Commission, Rental Income, and a Debt That Will Not Go Away
Kenji applies for a conventional purchase loan with 10% down. He is salaried at $5,400 per month and has received commission income continuously for four years, earning $30,000 two years ago and $24,000 last year. He owns a condo that he will rent out after closing; a signed 12-month lease shows $1,900 per month in rent, and the condo's PITI is $1,610. The new home's PITI is $2,650. Other monthly obligations are a car payment of $415, a student loan of $150, and a credit card minimum of $120. After closing he will have $9,000 in reserves. Kenji insists his rental should be counted at 100% 'because I have a lease.'
1. Calculate Kenji's qualifying monthly income, and explain how the condo's rent is treated.
Read the worked answer
Qualifying income: $7,650 per month.
- Salary: $5,400 (stable, no gaps)
- Commission: average the two most recent years - ($30,000 + $24,000) / 2 = $27,000; $27,000 / 12 = $2,250
- Commission income has been received for four continuous years with no gap, so it is eligible; the ~20% decline from year one to year two is a flag to mention, and if the decline continues or the current-year figure is materially lower, an underwriter may use the most recent year instead.
- Total: $5,400 + $2,250 = $7,650
Rental income is not counted at 100%. Kenji is converting a departing residence, not buying an investment property. The standard treatment is:
- 75% of gross rent = 0.75 × $1,900 = $1,425
- Less the condo's PITI of $1,610 = –$185 per month
- Because the net is negative, it is added to monthly obligations as a liability, not counted as income.
A lease alone does not entitle the borrower to count the full rent, and it never converts a negative-net rental into positive income.
2. Given the figures, what are Kenji's front-end and back-end ratios, and how should the file be judged?
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Monthly obligations: $3,520
- New PITI: $2,650
- Car: $415
- Student loan: $150
- Credit card minimum: $120
- Departing-residence shortfall: $185
- Total: $3,520
Ratios
- Front-end: $2,650 / $7,650 = 34.6%
- Back-end: $3,520 / $7,650 = 46.0%
Judgment: 46% is above the typical manual underwriting ceiling (36%/45%) and sits inside the range that can be approved only through an automated underwriting recommendation with compensating factors. Here the compensating factors are thin: reserves of $9,000 equal about 3.4 months of the new PITI, and 10% down means mortgage insurance will apply.
This is not a file to characterize as a comfortable approval. The LO should run AUS, disclose the result as a pre-qualification rather than a guarantee, and model alternatives - paying off the $415 car (verify the funds are the borrower's own and documented), or a larger down payment that removes MI. Do not simply tell the borrower he is approved.
3. Kenji proposes to pay off the $120 credit card with a $2,000 gift from a friend and then exclude the card from his debt ratio. How should the MLO respond?
Read the worked answer
Decline both parts of the plan.
- Excluding the account: a card is excluded only if it is actually closed or paid to zero with the borrower's own verified funds and the account is documented as paid. Kenji's card would be paid with borrowed/gifted money, so the obligation to repay that source still exists in substance.
- The gift source: acceptable gift donors for conventional financing are limited to relatives, a fiancé or domestic partner, or a party with a defined interest in the property (for example, the seller or real estate agent). A friend is not an acceptable donor, so the $2,000 must be treated as the borrower's own funds (requiring sourcing) or, more likely, as a loan - which adds a liability rather than removing one.
- Practical answer: Kenji can pay the card from verified own funds and provide the closing statement showing a zero balance, which improves the ratio modestly ($120 / $7,650 ≈ 1.6 percentage points of back-end). Anything else is an undisclosed debt in disguise.
- Documentation: if a friend genuinely transfers funds, the LO must ask about repayment. Undisclosed borrowed funds on the application are a misrepresentation risk, and the LO cannot look the other way to make the DTI work.