Ultimate Guide to Debt-To-Income for Real Estate Investors

As a real estate investor, understanding your debt-to-income (DTI) ratio is important for analyzing deals and securing traditional financing for your properties.

While you can always ask your lender to calculate this for you, knowing how it works can give you a significant advantage, especially when you’re planning to acquire multiple properties.

So, what is Debt-to-Income (DTI)?

Your DTI ratio is a key metric that lenders use to assess your ability to manage monthly payments and repay debts.

As an aside, it is also one of the ways that we measure risk in your real estate portfolio.

We’ll dive deep into the world of DTI ratios. You’ll learn how to calculate it, what factors influence it, and most importantly, how to optimize it for your real estate investments.

Whether you’re a seasoned investor or just starting out, mastering this concept can make a substantial difference in your ability to secure favorable financing terms and grow your real estate portfolio.

Front-End vs Back-End

There are two variations of Debt-To-Income ratios: Front-End DTI and Back-End DTI.

  • Front-End Debt-To-Income Ratio – This ratio focuses solely on your housing-related expenses. It includes your monthly mortgage payment (principal and interest), property taxes, homeowners association fees, homeowner’s insurance, and monthly private mortgage insurance (often abbreviated as PITIHP).
  • Back-End Debt-To-Income Ratio – This ratio is more comprehensive. It includes all your minimum monthly debts, including your housing expenses. This means it covers everything in the Front-End DTI plus other debts like car loans, student loans, credit card minimums, and any other regular monthly obligations.

The main difference? Front-End DTI gives you a snapshot of how much of your income goes towards housing, while Back-End DTI provides a more complete picture of your overall debt obligations.

As a real estate investor, you’ll want to pay close attention to both ratios, but most lenders will focus primarily on your Back-End DTI when evaluating your loan application. This is because it gives them a more comprehensive view of your financial commitments.

Debt-To-Income Ratio

Your Debt-To-Income (DTI) ratio is calculated by dividing your total monthly debt payments by your gross monthly income.

DTI = (Total Monthly Debt Payments / Gross Monthly Income) x 100

A lower DTI ratio shows that you have more of your income available after paying debts. Lenders see this as a sign that you can handle new debt responsibly.

With a lower DTI, you’re considered less risky, so lenders are more likely to offer you better loan terms. This can include lower interest rates, lower down payments, or even more flexible loan terms.

Your DTI ratio important because even a small reduction in your interest rate can save you thousands over the life of a loan. Additionally, lower payments make it easier for your property to generate positive cash flow. This is one of the reasons we’re discussing it as part of deal analysis.

A low DTI gives you an advantage when expanding your portfolio, as it shows you can handle the debt from multiple properties. This can be a limitation—especially if you’re acquiring properties with little or no down payments where cash flow can be tighter.

Understanding and improving your DTI can help you avoid this limitation and qualify for loans even in these situations.

What To Include/Exclude in DTI?

When calculating your DTI for real estate investing, you’ll need to understand what should and shouldn’t be included.

Here’s what you should include in your DTI calculation:

  • Monthly Mortgage Payments – This includes payments for your primary residence and—with some important caveats—the investment properties you own. We will talk about how we deal with investment property mortgages in just a bit.
  • Escrowed Expenses – Real estate taxes, homeowner’s insurance, and private mortgage insurance (if applicable) are typically included.
  • Vehicle Loans – Your monthly car payments should be factored into your DTI.
  • Student Loans – Even if they’re in deferment, lenders often include a percentage of the outstanding balance in your DTI.
  • Credit Card Payments – The minimum monthly payment on your credit cards should be included.
  • Other Regular Debts – This includes timeshare payments, personal loans, and any co-signed loan payments you’re responsible for.
  • Child Support and Alimony – If you’re required to make these payments, they should be included in your DTI calculation.

Now, let’s look at what you should exclude from your DTI calculation:

  • Utility Bills – Your regular monthly utilities like water, electricity, gas, and garbage are not included in DTI calculations.
  • Insurance Premiums – Car insurance, health insurance, and life insurance premiums are typically not included.
  • Discretionary Expenses – Things like cable bills, cell phone bills, groceries, and entertainment expenses are not part of your DTI.

Debt-To-Income Is Not…

When calculating your debt-to-income (DTI) ratio, there are a few common misconceptions about what affects this number.

It helps to understand what does and doesn’t factor into your DTI, especially when preparing for real estate investments.

Here are some key points to keep in mind:

