5306.1: Rental income (11/30/18)

This chapter contains requirements and guidance for the use of rental income:

General eligibility requirements (Refer to Section 5306.1(a))
Rental income from the Borrower's 1-unit Primary Residence (Refer to Section 5306.1(b))
Rental income from the Borrower's subject 2- to 4-unit Primary Residence, subject 1- to 4-unit Investment Property and non-subject investment property (Refer to Section 5306.1(c))
Establishing the debt payment-to-income ratio (Refer to Section 5306.1(d))
IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation (Refer to Section 5306.1(e))
Data delivery requirements for rental income (Refer to Section 5306.1(f))
Other Guide provisions related to rental income (Refer to Section 5306.1(g))

(a) General eligibility requirements

Stable monthly rental income must be generated from acceptable and verifiable sources and must be reasonably expected to continue for at least the next three years. For each income source used to qualify the Borrower, the Seller must determine that both the source and the amount of the income are stable. Refer to Section 5301.1 for additional information about income stability and continuance.

(i) Rental income eligibility

Rental income generated from the following property and occupancy types may be considered when determining the stable monthly income:

1-unit Primary Residence (rental income is eligible from a live-in aide)
Subject 2- to 4-unit Primary Residence (rental income is eligible from units that are not occupied by the Borrower)
Subject 1- to 4-unit Investment Property
Non-subject investment property owned by the Borrower (not restricted to residential property (e.g., commercial permitted))

(ii) Accessory units

When determining stable monthly income, rental income generated from an accessory unit may be considered for:

Subject 1-unit Investment Property
Non-subject investment property

The rental income requirements in this chapter must be met. Refer to Section 5306.1(b) and 4501.9(a) for information relating to rental income eligibility for a 1-unit Primary Residence with an accessory unit. Refer to Chapter 5601 for the property eligibility and appraisal requirements related to an accessory unit for the subject property.

(iii) Second homes

Rental income generated from the Borrower's second home may not be used as stable monthly income.

(b) Rental income from the Borrower's 1-unit Primary Residence

The following chart contains requirements related to rental income from a Borrower's 1-unit Primary Residence:

1-unit Primary Residence rental income eligibility requirements
Eligibility	Rental income generated from the Borrower's 1-unit Primary Residence, including rental income from an accessory unit, may be used to qualify a Borrower with a disability provided the rental income is from a live-in aide. Typically, a live-in aide will receive room and board payments through Medicaid waiver funds from which rental payments are made to the Borrower.
Documentation	Evidence that the Borrower has received stable rental income from a live-in aide for the most recent 12 months
Qualification	The rental income may be considered in an amount up to 30% of the total stable monthly income that is used to qualify the Borrower for the Mortgage

Refer to Section 4501.9(a) for use of rental income generated from the Borrower's 1-unit Primary Residence securing a Home Possible® Mortgage.

(c) Rental income from the Borrower's subject 2- to 4-unit Primary Residence, subject 1- to 4-unit Investment Property and non-subject investment propertyThis section contains requirements and guidance for the history, documentation, analysis, calculation and determination of stable monthly net rental income.

(i) Appraisal form documentation and analysisThe following chart contains requirements related to appraisal form documentation and analysis:

Appraisal forms – comparable rent data
Subject	Subject 1-unit Investment Properties	Subject 2- to 4-unit Primary Residences Subject 2- to 4-unit Investment Properties
Documentation	Form 1000, Single Family Comparable Rent Schedule	Form 72, Small Residential Income Property Appraisal Report
Analysis	The Seller's analysis of the rental information must include, at a minimum, the following factors: Rental market viability and income producing potential for subject property Whether the current market rents reasonably support the gross rents reported on Schedule E or the gross monthly lease income, if applicableIf the current market rents do not reasonably support the gross rents reported on Schedule E or the gross monthly lease income, the Seller must: Determine if additional documentation is necessary to support income stability, and Provide a written analysis explaining the discrepancy and justifying the determination that the rental income used to qualify the Borrower is stable and reasonably expected to continue

(ii) Documentation, history and analysisThe following charts contain requirements and guidance for documentation, history and analysis.

