Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.
- byJim Quist |
- Sep 27, 2021
Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.
You might be ready to move, but it doesn’t mean you have to be ready to sell. Having two homes doesn’t mean you have to qualify for two mortgages outright if you plan to rent out the house you’re vacating. With some careful planning, you can actually use the rental income you’ll collect from your current home to offset your costs, and give yourself the financial flexibility required to qualify for a new home.
We know how it goes: you shopped for months for your first home, you spent endless hours picking out paint colors and new floors and the perfect furniture. Your first home was a big step and an important one! But lately, you find yourself wishing you had a dedicated office space, a back patio, and definitely more closet space now that your partner has moved in. As much as you love your current place, it’s time to start thinking about what's next.
Whether you’ve recently gotten married, expanded your family, or just need more space, you can use the rental income from your current home to help buy a home that suits your current needs. Check out our resources below to learn more, including our step-by-step checklist at the end of this article:
- What is “future rental income”?
- How to calculate your future rental income.
- How will my future rental income help me afford a new home?
- When do I find a renter for my current home?
- How do I qualify for an additional mortgage with future rental income?
What is “future rental income”?
“Future rental income” refers to the amount of money you expect to receive from a home you rent out, rather than live in. It’s a term we use in the mortgage biz to represent the estimated income a rented property will bring in, and we use this number as part of our calculations when we qualify you for a home loan.
This term applies to all sorts of properties, whether you’re buying a dedicated investment property, a multi-unit property, or, in this case, you want to rent out your old home and buy a new one. Most buyers can’t afford multiple mortgages without the additional cash flow from tenants, but your future rental income can—and often does—help you qualify for an additional mortgage.
That said, you won’t get to claim 100% of your future rental income as you apply for another home loan. Rental income can be interrupted by property maintenance or renovations, nonpayment, or even periods of vacancy between tenants. To account for this, your lender will calculate your future rental income as 75% of the total expected rent you receive for the property.
In other words, you’ll be able to offset your mortgage costs with the rental income from your leased property, but only up to 75% of the total rent to be collected.
How do you calculate your future rental income?
So, to review: the good news is that you can use future rental income to offset the costs of and qualify for another mortgage. But you won’t use 100% of the total rent to be collected as part of your qualifying calculations. Accounting for routine maintenance, missed rent, and possible vacancies, your lender will calculate your future rental income amount as 75% of the rent to be collected each month.
To calculate your projected rental income, you’ll need to chat with your real estate agent to get a breakdown of the rental rates for similar homes in your area. This research will help you get an idea for the market rent for your neighborhood, and give you an idea of how much you can reasonably expect to collect from tenants each month.
As part of the qualifying process, your lender will calculate your future rental income, adjusting for maintenance, vacancies or other issues that may arise. This number—75% of the rent you expect to receive each month—is then used to offset your monthly mortgage costs for your previous home and its mortgage.
Sound a little confusing? Don’t stress—it’s actually pretty simple:
Let’s say you bought a home in 2018 that’s now too small for your family. You love the home and aren’t ready to put it on the market, but you can’t afford to pay for two mortgages outright given your current income. You decide to rent your current home, and, based on the local rental market, will collect $2,000 in rent each month. When a lender qualifies you for your new mortgage, they’ll consider your adjusted monthly rental income to be 75% of that $2,000, or $1,500 per month. This $1,500 will be used to offset your current mortgage debt, which can help you qualify for another mortgage on a new home.
It can be tricky knowing how to gauge or plan for income based on a market rental rate, or to make sure that your rental income will be enough to qualify you for a new home. In cases like this, it’s best to chat with a lender ahead of time and get pre-approved.
With NewCastle's streamlined pre-approval process, you receive a certified pre-approval letter that shows sellers you’ve already qualified for the loan you need to close on the home. With a buyer cert in hand, you're able to stay ahead of the homebuying process at every stage, from shopping for a new home to putting in an offer, then having that offer accepted.
How will my future rental income help me afford a new home?
It’s a question we get asked a lot: I want to rent out my current home and buy another one, but how do I know if I can afford it? And the answer’s short—if not entirely simple: It all depends on your debt-to-income ratio.