  • Not Impacted by How Much Money You Have – Your DTI only looks at your monthly debt payments compared to your gross monthly income. Having substantial savings or investments won’t lower your DTI unless you use that money to pay off debt.
  • Living Off Investments Doesn’t Count – If you’re relying on investments to cover your expenses, it won’t directly reduce your DTI unless you can demonstrate a regular, documented income stream from those investments.
  • Not Impacted by Your Credit Score – While your credit score itself doesn’t affect your DTI, it can influence the interest rates on your debts. Higher interest rates lead to higher monthly payments, which can increase your DTI.
  • Not Affected by Non-Mortgage Debts Paid Off Early – Paying off installment loans (such as car loans) early can reduce your monthly payments and improve your DTI. However, simply reducing balances won’t lower your DTI unless the minimum payment obligation decreases or goes away completely. This is the same issue we run into with paying off mortgages early… you don’t see any benefit in your cash flow with amortizing loans until the entire loan balance is paid off.
  • Future Rental Income Can Be Counted with Documentation – Lenders may consider future rental income from properties you plan to purchase, but you need to provide documentation, such as a signed lease or an appraiser’s rent schedule (Form 1007). Typically, lenders will include only 75% of the projected rental income to account for potential vacancies and expenses. This is important especially for Nomads™ who are converting their previous owner-occupant property to a rental and using the income from the new tenant to help them qualify to buy their next owner-occupant property.
  • Not Impacted by Tax Deductions – DTI is calculated based on your gross income, before taxes or deductions. Even if you have significant tax write-offs from your properties, this won’t reduce your DTI because the calculation doesn’t consider after-tax income.
  • Income is Averaged Over Time – Lenders often use an average of your income from the past two years to calculate your DTI. If your income has increased recently, it may not immediately lower your DTI because the lender will likely average your past earnings to assess stability.

But Wait…

When calculating your debt-to-income (DTI) ratio, you might encounter some unusual or tricky situations. Let’s explore a few common questions about DTI and how lenders typically handle them.

Remember, your specific situation may differ slightly, and underwriters might interpret things differently. Always double-check with your lender for the most accurate information about your particular case.

  • I Have a Loan to My Father-In-Law for Bail. Does That Count as a Debt? – Informal debts, like loans to family members, can be tricky. Most loan applications require you to disclose all debts, even informal ones. If there’s a clear repayment agreement, lenders may count it, especially if it impacts your ability to pay other debts.
  • There’s a Medical Bill That I’m Not Responsible For. Does That Count as Debt? – If you’re contesting a medical bill, but it still shows up on your credit report, lenders may treat it as a debt until the dispute is resolved. It’s essential to clarify the situation with your lender, but until it’s officially removed, they may include it in your DTI.
  • I Have a “Relationship” With Someone Who Sends Me Money Every Month. Does That Count as Income? – Money received informally, without a documented and stable source (like a job or investment), usually won’t count as income. Lenders need to see reliable, documented income to include it in your DTI. Gifts or informal transfers, even if consistent, don’t qualify.
  • My Mother Lives With Us. Can I Count Her SSD Income? – Social Security Disability (SSD) income can count, but only if your mother is contributing to household expenses. You may need to show proof, like shared bills, to include this in your DTI. Each lender may handle this situation differently, so ask for clarification.
  • I’m Paying Off a Large Credit Card Balance for a Friend. Does That Count as My Debt? – If the credit card account isn’t in your name, it typically won’t count toward your DTI, even if you’re paying it off. Lenders only include debts where you are legally responsible, meaning the cardholder’s name on the account matters.
  • I Have a Loan From My Small Business. Does That Count as Personal Debt? – If the loan is strictly for the business and isn’t personally guaranteed, it usually won’t count toward your personal DTI. However, if you’ve personally guaranteed the loan or your business finances are closely tied to your personal finances (as with many sole proprietorships), it may be included in your DTI.
  • I’m Receiving Child Support Payments. Can That Count as Income? – Yes, child support payments often count as income, but only if they are court-ordered and consistent. You’ll need documentation, like a divorce decree and proof of payment history, for the income to be included in your DTI calculation.
  • What About Student Loans for Myself? – Student loan payments are definitely included in your DTI calculation, even if the loans are deferred. Lenders may still factor in expected payments, so it’s important to know how much you’ll owe once repayments start.
  • What About Student Loans for My Kids? – If you co-signed on student loans for your children, those loan payments will count toward your DTI. Even though the loan benefits your child, your financial responsibility makes it part of your monthly debt obligations.
  • I’m Repaying a Loan From My 401(k). Does That Count as a Debt? – Even though a 401(k) loan is borrowing from yourself, many lenders count the repayment as part of your DTI. This is because the repayment reduces your available income, just like any other debt obligation.

Income for DTI Rules of Thumb

When calculating your debt-to-income (DTI) ratio, lenders use your gross monthly income to determine how much of your income goes toward paying debts.

Here are some general rules of thumb for estimating your gross monthly income based on how you get paid:

  • Weekly Income * 4 = Gross Monthly Income – If you’re paid weekly, multiplying your weekly paycheck by four gives an estimate of your gross monthly income. While this method is commonly used, it slightly underestimates your income since there are 52 weeks in a year. For a more accurate figure, you could multiply by 52 and divide by 12, but most lenders use the simpler method of multiplying by four.
  • Bi-Monthly Income * 2 = Gross Monthly Income – If you’re paid twice a month (on a set schedule, like the 1st and 15th), multiplying your paycheck by two gives an accurate gross monthly income. This is because you receive exactly two paychecks per month.
  • Annual Salary ÷ 12 = Gross Monthly Income – For salaried employees, dividing your total annual salary by 12 is the standard method to find your gross monthly income. This approach works best if your income is consistent each month.

These rules of thumb provide a quick way to estimate your gross monthly income, but it’s always good to verify the method your lender uses, especially if your pay schedule is irregular or if you receive bonuses or commissions. Knowing your accurate gross monthly income helps ensure you have the right expectations when calculating your DTI for loan applications.

