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Rental Income Refused

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Posted On: 04/28/2010

QUESTION:

I own a property with 75 percent equity, I have an 800-plus credit rating with all three bureaus, and yet my lender will not allow me to use any rental income unless it’s documented with two years of Schedule E tax forms. Is this rule applied at a lender’s discretion, or is it a permanent industry-wide rule going forward?

ANSWER:

Most likely the party making the loan is not actually a “lender” but is instead a loan originator, such as a mortgage broker selling a loan. That mortgage must conform to the underwriting standards created by the actual lender – the party putting up the cash. Standards can vary but when financing rental property a requirement to see tax returns is entirely common.

Once the loan originator has your returns, 75 percent of any claimed rental revenue will be added to your income for qualifying purposes. What about the other 25 percent? Lenders won’t count all the rental money because they want a 25 percent cushion for vacancies and repairs.

When looking at your tax returns lenders will also “add back” depreciation as an addition to your income. This happens because depreciation is an accounting fiction and not an actual cash reduction. Lenders, of course, can only add back depreciation that’s been claimed with a tax form.

By getting tax returns lenders are making sure that rental income actually exists – and that taxes have been paid. They’re also assembling documentation in case the loan is audited by a mortgage buyer or goes into default.

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It’s possible for mortgage originators to insist on additional requirements above those demanded by the actual lender, a process called layering. Layering is increasingly common because loan originators want to make sure the mortgage meets all underwriting criteria so that if something goes wrong in the future they’re not required to buy back the loans. That’s the liability originators can face when mortgages are not properly underwritten.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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