As a homeowner with a current mortgage, you’ve probably seen the term “debt-to-income ratio” before—it’s part of what your lender used to qualify you for your current home loan. Your debt-to-income ratio, or DTI, is your monthly debt divided by your monthly gross income. But because you already have a mortgage on the property you’re leaving, your DTI is a little more complicated this time around.
Your current mortgage increases your total debt, but in order to qualify for the home you want to buy, you’ll still need to have a debt-to-income ratio of about 43% or lower. Different lenders will have different stipulations for your DTI, but $3% or lower is a good benchmark to work with as you consider your options for your next home.
Because this situation is less common, and because every homebuyer’s debt-to-income ratio is a little different, we encourage buyers to work closely with a mortgage lender throughout the buying process. Checking your debt-to-income ratio and getting pre-approved for a loan amount will guarantee that you can afford the home before you put in an offer, and help you close on your new home with fewer complications.
Ready to get started? We’re pre-approval experts.
Fortunately, finding a renter for your current home helps reduce your debt-to-income ratio. By converting your current home to a rental property, you can use the future rental income to offset the cost of your current mortgage, then qualify for another mortgage based on your adjusted debt-to-income ratio.
In other words, your DTI for a new home loan will still include your current mortgage costs if you don’t plan to sell, but this cost will be offset by the adjusted rental income you can expect to collect from your renter(s).
Jessica, who recently got married, wants to rent out her current condo in order to buy a single-family home, she’ll need to do a little math first. Her current monthly housing cost is $1,832. This payment accounts for all of her associated mortgage costs—including the principal and interest payments, mortgage insurance, and property taxes—along with her homeowner's insurance payment and her condo’s homeowners association dues.
Jessica and her spouse want to buy a home priced at $560,000. Based on their down payment amount and interest rate, this would mean their new home comes with a monthly housing payment of $3,082. Their combined annual gross income is $132,000, or $11,000 per month, and their additional monthly debt comes out to $1,100, including one car payment and two student loan payments.
If we look at Jessica’s debt-to-income ratio with both mortgages factored in, she wouldn’t qualify for the mortgage on the new single-family home:
| Expense Amount | Expense Type |
| -$3,082 | Future home payment |
| -$1,832 | Condo housing payment |
| -$1,100 | Other monthly payments: car, student loans |
| -$6,014 | Total monthly debt |
With $6,014 in monthly debts and $11,000 in monthly income, this puts Jessica’s DTI at 55%. ($6,014 / 11,000 = 0.5467 or 54.67%)
Without a renter for her condo, a 55% debt-to-income ratio is too high for a lender to qualify her for both mortgages.
But based on the current rental market in her area, Jessica could bring in $2,500 in rent each month if she were to lease her condo. Based on the rental adjustment rate of 75%, this means Jessica could use 75% of that $2,500 rental amount to offset her condo housing costs, or $1,875 each month.
Because this adjusted rental amount is more than her condo housing payment, it won’t factor into her monthly expenses. With a renter for her condo, we would qualify Jessica based on the following debt-to-income ratio instead:
| Expense Amount | Expense Type |
| -$3,082 | Future home payment |
| -$1,832 | Condo housing payment |
| (+$1,875) | Adjusted monthly rental income |
| -$1,100 | Other monthly payments: care, student loans |
| -$4,139 | Total monthly debt |
With the adjusted rental income factored in, Jessica would easily qualify for her new home loan with a debt-to-income ratio of 38%. This would mean she can keep her condo, build equity, and ideally profit from the property over time.
Tip. Before converting the condo to an investment property, Jessica should also consider refinancing her current mortgage. Interest rates are lower today than when she bought her condo, and she has at least 20% equity in the property. With a new loan at a lower rate and no mortgage insurance, she’d lower her monthly payments, and further reduce her debt-to-income ratio before buying a new home.
Whether you’re ready to put in an offer on a new place, or you’re just weighing your options for the future, we’ve helped hundreds of borrowers buy new homes after converting their current homes to investment properties. Schedule a call today, and find out why we’re one of Chicago’s highest-rated lenders for customer satisfaction:
When do I find a renter for my current home?