Debt-To-Income Ratio from DU’s Evaluation

When lenders use Fannie Mae’s Desktop Underwriter (DU) system to evaluate your loan application, your debt-to-income (DTI) ratio plays a significant role in determining your risk level as a borrower.

The lower your DTI, the more favorably the system will view your application.

  • DU Evaluation – As Fannie Mae explains: “In DU’s evaluation, generally, the lower the borrower’s debt-to-income ratio (DTI ratio), the lower the associated risk. As the ratio increases, the level of risk also tends to increase; and a high ratio will have the greatest adverse impact on the recommendation when there are also other high-risk factors present.” This means that as your DTI climbs, especially if you have other risk factors (like a lower credit score), it can significantly impact your loan approval chances.
  • The Composition of Debt Matters – DU doesn’t just look at the overall DTI number; it also considers the type of debt you carry. Borrowers whose revolving debt (like credit card debt) makes up a smaller portion of their monthly expenses are seen as lower risk. On the other hand, if a large portion of your monthly payments are going toward revolving debt, DU may flag this as a higher risk.
  • Revolving Debt vs. Student Loans – Interestingly, borrowers with student loan debt have been shown to represent less risk than those who have only revolving debt. Student loans are typically seen as more stable and structured, while revolving debt, with its fluctuating balances and higher interest rates, is considered more risky in terms of debt management.

Understanding how DU evaluates your DTI can help you prepare your finances before applying for a mortgage.

By managing your debt composition—such as paying down high-interest revolving debt—you can lower your debt-to-income (DTI) ratio and improve your financial standing. A lower DTI shows lenders that you’re a less risky borrower, which can help you secure better loan terms, like lower interest rates or more flexible repayment options.

It’s a good idea to meet with your lender well before you’re ready to write a contract on a property. This gives you time to get personalized advice on how to improve your DTI and overall financial health.

Many strategies, like paying off debt or improving your credit score, take time to reflect on your credit report. Starting early ensures these improvements are fully accounted for when you’re ready to apply for a mortgage.

Calculating DTI

When analyzing real estate deals, calculating your debt-to-income (DTI) ratio is a straightforward process, but there are a few nuances to keep in mind. We’ll go over some basic examples, but if you’d prefer a more accurate calculation, it’s always a good idea to contact your lender. They can help ensure everything is factored in correctly.

In some cases, lenders may make errors, especially with more complicated files. This is why it’s important to understand how the calculation works and ask questions if the numbers seem off. Lenders might:

  • Leave out income that should be included.
  • Count expenses that shouldn’t be factored into the calculation.
  • Count expenses twice, which can inflate your DTI.

To double-check your numbers, you can find many websites that offer DTI calculators. These tools give you a quick way to estimate your ratio and catch potential discrepancies. While they aren’t a substitute for a lender’s calculation, they’re helpful for preliminary planning.

Basic Example

Let’s walk through a simple debt-to-income (DTI) ratio calculation to better understand how it works when analyzing real estate deals.

Debts:

  • Rent: $1,400/month.
  • Credit Card Payment: $200/month.
  • Car Payment: $400/month.
  • Student Loan: $400/month.
  • Local Mob Affiliate/Gambling Debt: $50/month.

Total Debts: $2,450/month.

Income:

  • Suzy’s Salary: $5,000/month.
  • Jon’s Salary: $4,000/month.
  • Jon’s Side Hustle/“Dance” Income: $500/month.

Total Income: $9,500/month.

To calculate the DTI, you would divide the total monthly debt ($2,450) by the total monthly income ($9,500). This gives a DTI ratio of approximately 25.79%.

This example shows how the DTI ratio provides a snapshot of your financial health. Lenders will use this ratio to assess whether you can manage additional debt, like a mortgage for a real estate investment.

Target Debt-To-Income Ratio

When analyzing real estate deals, it’s important to know the target debt-to-income (DTI) ratios for different loan programs.

Each type of loan has its own DTI limits, which can influence your loan approval and terms.

  • USDA Loans – The ideal DTI for USDA loans is 41% or less, but in some cases, it can go up to 44% with compensating factors like strong credit or extra cash reserves.
  • Conventional Financing – Conventional loans prefer a DTI of 36% or lower. However, borrowers with strong credit and adequate reserves may qualify with DTIs up to 50%. See table below for additional information.
  • FHA Loans – FHA loans are more flexible, allowing a DTI of 43% for most borrowers. In special cases, where compensating factors like excellent credit are present, the DTI can be as high as 57-59%.
  • VA Loans – VA loans generally aim for a DTI of 41%, though there’s no strict maximum. Some highly qualified borrowers can be approved with DTIs exceeding 50% if they meet residual income guidelines, which ensure they have enough income left after covering debts.

These guidelines serve as a benchmark for determining the maximum debt you can responsibly manage while still qualifying for your desired loan. Although other factors play a role in loan qualification, maintaining your DTI within the target range for your specific loan type significantly enhances your chances of approval and securing favorable terms.

Grading Debt-To-Income

When analyzing real estate deals, your debt-to-income (DTI) ratio is a key measure of your financial health.

A lower DTI generally signals to lenders that you’re in a strong position to manage additional debt, such as a mortgage.

