Definition:
A rental offset refers to the process by which a lender reduces a borrower’s mortgage application debt-to-income (DTI) ratio by considering rental income from a property owned by the borrower. The rental income is used to offset the borrower’s mortgage payment obligations, making it easier for them to qualify for a mortgage or obtain a larger loan amount. This is particularly useful for borrowers who own rental properties and rely on rental income to support their financial situation.

How a rental offset works

When you own rental property, the income generated from renting out the property is considered a part of your overall income for mortgage qualification purposes. However, lenders typically calculate your DTI ratio based on your total income and monthly obligations, including the mortgage payments on your rental property.

A rental offset works by reducing the amount of debt (mortgage payments) that lenders factor into your DTI ratio. Essentially, the rental income you earn helps offset the costs of the property’s mortgage, making it easier for you to qualify for a mortgage or refinance.

For example, if you have a rental property with a mortgage payment of $1,000 per month and rental income of $1,200, the rental income can offset the mortgage payment, effectively reducing the debt amount that lenders consider when evaluating your application.

Why the rental offset is important

The rental offset is an important tool for borrowers who:

• Own rental properties: If you generate significant rental income, the offset allows you to include that income in your mortgage application, which can improve your qualifying position.
• Want to reduce their DTI ratio: The rental offset reduces the impact of mortgage payments on your overall DTI ratio, potentially making it easier to qualify for a new mortgage or refinance an existing loan.
• Have multiple properties: If you own multiple rental properties, the rental income from each property can help to offset the debt from those properties, providing a financial buffer to qualify for larger loans.

How the rental offset helps with mortgage qualification

When applying for a mortgage, lenders evaluate your DTI ratio, which is the percentage of your gross monthly income that goes toward paying off debt. A higher DTI ratio can make it more difficult to qualify for a mortgage, as it indicates a higher risk of financial strain. By using rental income to offset the costs of a rental property’s mortgage payment, the rental offset reduces your overall debt obligations, thus lowering your DTI ratio and increasing your chances of qualifying for a loan.

For example:

• If you have a total monthly income of $5,000 and a mortgage payment of $1,200 on your primary residence, your DTI ratio would be 24% ($1,200 / $5,000).
• If you also have a rental property with a mortgage payment of $1,000 and rental income of $1,200, the rental income would be used to offset the $1,000 mortgage payment, meaning the lender only considers the remaining $200 (if any) in your DTI ratio.

This can significantly improve your mortgage qualification, especially if the rental property produces steady rental income.

Who can benefit from a rental offset?

The rental offset is especially useful for:

• Landlords with multiple properties: If you own several rental properties, the income from each can help offset the associated mortgage payments, reducing your overall debt load for qualification purposes.
• Investors: Property investors who buy homes or units to rent them out can use the rental offset to qualify for additional financing or to refinance their existing properties.
• Homebuyers with rental income: If you plan to rent out part of your primary residence (such as a basement suite or separate unit), the rental income can be used to offset your mortgage payments, helping you qualify for a mortgage in the first place.

Rental offset requirements and considerations

While a rental offset can be beneficial, there are certain requirements and considerations:

• Documentation: Lenders will require proof of consistent rental income, such as lease agreements, tax returns, or rent rolls, to verify the rental income. They may also require evidence that the rental property is rented out at market rates.
• Vacancy rates: Some lenders may only allow a partial rental offset if there is a risk that the rental property could be vacant for periods of time, as this would impact the amount of income generated.
• Expense deductions: Lenders may deduct certain property-related expenses from the rental income before applying the rental offset. These could include property management fees, maintenance costs, property taxes, and insurance premiums.
• Loan-to-value (LTV) ratio: The amount of rental income that can be offset may depend on the LTV ratio of the property. Properties with higher LTV ratios may receive less of an offset from rental income.

How to use a rental offset in your mortgage application

To take full advantage of a rental offset, you should:

• Provide complete documentation: Ensure that you provide all necessary documentation to prove your rental income, including tax returns, leases, and property management records.
• Work with a mortgage broker: A mortgage broker can help you navigate the rules and ensure that your rental income is properly included in the mortgage application, helping you qualify for the best possible loan terms.
• Understand lender policies: Different lenders have different rules regarding rental offsets, so it’s important to shop around and choose a lender that offers favourable terms for properties with rental income.

Last modified: November 12, 2024