Subject	Subject property purchase transaction		Subject property refinance transaction or non-subject investment property Property purchased in the current calendar year, or Property placed in service for use as a rental property in the current calendar year
Documentation and analysis Streamlined Accept and Standard Documentation Levels	A lease, if available, must be used to determine the net rental income. The Seller must make reasonable efforts to determine lease availability, including review of the appraisal, comparable rent data, purchase contract, a discussion with the Borrower and/or any other applicable and reasonable method or If a lease is not available, Forms 72 or 1000, as applicable, may be used to determine the net rental income The rental income may not be used to qualify if the Seller has knowledge, information or documentation that indicates that the Borrower does not intend to utilize a lease with a minimum term of one-year for the rental income source		Lease must be used to determine the net rental income Purchase date or conversion date, as applicable, must be documented
Lease requirements	Leases must be current and fully executed, with a minimum original term of one year. If the lease is documented as assigned from the property seller to the Borrower and is in the automatically renewable month-to-month phase of an original one-year (or longer) term lease, then a month-to-month term is acceptable.
Investment property management experience and maximum eligible amount of net rental income	The Borrower must have a minimum one-year history of investment property management experience occurring within the most recent 36 months. The management experience must be documented with at least the most recent year of complete federal income tax returns for which the investment property was in service. or The net rental income, as described in Section 5306.1(c)(iii), may only be considered in an amount up to 30% of the sum of the net rental income and all other stable monthly income (e.g., employment earnings) that is used to qualify the Borrower for the Mortgage If there are multiple properties that are subject to the 30% requirement (e.g., a subject property purchase transaction and a non-subject investment property purchased in the current calendar year), the 30% requirement applies to the combined total of net rental income. Examples of how to apply these calculations are shown in the following chart:
	Examples: Calculations of the maximum amount of net rental income that is eligible to be included in the stable monthly income
	Employment earnings	Net rental income (Section 5306.1(c)(iii))	Sum of net rental income plus employment earnings	Calculation	Eligible net rental income
	$5,000	$1,500	$6,500	$6,500 x 30% = $1,950	$1,500
	$2,500	$2,625	$5,125	$5,125 x 30% = $1,537.50	$1,537.50

The Seller must review the following documentation options and determine which is the most appropriate to establish and support the stable monthly net rental income based on the individual transaction.

Option 1: One-year tax return and current lease
Subject	Subject property: refinance transaction owned in the prior calendar year(s) Non-subject investment property: owned in the prior calendar year(s)
Option I is for long-term rental income sources (e.g., lease with at least a one-year term). It requires a current lease which lends support to income stability and continuance, so a shorter documented history (one-year tax return) is acceptable.
Documentation Streamlined Accept and Standard Documentation Levels	Complete federal individual income tax return (Internal Revenue Service (IRS) Form 1040), including Schedule E, for the most recent year, and Current, fully executed lease with an original minimum term of at least one-year. If the lease is in the automatically renewable month-to-month phase of an original one-year (or longer) term lease, then a month-to-month term is acceptable. The Seller may determine that the rental income is stable without obtaining the current lease if: The fair rental days reported on Schedule E for the most recent year document rental income consistent with a long-term lease (e.g., 360 days) The tax returns are no more than six months old based on the ending date of the last tax year, and No information is present that would contradict a reasonable expectation of income stability, continuance or current receipt of rental income from a lease
Sufficient historical data on Schedule E	If the Seller determines that the information on Schedule E contains sufficient historical data to analyze and determine stable net rental income and expenses, the Schedule E must be used to calculate the net rental income. A 12-month history of income and expenses reported on Schedule E is generally required to establish a stable net rental income amount; however, the Seller may determine that less than a 12-month history is sufficient based on the analysis of the historical data on Schedule E.
Insufficient historical data on Schedule E	If the Seller determines that the information reported on Schedule E does not contain sufficient historical data to analyze and determine the rental income and expenses, the Seller may determine that the use of a lease is more appropriate to establish the income amount. For example, the Seller may determine that there is insufficient historical information on Schedule E when: The rental property is documented as purchased later in the prior calendar year A documented catastrophic event or major renovation occurred causing the property to be out of service for a portion of the year The source of the rental income changed from a source without a lease (e.g., short-term rental income) to a one-year term lease during the calendar year When the lease is used to determine net rental income: The gross monthly rent amount on the lease must be consistent with the gross rents received on Schedule E (based on the annualized amount of fair rental days reported on Schedule E) The Seller must provide a written analysis and supporting documentation, if applicable, justifying the use of the lease to determine the net rental income
Analysis	When evaluating stability of net rental income, the Seller must analyze: The length of historical data for the rental income source and amount, expenses, and Whether the gross rents on the lease, if present, are consistent with the rents received on Schedule E