Here’s a simple way to grade your DTI:

  • As Low as Possible – A lower DTI is always better, as it shows you have plenty of income available after covering your debts.
  • 36% or Less = Amazing – If your DTI is 36% or lower, you’re in an excellent position. Lenders typically see this as ideal and will be more likely to offer favorable loan terms.
  • 37% – 42% = Good – A DTI in this range is still good. You might not get the absolute best terms, but lenders will view you as a relatively low-risk borrower.
  • 43% – 49% = Improve – When your DTI starts to approach 43%, it’s time to be cautious. Many loan programs begin to limit approval at this level, and you may face stricter terms or higher interest rates.
  • 50% or More = Danger – A DTI above 50% is considered high risk by most lenders. At this level, your ability to take on more debt is questionable, and you may struggle to secure financing for real estate investments without taking steps to lower your DTI.

Calculating Max Debt

When planning real estate investment purchases, knowing the maximum amount of debt you can carry while maintaining a specific debt-to-income (DTI) ratio can be helpful. Instead of calculating your DTI from your existing debts and income, you can rearrange the formula to solve for the maximum amount of debt you can support based on your income.

For example, many lenders require a 45% DTI for conventional loans. You can use this ratio to figure out the maximum monthly debt payments you can afford while staying within the lender’s limit.

The formula is simple:

Max Debt Payments = Income x 0.45

Here’s how it works in practice:

  • If your monthly gross income is $10,000, multiply that by 0.45.
  • Max Debt Payments = $10,000 x 0.45 = $4,500.

This means that, based on a 45% DTI, you could support up to $4,500 in total monthly debt payments, including your mortgage, credit card payments, car loans, and any other monthly debts. This calculation helps you set a clear budget for taking on additional debt when planning real estate purchases.

This reverse calculation is useful because it provides an upper limit on how much debt you can reasonably manage based on your income, ensuring you stay within lender requirements while expanding your real estate portfolio.

Remember that your monthly debt payments are a combination of all your other monthly debt payments + any new mortgage debt.

How Do Rentals Affect DTI?

When considering rental properties in your debt-to-income (DTI) calculations, several important questions arise:

  • Does it count as income?
  • Does it count as an expense?
  • Do you add the rent as income and the PITI as expenses?

To address these questions, we’ll refer to Fannie Mae guidelines, as the specifics are crucial for understanding. However, we won’t cover every possible scenario here. It’s important to review the guidelines thoroughly and consult with your lender for a comprehensive understanding of your specific situation.

For detailed information, refer to the Fannie Mae Selling Guide:

https://selling-guide.fanniemae.com

Calculating Monthly Qualifying Rental Income (or Loss) from Fannie Mae Website

The following are Fannie Mae guidelines:

Calculating Monthly Qualifying Rental Income (or Loss)

  1. If the borrower currently owns a principal residence (or has a current housing expense), and has at least a one-year history of receiving rental income or documented property management experience then:
    • There is no restriction on the amount of rental income that can used.
  2. If the borrower currently owns a principal residence (or has a current housing expense), and has less than one-year history of receiving rental income or documented property management experience then:
    • For a principal residence, rental income in an amount not exceeding PITIA of the subject property can be added to the borrower’s gross income, or
    • For an investment property, rental income can only be used to offset the PITIA of the subject property.
  3. If the borrower does not own a principal residence, and does not have a current housing expense then:
    • rental income from the subject property cannot be used.

To determine the amount of rental income from the subject property that can be used for qualifying purposes when the borrower is purchasing or refinancing a two- to four-unit principal residence or one- to four-unit investment property, the lender must consider the following:

Let’s summarize what’s going on above.

For the first one, if you’re an experienced landlord you can use the rental income to help you qualify without limits.

For the second one, if you don’t have a year of experience as a property manager you are limited in the rental income you can use for your DTI calculation. It can only count as income up to the Principal, Interest, Taxes, Insurance and HOA of the property you’re buying as an owner-occupant (think Nomad™ since that’s an owner-occupant property). Or, if can only be used to offset the expenses on the rental property of Principal, Interest, Taxes, Insurance and HOA.

For the third one if you don’t have a principal residence or you’re not paying rent somewhere (have a housing expense of some type) then you can’t use the rental income from the property you’re buying at all.

Establishing History of Property Management

You may be wondering, how do I establish a history of property management so I can get the advantages of calculating DTI in Fannie Mae’s guidelines.

Glad you asked. Here are Fannie Mae guidelines for that:

  • The lender must establish a history of property management experience by obtaining one of the following:
    • The borrower’s most recent signed federal income tax return, including Schedules 1 and E. Schedule E should reflect rental income received for any property and Fair Rental Days of 365;
    • If the property has been owned for at least one year, but there are less than 365 Fair Rental Days on Schedule E, a current signed lease agreement may be used to supplement the federal income tax return; or
    • A current signed lease may be used to supplement a federal income tax return if the property was out of service for any time period in the prior year. Schedule E must support this by reflecting a reduced number of days in use and related repair costs. Form 1007 or Form 1025 must support the income reflected on the lease.
  • The lender must document the borrower has at least a one-year history of receiving rental income in accordance with Documenting Rental Income From Property Other Than the Subject Property.

