Author Topic: Debt to income question  (Read 2505 times)

dhlogic

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Debt to income question
« on: March 09, 2016, 03:16:03 PM »
Hello,

I've been reading about real estate investments for a little while now and am planning to get into long term rental properties. I generally understand how things work, but have a theoretical question on what to do next in the situation presented here.

I'll make some very simple assumptions to get to the crux of my issue: all properties cost and rent the same, single individual making $4000 gross a month from whatever job they have, with no recurring debt outside of the rentals, buying ~$80k SFR properties in the Midwest and putting 20% down. $305 mortgage/interest, $250 taxes, $80 insurance and rent for $950 after accounting for vacancies. With the 1% rule, these all come out to ~1.2%. The rental income will also be counted as income by the lender for DTI ratio purposes.

What happens when you reach this situation?

Code: [Select]
Income Expense
4000 0
950 635
950 635
950 635
950 635
950 635
950 635
DTI
9700 3810 0.39

You will pretty much hit the wall and will not be approved for any more mortgages with that kind of DTI ratio. What's the game plan at this point?

Tremeroy

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Re: Debt to income question
« Reply #1 on: March 09, 2016, 03:37:02 PM »
If you're reaching a point where you have a portfolio of properties, you should be able to find a lender that will evaluate your future investments more  as a real-estate investor than as an individual. Those types of loans are more business-like and have different terms than consumer mortgages (short terms, higher interest rates, etc.). In my opinion, you'd do well to talk to a few small business bankers to get a sense of when you'd need to start looking into business financing & how their respective banks would evaluate you.

Lmoot

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Re: Debt to income question
« Reply #2 on: March 12, 2016, 01:39:39 PM »
 First consider that many lenders will require at least 25% down when dealing with multiple properties and they will not count the income from rent until at least two years of rental income on tax forms so any properties you purchase in that time may not be used towards income.

One thing you could do though in the situation you presented is to do a re-cast on the properties by putting an additional amount down on each property (or just one property if it's easier and it'll be cheaper that way too if you only have to pay for one recast) and that will re-amortize your balance so you have less monthly debt.

You could also try raising the rent slightly on each property and see how that goes.  Generally though unless you have a huge emergency fund or savings of some sort it's a sort of protection to not allow you to continue to borrow if you're DTI is that high.

dhlogic

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Re: Debt to income question
« Reply #3 on: March 12, 2016, 03:05:35 PM »
Thanks for the replies.

I know that lenders might require 2 years of income history before counting it and that 25% is a more realistic number for a down payment, I should have made my scenario a little more realistic :) I also plan to have 6 months of PITI per property.

I forgot about recasting, looks like any conforming conventional loan would be eligible for it.

Quote
Bank of America and Wells Fargo Home Mortgage charge customers $250 for a loan recast. At Wells Fargo, customers must make a lump sum payment of $5,000 or 10 percent of the remaining loan balance, whichever is greater, to qualify for a loan recast.

I ask this question because I will have $150-200k I want to use to start purchasing properties, but as I think through how I will progress in acquiring more I keep running into this problem of once I hit 5-6 properties, I will hit the DTI limit.

I guess another option is just to aggressively pay a mortgage off every year or so and stay around 5-6 financed?
« Last Edit: March 12, 2016, 03:10:26 PM by dhlogic »

Lmoot

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Re: Debt to income question
« Reply #4 on: March 12, 2016, 05:02:58 PM »
Another thing you can do is purchase cheaper properties that provide a higher cashflow (because they're less expensive). Lower value can mean lower insurance and lower taxes. At least consider this for the first few properties. Even though you can charge higher rent with higher valued properties, the higher carrying costs will eat that up until you can pay it off (which is where the higher value benefit finally kicks in). And it seems that at the beginning, quantity might need to be your focus until you can earn enough cash flow on the minimum debt in order to qualify for mortgages on higher quality homes without exceeding the ideal DTI.

Also, you don't just want to qualify....you want to qualify for premium rates. For that many properties, you could pay extra in the thousands (per year) for even 0.5% below premium....and higher rates also raise your monthly payments, raising your DTI.

I'm struggling with the same thing now. Even though the mortgage on my current property is tiny, I earn so little that I could only realistically purchase 2 more properties no more than totaling maybe $160k. I'm going to make my next purchase a student condo between $50-65k...which is not the SFR I originally wanted at up to $100k. But it's what is necessary to allow me to move forward with my next purchase after that.

Think of it this way...you could have a $45k condo cash flowing $250, and a $90k SFR cash flowing $350:

- The $90k SFR doesn't allow you to buy another property due to DTI, but it still looks like a better deal than the cheaper property, right?
- Until you realize that you have room in your DTI to purchase a second $45k condo, also cash flowing $250. Now you're looking at $500 vs $350.

Just something to think about (and something I've been thinking about as well). Or go for a du/triplex, multi-unit thingy that will instantly cash flow for higher than multiple SFR's, with less impact on your DTI as well.


« Last Edit: March 12, 2016, 05:20:13 PM by Lmoot »

cchrissyy

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Re: Debt to income question
« Reply #5 on: March 12, 2016, 05:36:56 PM »
250/m for taxes on a 80k house?!

SwordGuy

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Re: Debt to income question
« Reply #6 on: March 12, 2016, 06:20:42 PM »
Several options:

1. Real estate investors who will partner with you.  They do not have to follow the bank's rules.

2. Put the property into a corporation and have the corporation borrow the money.

3. Buy and flip one, use the proceeds from the flip to pay down a mortgage.  Repeat as necessary.

4. Owner financing.  Ditto on not having to follow the bank's rules.  This can be the absolute best option if you learn how to structure the deal for both parties.

clarkfan1979

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Re: Debt to income question
« Reply #7 on: March 18, 2016, 02:16:11 AM »
Thanks for the replies.

I know that lenders might require 2 years of income history before counting it and that 25% is a more realistic number for a down payment, I should have made my scenario a little more realistic :) I also plan to have 6 months of PITI per property.

I forgot about recasting, looks like any conforming conventional loan would be eligible for it.

Quote
Bank of America and Wells Fargo Home Mortgage charge customers $250 for a loan recast. At Wells Fargo, customers must make a lump sum payment of $5,000 or 10 percent of the remaining loan balance, whichever is greater, to qualify for a loan recast.

Yes, I think you have to pay off some mortgages.

I ask this question because I will have $150-200k I want to use to start purchasing properties, but as I think through how I will progress in acquiring more I keep running into this problem of once I hit 5-6 properties, I will hit the DTI limit.

I guess another option is just to aggressively pay a mortgage off every year or so and stay around 5-6 financed?