Option 2: Two year's tax returns
Subject	Subject property: refinance transaction owned in the prior calendar year(s) Non-subject investment property owned in the prior calendar year(s)
Option II is for short-term rental income sources (e.g., rental income from a source where a lease is not utilized, lease with less than a one-year term). Short-term rental income sources may be more volatile than long-term rental income sources, so a longer documented history (two year's tax returns) is required to support income stability and continuance.
Documentation Streamlined Accept and Standard Documentation Levels	Complete federal individual income tax returns (IRS Form 1040), including Schedule E, for the most recent two years If the tax returns are more than six months old based on the ending date of the last tax year: A current year-to-date (YTD) gross rental income statement from the independent third party (i.e., company that collects rents and disburses same to Borrower), and year-end statement or IRS Form 1099-K, Payment Card and Third Party Network Transactions, if applicable, that supports the gross rental income and source reported on the tax returns is requiredor If a gross rental income statement is not provided to the Borrower, other equivalent supporting documentation must be obtained to justify the stability of the rental income Rental income reported on Schedule C: If short-term rental income is reported on Schedule C instead of Schedule E (e.g., due to tax rule interpretations), the Seller may determine the rental income is stable if all requirements in this chapter are met.
Length of history requirement	A 24-month history of income and expenses reported on Schedule E is generally required to establish a stable net rental income amount The same short-term source must have been producing the rental income and the property must have been used for the purposes of producing rental income for this period of time IRS Form 4562, Depreciation and Amortization, is an example of documentation that may be used to determine the date the property was placed in service for use as a rental property for the purposes of producing rental income
Less than a 24-month history reported on the tax returns	In certain instances, the Seller may determine that less than a 24-month history of rental income and expenses from the same source reported on the Schedule E is sufficient to determine a stable net rental income amount. The history reported on Schedule E for the most recent year must not be less than 12 months. The overall documented history of income and expenses, and length of time the property has been used for the purposes of producing rental income, must not be less than 18 months. The Seller must provide a written analysis and supporting documentation justifying a history of less than 24 months reported on Schedule E. The following examples represent situations that may support less than a 24-month history of income and expenses reported on the Schedule E: The Borrower purchased and placed the rental property in service 20 months ago; however, the tax returns only reflect a 12-month history of income and expenses from the same source. The Borrower receives a YTD gross rental income statement from an independent third party (i.e., a company that collects rents and disburses same to Borrower) that supports the gross rental income and source reported on the tax returns and an overall 18-month history of income stability. Documentation evidences: (a) a tax return extension has been filed for the most recent calendar year; however, the tax returns from prior years evidence a 15-month history of rental income and expenses from the same source, and (b) IRS Form 1099-K, Payment Card and Third Party Network Transactions, for the most recent calendar year and the YTD gross rental income statement (as described directly above) support the gross rental income and source reported on the tax returns, supporting continued income stability from the same source.
Analysis	When evaluating stability of rental income, the Seller must analyze the length of historical data for the rental income source, amount and expenses. The analysis must include factors such as the potential for fluctuation and associated degree of volatility and/or irregularity within the rental income amount and source, and validation that the income is consistently derived from the same type of source which includes a review of the fair rental days reported on Schedule E, year over year. For example: If the year-over-year review of the fair rental days reported on Schedule E shows a decrease from 350 days (which may be indicative of a lease) to 150 days (potentially indicative of short-term rental income) further analysis would be required to: (i) validate that the income is consistently derived from the same type of source and (ii) support the stability of the rental income source. If a significant degree of volatility or irregularity is present, (e.g., year over year), additional analysis is required and additional documentation may be necessary to determine income stability.