So, you either need to have it on your tax return, or have a current signed lease if it is less than a full year on your tax returns.

And, the lender will need to document that you’ve been receiving rental income according to Documenting Rental Income From Property Other Than the Subject Property.

What’s that? That’s what we will cover next.

Documenting Rental Income from Property Other Than the Subject Property

Here’s the Fannie Mae guidelines:

“When the borrower owns property – other than the subject property – that is rented, the lender must document the monthly gross (and net) rental income with the borrower’s most recent signed federal income tax return that includes Schedule 1 and Schedule E. Copies of the current lease agreement(s) may be substituted if the borrower can document a qualifying exception. See Reconciling Partial or No Rental History on Tax Returns below.”

That’s how the lender will document your rental income.

What if you only have partial or no rental history on your tax returns to document the rental income?

That’s next.

Reconciling Partial or No Rental History on Tax Returns

Here’s the Fannie Mae guidelines for that:

  • In order for the lender to determine qualifying rental income, the lender must determine whether or not the rental property was in service for the entire tax year or only a portion of the year. In some situations, the lender’s analysis may determine that using alternative rental income calculations or using lease agreements to calculate income are more appropriate methods for calculating the qualifying income from rental properties. This policy may be applied to refinances of a subject rental property or to other rental properties owned by the borrower.
  • If the borrower is able to document (per the table below) that the rental property was not in service the previous tax year, or was in service for only a portion of the previous tax year, the lender may determine qualifying rental income by using
    • Schedule E income and expenses, and annualizing the income (or loss) calculation; or
    • fully executed lease agreement(s) to determine the gross rental income to be used in the net rental income (or loss) calculation.
  • If the borrower is converting a principal residence to an investment property, see B3-6-06, Qualifying Impact of Other Real Estate Owned, for guidance in using that rental income to qualify the borrower.

Qualifying Impact of Other Real Estate Owned

And, here’s what it says about that from Fannie Mae’s guidelines:

  • If the property was acquired during or subsequent to the most recent tax filing year, the lender must confirm the purchase date using the settlement statement or other documentation.
    • If acquired during the year, Schedule E (Fair Rental Days) must confirm a partial year rental income and expenses (depending on when the unit was in service as a rental).
    • If acquired after the last tax filing year, Schedule E will not reflect rental income or expenses for this property.
  • If the rental property was out of service for an extended period,
    • Schedule E will reflect the costs for renovation or rehabilitation as repair expenses. Additional documentation may be required to ensure that the expenses support a significant renovation that supports the amount of time that the rental property was out of service.
    • Schedule E (Fair Rental Days) will confirm the number of days that the rental unit was in service, which must support the unit being out of service for all or a portion of the year.
  • If the lender determines that some other situation warrants an exception to use a lease agreement,
    • The lender must provide an explanation and justification in the loan file.

For Nomads™, you’re likely going to need a lease agreement and have the lender to provide an explanation and justification in the loan file for the third option.

  • When the borrower owns mortgaged real estate, the status of the property determines how the existing property’s PITIA must be considered in qualifying for the new mortgage transaction. If the mortgaged property owned by the borrower is
    • an existing investment property or a current principal residence converting to investment use, the borrower must be qualified in accordance with, but not limited to, the policies in topics B3-3.1-08, Rental IncomeB3-4.1-01, Minimum Reserve Requirements, and, if applicable B2-2-03, Multiple Financed Properties for the Same Borrower;
    • an existing second home or a current principal residence converting to a second home, the PITIA of the second home must also be counted as part of the borrower’s recurring monthly debt obligations; or
    • the borrower’s current principal residence that is pending sale but will not close (with title transfer to the new owner) prior to the subject transaction, the lender must comply with the policies in this topic.
  • In conjunction with the policies in this topic, the lender must also comply with the policies in B2-2-03, Multiple Financed Properties for the Same BorrowerB3-3.1-08, Rental Income, and B3-4.1-01, Minimum Reserve Requirements, as applicable.

Method of Calculating the Income

How does Fannie Mae calculate the income that you can use to qualify for the loan? Here’s there guidelines:

  • The method for calculating rental income (or loss) for qualifying purposes is dependent upon the documentation that is being used.
  • Federal Income Tax Returns, Schedule E. When Schedule E is used to calculate qualifying rental income, the lender must add back any listed depreciation, interest, homeowners’ association dues, taxes, or insurance expenses to the borrower’s cash flow. Non-recurring property expenses may be added back, if documented accordingly.
  • If the property was in service
    • for the entire tax year, the rental income must be averaged over 12 months; or
    • for less than the full year, the rental income must be averaged over the number of months that the borrower used the property as a rental unit.
  • See Treatment of the Income (or Loss) below for further instructions.

Lease Agreements or Form 1007 or Form 1025

Does Fannie Mae use all the income from the rental properties? No.

Here are their guidelines:

  • When current lease agreements or market rents reported on Form 1007 or Form 1025 are used, the lender must calculate the rental income by multiplying the gross monthly rent(s) by 75%. (This is referred to as “Monthly Market Rent” on the Form 1007.) The remaining 25% of the gross rent will be absorbed by vacancy losses and ongoing maintenance expenses.
  • See Treatment of the Income (or Loss) below for further instructions.

