Definition:
A rental add-back refers to a financial adjustment made when calculating a borrower’s income for mortgage qualification purposes. Specifically, it allows lenders to add back rental income or certain property expenses that are deducted from a borrower’s income on their tax returns. The rental add-back can help increase a borrower’s qualifying income, making it easier to qualify for a mortgage or a larger loan.

How a rental add-back works

When applying for a mortgage, lenders often look at a borrower’s total income to determine their ability to repay the loan. If the borrower owns rental properties, the rental income they earn is typically considered part of their overall income. However, there are often deductions that reduce this income, such as expenses for property management, repairs, and maintenance.

The rental add-back adjusts for these deductions, effectively increasing the borrower’s income by “adding back” some or all of the expenses deducted on tax returns. This can be particularly useful when a borrower’s rental income is not accurately represented due to these expenses.

Why the rental add-back is important

The rental add-back is important because it can:

• Increase qualifying income: By adding back rental expenses that are deducted from taxable income, the rental add-back can improve a borrower’s financial profile and help them qualify for a mortgage.
• Help landlords qualify for larger mortgages: For individuals who own rental properties, a rental add-back can make it easier to qualify for loans, especially if the borrower’s primary income is not sufficient to meet the mortgage qualifications.
• Simplify the application process: By factoring in the rental add-back, the lender can more accurately assess the borrower’s ability to repay the mortgage based on their actual financial situation.

How to calculate the rental add-back

The rental add-back is typically calculated by adding back certain expenses that are deducted from rental income on a borrower’s tax return. These may include:

• Property management fees: If the borrower pays a third-party company to manage the rental property, those fees are often deducted from rental income. A rental add-back will add those fees back to the borrower’s qualifying income.
• Maintenance and repair costs: Expenses related to property maintenance and repairs are often deducted, but these can be added back to increase the borrower’s income.
• Depreciation: Depreciation is a non-cash expense often deducted from rental income for tax purposes. Lenders may add back a portion of this depreciation to increase the borrower’s qualifying income.
• Mortgage interest: If the borrower’s rental property is financed, the mortgage interest is deducted. A rental add-back may add back a portion of this expense.

The exact calculation will depend on the lender’s policies and the specific tax deductions the borrower has claimed. Lenders may adjust for different types of expenses to ensure the borrower’s true income potential is considered.

Benefits of the rental add-back

The rental add-back can be beneficial for several reasons:

• Improved eligibility: If rental income is essential to a borrower’s overall financial situation, the rental add-back can improve the chances of mortgage approval by reflecting a higher income.
• More favorable loan terms: With an improved financial profile, borrowers may qualify for better mortgage terms, such as lower interest rates or higher loan amounts.
• Increased flexibility: Landlords who rely on rental income to support their mortgage applications can use the rental add-back to strengthen their financial standing, allowing for more flexibility in securing financing.

Considerations when using the rental add-back

While the rental add-back can be advantageous, there are some factors to consider:

• Lender policies: Not all lenders allow the rental add-back, and the rules for qualifying may vary between financial institutions. It’s important to understand a lender’s specific guidelines before relying on the rental add-back.
• Verification of rental income: Lenders will typically require documentation to verify rental income, such as lease agreements, tax returns, and proof of property ownership. Without this verification, the rental add-back may not be applied.
• Limits on add-backs: Lenders may only allow a partial add-back for certain expenses or may require specific documentation to justify the add-back. It’s essential to work with a mortgage broker or lender who understands how to navigate these rules.

Who can benefit from a rental add-back?

A rental add-back can benefit:

• Landlords with multiple properties: If you own rental properties and have substantial property management or repair expenses, a rental add-back can help you qualify for a mortgage by increasing your qualifying income.
• Self-employed individuals: Self-employed borrowers who own rental properties may benefit from the rental add-back if rental income is a significant part of their overall income.
• First-time homebuyers with rental properties: Even if you’re a first-time homebuyer, the rental add-back can make it easier to secure financing for a home purchase or investment property.

How to use a rental add-back in your mortgage application

To make use of the rental add-back, you will typically need to:

• Provide accurate tax documents: Ensure that your tax returns and other supporting documents accurately reflect your rental income and expenses.
• Work with your lender: Speak with your lender or mortgage broker to confirm that they allow the rental add-back and to understand the specific requirements for using it in your application.
• Gather documentation: Be prepared to submit additional documentation, such as leases, rent rolls, or property management agreements, to verify your rental income.

Last modified: November 12, 2024