(iii) Net rental income calculation requirementsThe following chart contains requirements pertaining to net rental income calculation.

Net rental income
Rental income source	Calculation requirements
Lease	75% of the gross monthly rent or gross monthly market rent. The 25% adjustment is made to compensate for vacancies, operating and maintenance costs and any other unexpected expenses.
Forms 72 or 1000
Schedule E	The net rental income for each individual property is determined based on the history of income and expenses reported on Schedule E. Calculate the net rental income from Schedule E using Form 92, Net Rental Income Calculations – Schedule E, or a similar alternative form, as follows: Rents received - Less total expenses Add back the following expenses: + Insurance + Mortgage interest paid to banks, etc. + Taxes (real estate taxes only) + Depreciation and/or depletion + Homeowners association dues (if specifically reported as an expense) + One time losses (e.g., casualty loss due to documented catastrophic event); Result: Net rental income (calculated to a monthly amount) When calculating the net rental income for each individual property, the following expenses reported on Schedule E (and noted above) can only be added back if they are included in the payment amount being used to establish the debt payment-to-income ratio for that property: insurance, mortgage interest paid to banks, real estate taxes, homeowners association dues.

(d) Establishing the debt payment-to-income ratioThe following chart contains requirements pertaining to establishing the debt payment-to-income ("DTI") ratio.

DTI ratio using net rental income
Subject	Requirements
Net rental income amount and usage	When establishing the DTI ratio, refer to Section 5306.1(c)(iii) for the net rental income calculation requirements. Refer to Section 5306.1(c) for additional requirements about rental property management experience and maximum amount of eligible net rental income.
Subject 2- to 4-unit Primary Residence	The monthly housing expense (as described in Section 5401.1) must be added as a liability The net rental income may be added to the stable monthly income
Subject 1- to 4-unit Investment Property	Subtract the monthly payment amount (as described in Section 5401.2(a)(7)) from the net rental income: If the result is positive, add it to the stable monthly income If the result is negative, add it to the monthly liabilities
Rental income from non-subject investment property owned by the Borrower	Subtract the monthly payment amount (as described in Section 5401.2(a)(7)) from the net rental income: If the result is positive, add it to the stable monthly income If the result is negative, add it to the monthly liabilities For multiple non-subject investment properties, apply the calculation above to each property, and: If the combined result is positive, add it to the stable monthly income If the combined result is negative, add it to the monthly liabilities

(e) IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation

Refer to Chapter 5304 for the treatment of all rental real estate income or loss reported on the IRS Form 8825, which reflects all income and expenses for the rental property and the IRS Schedule K-1, which reflects the Borrower's proportionate share of the net rental income or loss. The requirements of Chapter 5304 are applicable regardless of the Borrower's percentage of ownership interest in the partnership or S corporation and regardless of whether the Borrower is personally obligated on the Note.

(f) Data delivery requirements for rental income

Refer to Section 6302.8 for delivery requirements for rental income. Regardless of whether rental income from the subject Investment Property is being used to qualify the Borrower, the Seller must deliver the ULDD Data Point Property Dwelling Unit Eligible Rent Amount for:

Subject 1-unit Investment Property
Each non-owner occupied unit in a 2- to 4-unit Primary Residence
Each unit in a subject 2- to 4-unit Investment Property

(g) Other Guide provisions related to rental incomeRefer to the following Guide provisions for additional information related to the rental income topic:

Guide Provision	Guide Location
Appraisal form rental information	Section 3401.12
Investment Property Mortgages	Section 4201.16
Home Possible® Mortgages	Section 4501.9(a)
General requirements for verifying documents	Section 5102.3
Age of documentation	Section 5102.4
General requirements for all stable monthly income	Section 5301.1
General requirements for documentation used to verify employment and income	Chapter 5302
IRS Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation	Section 5304.1(d)
Monthly housing expense	Section 5401.1
Monthly payment amount	Section 5401.2(a)(7)
Reserves	Section 5501.2
Property Eligibility and Appraisal Requirements	Topic 5600
Property data required for all Mortgages	Section 6302.8