So, you’re only counting 75% of the gross rents coming in to use for qualifying based on DTI.

Treatment of the Income (or Loss)

Fannie Mae’s treatment of rental income or loss varies based on whether the property is your principal residence (such as a duplex, triplex, or fourplex where you live and rent out other units, or have roommates) or an investment property.

Here are the guidelines:

  • The amount of monthly qualifying rental income (or loss) that is considered as part of the borrower’s total monthly income (or loss) — and its treatment in the calculation of the borrower’s total debt-to-income ratio — varies depending on whether the borrower occupies the rental property as his or her principal residence.
  • If the rental income relates to the borrower’s principal residence:
    • The monthly qualifying rental income (as defined above) must be added to the borrower’s total monthly income. (The income is not netted against the PITIA of the property.)
    • The full amount of the mortgage payment (PITIA) must be included in the borrower’s total monthly obligations when calculating the debt-to-income ratio.
  • If the rental income (or loss) relates to a property other than the borrower’s principal residence:
    • If the monthly qualifying rental income (as defined above) minus the full PITIA is positive, it must be added to the borrower’s total monthly income.
    • If the monthly qualifying rental income minus PITIA is negative, the monthly net rental loss must be added to the borrower’s total monthly obligations.
    • The full PITIA for the rental property is factored into the amount of the net rental income (or loss); therefore, it should not be counted as a monthly obligation.
    • The full monthly payment for the borrower’s principal residence (full PITIA or monthly rent) must be counted as a monthly obligation.

This is super interesting.

If it is your primary residence like a duplex, triplex or fourplex or if you have roommates, then you take the income you’re receiving and that counts in the income portion of the calculation. Then, you include the full debt from the property in your debts.

However, if this is an investment property that you’re not living in, the calculation is different.

75% of Gross Rent – PITIA

To accurately assess rental income for qualifying purposes, lenders typically use 75% of the gross rental income to account for potential vacancies and other operating costs. This portion of the rental income is compared against the PITIA (Principal, Interest, Taxes, Insurance, and Association dues) for the property.

Here’s how it is calculated step-by-step:

  1. Determine the Gross Rent: First, you start with the total monthly rent you collect from each rental property. For example, if your gross rent is $2,000, this is the starting point.
  2. Apply the 75% Rule: Lenders assume that 25% of your gross rent will be used to cover vacancies and operational expenses. Multiply the gross rent by 0.75 to calculate the amount of rental income you can use:
    • $2,000 × 0.75 = $1,500.
  3. Subtract the PITIA: Now, subtract the full PITIA (your total monthly payment for the property, including mortgage principal and interest, taxes, insurance, and any HOA dues). For example, if your PITIA is $1,200:
    • $1,500 (qualifying rent) − $1,200 (PITIA) = $300.
  4. Positive Cash Flow: In this case, the remaining amount, $300, is positive, meaning this property is producing positive cash flow. This positive amount will be added to your monthly income when calculating your debt-to-income (DTI) ratio.
  5. Negative Cash Flow: If the qualifying rent is less than the PITIA, the result will be a negative cash flow. For example, if the PITIA was $1,600, the difference would be:
    • $1,500 − $1,600 = -$100.
    • In this case, the $100 would be added as a debt obligation, increasing your DTI ratio.

That means:

  • Positive cash flow from rental properties not used as your primary residence is added to your income, improving your DTI.
  • Negative cash flow from these properties is treated as debt, potentially reducing your borrowing power.

Why am I making a big deal out of this? Well, as it turns out, whether it goes in the top or the bottom has a pretty significant impact on your DTI.

It’s also important to note that this calculation must be done for each individual rental property you own. Lenders assess cash flow on a property-by-property basis rather than aggregating all rental properties into a single figure.

Example: 75% of Gross Rent – PITIA

Let’s explore how a simple $50 change in cash flow impacts your debt-to-income (DTI) ratio, either as positive income or an added debt. The placement of that $50 makes a noticeable difference in your DTI.

Example 1: +$50/month Rental (Positive Cash Flow)

In this example, you have $50 in positive cash flow from your rental property after applying the 75% rule for gross rent minus PITIA:

  • With positive cash flow:
    • Total debts: $2,450
    • Total income: $9,500 + $50 = $9,550
    • DTI = $2,450 ÷ $9,550 = 25.65%
  • Without rental income:
    • DTI = $2,450 ÷ $9,500 = 25.79%

Adding just $50 of positive cash flow reduces your DTI from 25.79% to 25.65%. While it may seem minor (0.14 points), this improvement can accumulate across multiple properties, enhancing your ability to qualify for additional financing.

It is a small improvement because the income was already large at $9,500 per month so $50 more per month doesn’t move the needle much. If you had a smaller income, it would have a larger impact.

Example 2: -$50/month Rental (Negative Cash Flow)

Now, consider negative cash flow of $50, where the rental income doesn’t cover the full PITIA:

  • With negative cash flow:
    • Total debts: $2,450 + $50 = $2,500
    • Total income: $9,500
    • DTI = $2,500 ÷ $9,500 = 26.32%
  • Without rental income:
    • DTI = $2,450 ÷ $9,500 = 25.79%

Adding $50 in debt increases your DTI from 25.79% to 26.32%, a more significant jump of 0.53 points.

