how the calculations differ between subject property and other holdings.
Working with an experienced FHA lender who understands these nuances can help ensure your rental income is properly documented and calculated, maximizing your qualification potential while meeting all FHA requirements.
Always gather your documentation early in the process, including tax returns with Schedule E, appraisals, and lease agreements, to avoid delays in your mortgage approval.