As hard as it might be to wait, you don’t want to find a renter before you know for sure that you’re moving. The housing market moves fast and can be unpredictable. Most importantly, you don’t want to have a renter sign a lease and then have your closing fall through. You will have some time after signing your sales contract to find a tenant.
This is why it’s crucial that you’re pre-approved for your loan, and that you wait until the seller has accepted the offer on your new home to look for a renter. You’ll find tenants for your home when you know that you qualify for the loan, and when the seller has agreed to sell the property to you by a scheduled closing date. These details will be outlined in your sales contract.
Once you receive a sales contract for the purchase of your new home, you’ll have some time—typically about 30 days from the date the seller accepted your offer—to find a renter.
The period after your offer’s been accepted but before you close on the loan is called the “contingency period.” It's a safeguard for you, the buyer, that exists because of a clause added to your contract with the seller.
You’ll want to include this clause in your sales agreement along with some earnest money, or good-faith money, to indicate you’re serious about buying the home. Ultimately, this mortgage contingency protects you and your earnest money deposit. If, for example, you can't find a tenant in time to close, your lender won't be able to commit to the mortgage with your higher DTI. But because of the mortgage contingency in your sales contract, you can still pull out of the deal and the seller will refund your earnest money.
The mortgage contingency is the sweet spot for you to find your renter. You’ve already committed to buying the home, your mortgage process is underway, and the contingency clause offers a little bit of protection in case you can’t find a renter in time. If you have trouble finding a tenant, you can still back out of the deal and the seller will refund your earnest money.
And while it’s true that 30-or-so days seems like a tough deadline to meet, again—the real estate and rental markets move fast! During the contingency period, you’ll have time to advertise and show your property to prospective tenants, then draw up a lease agreement for your renter(s) while your mortgage lender gets everything together to process and approve your loan.
If you don’t qualify for both mortgages outright, you’ll need to provide your lender with proof that you’re renting out your current home before the contingency period expires.
Typically, lenders will want to see a copy of the legally executed lease and a security deposit check as proof that your renter has committed to rent payments that reduce your monthly housing expenses. With these documents in hand, the lender will process and approve the loan, and you’ll be ready to close on your new home.
How do I qualify for an additional mortgage with future rental income?
At NewCastle, we’ve perfected the process of pre-approval and transitioning your current residence into an investment property.
Much of the mortgage process is time-sensitive, and when you need to find a renter before closing on your new property, the timelines get even tighter. We know from experience that meeting your tight approval deadlines often depends on the team you’re working with.
Our all-online process is designed to get you the loan you need in record time. We’ve broken it down into four simple steps to get you approved for an additional mortgage on a new home:
1. Get pre-approved.
The best way to eliminate additional stress and avoid possible roadblocks later on is to apply for pre-approval with a supportive and qualified lender—like us!
With a pre-approval letter as part of your offer, your real estate agent will be able to expedite the process with the seller and get the ball rolling on your formal loan approval as soon as possible.
2. Make an offer to buy.
Once you’ve found the home you want to buy, it’s time to make an offer. Submit your pre-approval letter along with your offer so that the buyer knows you’re already proactively working with a lender for your mortgage.
Make sure that you have enough time to find a renter, too. Leave yourself time from the date of acceptance to the closing date (mortgage contingency date), so that you can find a renter and execute a valid lease.
3. Find a renter and execute a lease.
Research rent values, advertise your property and find a renter to lease your property. You’ll provide the lease and proof of the security deposit to the lender as part of your qualifying for the new home loan.
Keep in mind, too, that you need to execute a lease and collect a security deposit before the mortgage contingency expires.
4. Receive final loan approval from your lender.
Once your lender has received proof of a valid lease and that you’ve collected a security deposit, they’ll be able to process and officially approve the loan. Once this final loan approval is in hand, you’re set to close on your new home!
At NewCastle, we believe in simplifying the mortgage process and empowering our customers with the knowledge they need to confidently buy a home. As daunting as this process may seem at first, we’re committed to getting your questions answered, and clarifying your path to the home you need.
Still have questions about renting out your current home? Want to see if your situation fits the process we’ve described above? Ready to get pre-approved. Our team is ready to help!
Schedule a call today to chat with our industry experts, and receive the one-on-one help your unique situation requires.