Departing Residence: Lease Income With Only 5% Equity
A borrower is purchasing a new primary residence for $540,000 with 95% financing. Gross monthly income is $11,200; other monthly debt is $650; new PITIA is $3,600. She currently owns a home valued at $420,000 with a $399,000 mortgage and PITIA of $2,850. She has signed a 12-month lease at $2,700 per month, collected a $2,700 security deposit, and will move in 10 days before closing. After closing she will have $18,000 in reserves. The loan officer wants to use 75% of the lease income to offset the departing residence PITIA. The title company confirms the current home is a primary residence with no HELOC. The borrower has no other financed properties and no documented relocation package.
1. Can the lease income be used? Compute DTI with and without the rental offset.
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Equity is ($420,000 - $399,000) / $420,000 = 5%. Under common agency guidance, rental income on a departing primary residence may be used only when the borrower has at least 30% equity, absent a documented relocation or lease exception. At 5% equity, the property must be treated as an investment property: include the full $2,850 PITIA and do not offset it with lease income. If the lender incorrectly allowed 75% of the lease, the offset would be $2,700 × 75% = $2,025; net rental = $2,025 - $2,850 = -$825. Total debt = $650 + $3,600 + $825 = $5,075; DTI = $5,075 / $11,200 = 45.3%. Without the offset: $650 + $3,600 + $2,850 = $7,100; DTI = 63.4%. At a 45% maximum, neither structure works, although the offset version is close; at 50%, the offset version would fit but is not permitted without the equity condition.
2. What restructuring or conditions could make the loan work?
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The cleanest cure is to pay down the current mortgage to $294,000, which is 70% of $420,000 and creates the required 30% equity. That requires a $105,000 principal reduction. Alternatively, sell the current home and close concurrently so it is not a departing residence, or add a co-borrower or documented income. With the offset, total debt is $5,075; at a 45% DTI the borrower needs $11,278 per month, only $78 more than the current $11,200, so a small verified income increase or a modest reduction in the new PITIA or other debt could also cure the file. Reserves of $18,000 equal five months of new PITIA and may satisfy a reserve requirement, but reserves do not cure the DTI or the equity condition.
3. How should the lease and security deposit be documented, and does it matter if the tenant is her brother?
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Obtain a fully executed lease, evidence the security deposit cleared the borrower’s account, and support market rent with an appraisal rent schedule or a rental survey. If the tenant is her brother, treat it as a related-party lease: document market rent and actual receipt of rent, and expect the lender to apply a conservative rent figure or discount. A related-party lease does not create the 30% equity the borrower lacks, so the full PITIA would still be counted. A lease alone does not convert a departing residence into an investment property for underwriting purposes when equity is below the threshold.