This can have a much bigger impact on your borrowing capacity, especially if multiple properties produce negative cash flow.

It is a larger impact because your debts were relatively small and a $50 negative cash flow is a more significant increase in the amount of debt.

A small difference, like $50, can shift your DTI noticeably depending on whether it’s added as extra income or as debt.

Positive cash flow boosts your income and lowers your DTI, improving your eligibility for loans.

Negative cash flow, however, increases your debt and raises your DTI, potentially limiting how much you can borrow or resulting in higher interest rates. Managing this balance across properties is key to optimizing your investment strategy.

Maximum DTI Ratios

Back to Fannie Mae guidelines:

  • For manually underwritten loans, Fannie Mae’s maximum total DTI ratio is 36% of the borrower’s stable monthly income. The maximum can be exceeded up to 45% if the borrower meets the credit score and reserve requirements reflected in the Eligibility Matrix.
  • For loan casefiles underwritten through DU, the maximum allowable DTI ratio is 50%.
  • See B3-1-01, Comprehensive Risk Assessment for information about the DTI.

Exceptions to the Maximum DTI Ratio

There are exceptions to the maximum DTI ratio the lender can use. Here is the Fannie Mae guidelines explaining some of the exceptions:

Fannie Mae makes exceptions to the maximum allowable DTI ratios for particular mortgage transactions, including:

  • cash-out refinance transactions — the maximum ratio may be lower for loan casefiles underwritten through DU (see B2-1.3-03, Cash-Out Refinance Transactions);
  • high LTV refinance transactions — except for loans underwritten under the Alternative Qualification Path, there are no maximum DTI ratio requirements (see B5-7-01, High LTV Refinance Loan and Borrower Eligibility);
  • borrowers who do not have a credit score — the maximum ratio may be lower for manually underwritten loans and DU loan casefiles (see B3-5.4-01, Eligibility Requirements for Loans with Nontraditional Credit);
  • non-occupant borrowers — the maximum ratio is lower than 45% for the occupying borrower for manually underwritten loans (see B2-2-04, Guarantors, Co-Signers, or Non-Occupant Borrowers on the Subject Transaction); and
  • government mortgage loans — lenders must follow the requirements for the respective government agency.

Monthly Housing Expense

We’ve been talking about PITIA during our discussion of DTI and how it is calculated.

Just in case you wanted to know exactly what is and is not included in PITIA according to Fannie Mae, here are the guidelines for that:

  • Monthly housing expense is the sum of the following and is referred to as PITIA for the subject property:
    • principal and interest (P&I);
    • property, flood, and mortgage insurance premiums (as applicable);
    • real estate taxes;
    • ground rent;
    • special assessments;
    • any owners’ association dues (including utility charges that are attributable to the common areas, but excluding any utility charges that apply to the individual unit);
    • any monthly co-op corporation fee (less the pro rata share of the master utility charges for servicing individual units that is attributable to the borrower’s unit);
    • any subordinate financing payments on mortgages secured by the subject property.
  • Note: The monthly payment of a subordinate lien associated with a business debt secured by the subject property can be excluded from the monthly housing expense if it meets the requirements of Business Debt in the Borrower’s Name in B3-6-05, Monthly Debt Obligations.
  • Lenders must enter all components of the monthly housing expense on the loan application including subordinate financing P&I, homeowner’s insurance, supplemental property insurance, real estate taxes, mortgage insurance, association/project dues, and other proposed housing expenses.
  • If the subject mortgage is secured by the borrower’s principal residence, the monthly housing expense is based on the qualifying payment required in accordance with B3-6-04, Qualifying Payment Requirements. This amount is the monthly housing expense used to calculate the debt-to-income (DTI) ratio.
  • If the subject mortgage is secured by a second home or an investment property, the qualifying payment amount is considered one of the borrower’s monthly debt obligations when calculating the DTI ratio.

Calculating Monthly Real Estate Tax Payment

How does Fannie Mae calculate your monthly real estate tax payment? Here are the guidelines for that:

  • The lender must base its calculation of real estate taxes for borrower qualification on no less than the current assessed value. However, the lender must project the real estate taxes if one of the following applies:
  • For purchase and construction-related transactions, the lender must use a reasonable estimate of the real estate taxes based on the value of the land and the total of all new and existing improvements. This policy also applies to properties in jurisdictions where a transfer of ownership typically results in a reassessment or revaluation of the property and a corresponding increase in the amount of taxes.
  • There is a tax abatement on the subject property that will last for no less than 5 years from the note date. For example:
    • for a municipality with a 10-year abatement, the lender may qualify the borrower with the reduced tax amount;
    • for a municipality with a 10-year abatement and with annual real estate tax increases in years 1 through 10, the lender must qualify the borrower with the annual taxes that will be required at the end of the 5th year after the first mortgage payment date.
  • The lender has the option to project the real estate taxes if the amount of taxes will be reduced based on federal, state, or local jurisdictional requirements. However, the taxes may not be reduced if an appeal to reduce them is only pending and has not been approved.

