Using Rental Income to Qualify

Buying a home with extra bedrooms or an Ohana unit with plans on renting them out is a good way to have tenants help pay your mortgage. Or are you planning on buying a property to be used 100% as a rental? What about a vacation rental condo in one of the many resort areas throughout the state? If this is your plan, you need to understand how underwriting looks at that potential income for these various types of properties. This is not the article to skip over!

When Residing in a Home or Multi-unit Property:
Buying a home to live in with the plan to rent out a portion of the home, has the most restrictive rules on using rental income to help you qualify. While there are some new programs to help moderate income borrowers qualify to buy their home, in general, proposed rental income from a single family home or condo is never considered. Even if the property you are wishing to buy has a detached separate Ohana, the rental income from that dwelling cannot be counted. The reasoning behind it is simple. You are buying a home to live in. In order to qualify, you should be able to qualify without the need to use boarder income to do it. But why not count income from an Ohana? Obviously these tenants don’t live in your house. While it is true these types of tenants do not physically live in your dwelling, an Ohana (attached or detached) is considered part of the main structure. In the world of lending, an Ohana’s bedrooms and baths are lumped into the total room count of the property.

If you are buying a legal 2-4 unit property, rental income from those other units can be used to qualify. I have run into so many problems lately, especially on the neighbor islands of what constitutes a legal 2-unit property versus a main structure with an Ohana. An Ohana is technically considered an accessory unit. Here’s the simple test: Look to see what the zoning classification is for the land. Every parcel in U.S. has zoning regulations that state what the minimum amount of land required is in order to build one home. A very common designation is R-10. “R” designates residential, and the “10” refers to a minimum of 10,000 square feet required for one home. If the lot size is 18,000 square feet, you cannot legally have a 2-unit property. A 2-unit property would require a minimum of 20,000 square feet. While you might have a second structure or dwelling on that property (including a separate electric meter), that second structure is not a legal 2nd unit. You could never subdivide the property and sell off that other unit.

Even agricultural lots have requirements as to the minimum parcel size. I’ve had more than one Real Estate agent tell me “You don’t understand how it is done here on the neighbor islands. It is different than Oahu”. I can tell you definitively that the rules are not different on Oahu versus the Neighbor Islands.

The big confusion on the neighbor islands versus Oahu is numerous. First, Oahu doesn’t have much land available today as agricultural for this issue to arise – along with the small availability of multi-acre parcels. Second, the neighbor islands are notorious on agricultural zoned properties to have structures built with no building permit. Third, the counties do allow on agricultural zoned lots additional living structures. But if you go to the zoning of the lot, it will have some designation such as A-2 or A-5. “A” denotes agricultural, while the digit denotes the minimum acreage allowed to build a residential structure. I recently refinanced an upcountry Maui property on 5 acres that had 3 beautiful detached homes (structures, dwellings) on it. Even though the homes were as far away from each other as possible on that lot, it was not a legal multi-unit property. None of the rental income received by the owner could be used in the refinance transaction.

If you are going to live at the property, unless it is a legal multi-unit property, no rental income will be counted in your mortgage application.

Buying to Use as a Full-time Rental:
This is where the rules seem weird. But if you understand the subtle difference you will comprehend why the rules are different on rental income if you don’t live there.

If you don’t live at the property, and it is used 100% for investment rental purposes, rental income from every structure is considered when applying for a mortgage. Why is this so drastically different than if you live there? The reason is boarder (tenant) rent. If you live there, no boarder rent can be considered. If you don’t live there, all bedrooms and baths are for rent. It doesn’t matter if it is a main structure, an Ohana, detached or attached.

The only type of structure or portion of a home whose rental income cannot be counted are those areas not permitted as bedrooms or permitted at all. That includes enclosed lanais, converted living rooms and dens, converted garages, basements originally permitted for storage, converted storage sheds, and agricultural buildings. I am sure I didn’t list every possible example, but hopefully you can understand that if it wasn’t permitted for people to sleep in, you cannot use rental income derived from it regardless of doing so now.

Buying a Vacation Home or Condo – Personal Use:
Virtually everyone misinterprets the 2nd (Vacation) home rules. Everyone has heard that if you buy a property as a 2nd home, you must spend at least 14 days a year at that property. That is true. What that doesn’t mean is that you are now allowed to rent that place out for the other 50 weeks of the year.

If you are buying a property for your personal use, no matter is it is only for 2 weeks a year, especially in areas like Hawaii where vacation rentals flourish, you are not allowed to rent them out. This also obviously means you cannot use any potential rental income to qualify!

Buying an Investment Home or Condo:
Like in the section above on buying a full-time rental, proposed rental income can be considered, so long as you are buying this property and designating it as an investment. The important fact to understand here is how underwriting determines how much income can be used.

So many places in Hawaii are now purchased not for long-term rental, but those trying to capitalize on the booming vacation short-term market. With sites like VRBO and AirBNB, Hawaii’s once anemic investor home market is now flooded with those seeing that for once, even high-priced Hawaii properties can make money if done so with transient vacation rentals. Banks do not consider the amounts of money one receives through short-term rentals.

If you are considering buying a property to do short-term rentals, even in a condominium-hotel property, the only income banks will consider is long-term rent. That’s a rental period of generally 6-months or longer. In every case I have seen, that results in significantly smaller amounts being used to qualify.

While the rules above are meant to help you better understand how we do, what we do, when considering rental income, there are so many nuances, too numerous to list – unless I were printing pages of underwriting manuals, I could not dive in that deep.

It is best to say that before you decide to buy that property in which you are counting on using rental income to help you qualify, you should talk to an experienced, seasoned, lending professional, with lots of first-hand knowledge of how the potential income for your specific property can or will be used. When deciding on which lender to use, familiarize yourself with the above. Ask lots of questions. If it seems that you now know more than that person on the phone, that’s not the right person to be handling your loan.