Last week’s blog we went over the differences for self-employed borrower’s income calculations between FHA and the conventional loan programs from Fannie & Freddie Mac. The article was well received, and we were able to get a good amount of feedback from the “pro-deduction” versus “anti-deduction” camps on why they calculated income using the process they advocated for, so thank you for all the feedback!
Our next widely debated topic is the differences in how FHA rental income calculations are considered. The comparisons below are between total scorecard method and the automated underwriting methods on Fannie/Freddie. While both loan types have manual underwriting rules a majority of the time the loans will be automated, so we will stay in that swim lane today.
Comparing these key points of conventional vs FHA I do find the “extra” items that FHA requires to make a lot of sense. I believe would both agencies rules make great overlays to mitigate risk in a mortgage portfolio. Ok enough chatter let’s dive right in!
Required history of receiving rental income
All three agencies allow a borrower to be a “new” landlord and qualify with rental income either from the subject or other properties. This will change as of 11/28/18 when Freddie Mac will require a minimum one-year rental history within the most recent thirty-six month period (documented by tax returns).
FHA has a big difference here, FHA requires a minimum of 25% equity documented by an appraisal before the borrower can use this “new” rental income if the source of the rental income is the departure residence or “other” property. So yes they allow it but with a large barrier to get in the rental income game.
Subject property income – not on the Schedule E
For this section I like FHA and Freddie rules much better than Fannie rules due to the “extra” that FHA/Freddie require. Here is a quick overview of all three agencies:
FNMA allows use of rental income at 75% of the comparable rent schedule as the starting point
Whether you subject the PITI depends on if the property an investment or primary residence
FHLMC allows use of the rental income using the MOI (monthly operating income) on form 998 as the starting point. Whether you subject the PITI depends on if the property an investment or primary residence
FHA allows you to use the FHLMC method (MOI form 998) or the lessor of 75% reported by the appraiser, or the amount reflected on the lease
Subject property income – on the Schedule E
Here is another big split in the methods used by Fannie/Freddie versus FHA. Here we are dealing with situations where there is income from the subject property when the subject property is on the Schedule E as non-primary residence.
Both Fannie/Freddie follow the same formula of taking the schedule E line 21 and adding back insurance, interest, taxes, depreciation, and (with some extra rules) repairs and items listed as “other”. After this math is complete you turn the annual calculation into a monthly calculation and subtract the current PITI to get your net rental income or loss.
FHA however is a much simpler calculation and follows more along the lines of a “business” thought process. FHA says to take two years of schedule E rental income (Fannie / Freddie only required one year) from line 21 and add back depreciation then divide by 24 months and you have effective income (or the actual number of months the borrower owned the property less than 24 use the “lessor” number). There is no extra step of subtracting the PITI here, so the income or loss is just basically one adjustment and use line 21!
This is one area I see many underwriters use the conventional method on FHA loan. I have not really had a uniformed answer to why though. I often get comments on how the FHA method I described is wrong. Yet when I point them to 4000.1 Section II A. 4 pages 214-218 and ask them to go over the guidelines with me to see their point of view, the answer is “that is how Fannie Mae Does it”. My only response is “we agree, but underwriters should not apply Fannie Mae guidelines to FHA loans”.
Departure Residence Rental Income
I hesitated to add this section to the blog since Fannie and Freddie retired departure residence rules in the last few years, but since FHA does have guidance I will make a quick mention. Pretty easy here, Fannie and Freddie don’t use departure residence rules any more, you just follow the rules we went over when the property is not on the schedule E (lease x 75% minus PITI (Fannie) and form 998 MOI minus PITI (Freddie).
FHA first requires that the borrowers move 100 miles away from the departure residence and show evidence of 25% equity in the departure residence (25% only applies to “new” landlords). In addition, provide a copy of the lease, and evidence the borrower received the “first and security payments” from the new tenant.
Ok that about wraps it up for rental income, as a reminder our income analysis software will be fully aligned with these FHA topics on April 21st. Are you looking for an income analysis tool that will help you keep properly calculate income for Fannie Mae / Freddie Mac / FHA / VA (coming soon) / USDA (coming soon)?
We invite you to check out UberWriter (www.uber-writer.com) ,where we are excited to announce our three new pricing tiers effective April 16th! Good news is we now have a tier that is “free for life”. Check back with us on April 16th to learn more.
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