Calculating Total Monthly Obligation

How does Fannie Mae calculate your total monthly obligation? Here’s the guidelines for that:

The total monthly obligation is the sum of the following:

  • the housing payment for each borrower’s principal residence
    • if the subject loan is the borrower’s principal residence, use the PITIA and qualifying payment amount (see B3-6-03, Monthly Housing Expense for the Subject Property);
    • if there is a non-occupant borrower, use the mortgage payment (including HOA fees and subordinate lien payments) or rental payments (see B3-6-05, Monthly Debt Obligations);
    • if the subject loan is a second home or investment property, use the mortgage payment (including HOA fees and subordinate lien payments) or rental payments (see B3-6-05, Monthly Debt Obligations;
  • the qualifying payment amount if the subject loan is for a second home or investment property (see B3-6-04, Qualifying Payment Requirements);
  • monthly payments on installment debts and other mortgage debts that extend beyond ten months;
  • monthly payments on installment debts and other mortgage debts that extend ten months or less if the payments significantly affect the borrower’s ability to meet credit obligations;
  • monthly payments on revolving debts;
  • monthly payments on lease agreements, regardless of the expiration date of the lease;
  • monthly alimony, child support, or maintenance payments that extend beyond ten months (alimony (but not child support or maintenance) may instead be deducted from income, (see B3-6-05, Monthly Debt Obligations);
  • monthly payments for other recurring monthly obligations; and
  • any net loss from a rental property.

Note: Fannie Mae acknowledges that lenders may sometimes apply a more conservative approach when qualifying borrowers. This is acceptable as long as Fannie Mae’s minimum requirements are met, and lenders consistently apply the same approach to similar loans. For example, a lender might calculate a higher minimum payment on a credit card account than what Fannie Mae requires, which is acceptable as long as the lender consistently applies this calculation to all mortgage applications with revolving debts.

Factors Impacting DTI and Possible Solutions

When analyzing real estate deals, your debt-to-income (DTI) ratio plays a crucial role in determining whether you qualify for financing and the terms you’re offered. Fortunately, there are several factors that impact your DTI, and some practical strategies can help you improve it.

  • Amount Borrowed – The larger the loan, the higher your monthly payments, which increases your DTI. By being selective about the properties you buy or making a larger down payment, you can reduce the loan amount, which lowers your monthly debt obligations and improves your DTI.
  • Private Mortgage Insurance (PMI) – PMI adds to your monthly debt if you put down less than 20%. One way to reduce this is to pre-pay a portion of the PMI upfront or aim to eliminate it by increasing your down payment to 20%, thereby lowering your overall monthly payments.
  • Interest Rate – A higher interest rate increases your monthly mortgage payment, raising your DTI. You can buy down the rate by paying points at closing, which reduces your interest rate and monthly payment, resulting in a better DTI.
  • Term of Loan – Longer loan terms reduce your monthly payments, making your DTI look better. While you might not qualify for a 15-year mortgage because of the higher payments, switching to a 30-year mortgage extends the term and lowers the payment, improving your DTI. You can also look into refinancing or restructuring other debts to extend the repayment period and lower your obligations.
  • Pay Off/Consolidate Other Debt – Paying off or consolidating high-interest credit cards, auto loans, or personal loans can significantly improve your DTI. By reducing or eliminating other debts, you free up more of your income and lower your total debt obligations.
  • Earn More Income – Increasing your income directly helps your DTI. You can boost your earnings by taking on a side job or getting better income from your rental properties by raising rents or improving cash flow through better property management. Every increase in income improves your DTI ratio by lowering the percentage of your income that goes toward debt.

Improving your DTI is not just about reducing debt but also strategically managing how you borrow and increasing your income. By implementing these solutions, you can position yourself for better loan terms and greater financial flexibility as you grow your real estate portfolio.

New DTI Rules of Thumb

When analyzing deals, it’s helpful to understand how debt reduction or income increases can affect your debt-to-income (DTI) ratio.

Now that you understand a lot of the details of how it is calculated, here are some useful rules of thumb.

Reducing Debt vs. Increasing Income

Reducing debt is generally more effective than increasing income when trying to improve your DTI. This is because each dollar of debt reduction has a greater impact on the ratio compared to increasing income.

Here are some examples to show you what I mean.

Maintaining a 45% DTI

To keep your DTI at 45%, you can use the following guidelines:

  • For every $100 you reduce in monthly debt, it’s equivalent to earning $222.22 in additional monthly income. This almost 2:1 ratio shows how reducing debt has a stronger effect on your DTI.
  • For every $100 of income you increase per month, you can support $45 more in debt. This means it takes more income growth to support the same debt reduction.

Maintaining a 36% DTI

If your goal is a 36% DTI, the impact of debt reduction becomes even greater:

  • $100 of debt reduction equals $277.77 in additional income, giving you an almost 3:1 ratio. This shows how powerful paying off debt can be.
  • $100 in additional income allows you to take on $36 more in monthly debt, again with a nearly 3:1 ratio.

Improving Rental Property Cash Flow

It’s helpful to get your rental properties to generate positive or, at least, less-negative cash flow. One rule of thumb is to focus on 75% of gross rents minus PITIA (Principal, Interest, Taxes, Insurance, and Association dues).

Ensuring positive cash flow can improve your DTI by adding income rather than debt.

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