I figured out why my debt to income ratio sucks

[clarkfan1979]

I currently make 65K at my day job. I also have a wife that works part-time. However, to make things simple, I will ignore her income. We own two rental properties that are doing well. They each generate a little over $1,000/month above the mortgage, taxes and insurance. This is an extra $25,000/year. After repairs and cap ex it's around an extra $20,000/year.

Even though the rental properties add extra income, when we add the two rental properties, our debt to income ratio goes up, making it more difficult to qualify for our 3rd home. We are not overleveraged. We have about 65% equity across the two properties.

Rental #1

Rent = $2000/month
Mortgage, Taxes & Insurance = $953
Owe= $115,000
Worth = $320,000


Rental #2

Rent = $1700/month
Mortgage, Taxes & Insurance = $670
Owe= $76,000
Worth = $225,000


Debt to Income for myself only

My monthly income is $5416. Our apartment is 1,100/month and I have $240/month in student loans. Without any rental real estate my debt to income ratio is $1340/$5416 = 24.74%

When I add rental house #1, the bank only count 75% of the income because of vacancy and repairs. My new debt to income ratio is $2293/$6916 = 33.15%

When I add rental house #2, my new debt to income ratio is $2963/$8191 = 36.17%

As you can see, even though each rental house adds another 10K to our annual income, it also drives up my debt to income ratio. When shopping for our 3rd house, it's hard to stay under 45%.

I think we have two options. One, my wife and I take on extra W-2 income work to qualify for a loan. Two, try to do an owner financer deal.

Has anyone else had a similar problem?

[SwordGuy]

Haven't had your problem yet, I've been mostly buying inexpensive properties for cash and fixing them up with cash flow from my job. 

I have some ideas, though.

Obviously, your wife working full time long enough to qualify for a loan is one case.   They will want to see 2 statements as part of the loan process, so she would need to have been working about 3 months for the income to show up as a "regular" income stream.

Second is to pump the extra earnings into one of the mortgages to drop the debt down, so the next property doesn't go over the debt-to-income ratio.

You mentioned owner financing.  That's a great way to buy property!   Plus you only have to make the owner happy, not some bank and Fannie Mae mortgage product rules.  You might even get the property with little money down!

A fourth way is to save up and buy an inexpensive property for cash, then cash flow the repairs.  We buy houses in the $33k to $40k range and fix them up for $7k to $13k.  Sweat equity keeps the dollar cost down.  Depending upon your income and savings rate, and your local real estate market, this might work for you.   This also has the advantage of improving your income to debt ratio.

A fifth way is to use any of the methods to get your next property, but buy it as a flip or buy and hold property.   Flip it if you can get the price you want and use the profit to pay down debt.    You might fund this via a professional real estate investor instead of a bank.   They will care more about the numbers on the house and less about government mortgage reselling rules.  You might pay a higher interest rate, but if it's a flip you can profit on a sale at 90% of after repair value, you won't have to pay interest long.

Hope that helps!

[NoNonsenseLandlord]

A bank should look at the rental property income, after two years of it being on your taxes.  They add back in depreciation to make for a true income picture.

If a bank doesn't want to lend you money, that is a red flag.  Pay off any car loans, credit cards, student loans, etc.  A bank is looking at the amount of income available for paying debt.  Not total debt to income.

[clarkfan1979]

A bank should look at the rental property income, after two years of it being on your taxes.  They add back in depreciation to make for a true income picture.

If a bank doesn't want to lend you money, that is a red flag.  Pay off any car loans, credit cards, student loans, etc.  A bank is looking at the amount of income available for paying debt.  Not total debt to income.

Our only debt is student loans at $240/month.

When I call the mortgage brokers, they actually calculate my total debt to income. They won't give me an approval letter because they add all the debt from the mortgages. Should I ask to speak with a supervisor?

I actually ran into the same problem with my last house and it was after underwriting.

Here are the numbers on my last house purchase.

Income: 40,000 or 3333/month
Mortgage, taxes and insurance = 685
Student Loans = 333

Debt to income as I would calculate it: 1018/3333 = 30.54%

Rental Property #1

Mortgage, Taxes and Insurance = $950
Rent = $950 (average on taxes over 3 years)

I was living in one of the rooms and renting out 3 rooms.

After adding the rental house and going through underwriting, the credit union called and said that I was approved, but barely. They calculated my debt to income ratio to be 43%.

How did they get 43%?

[waltworks]

I have never run into this. Every lender I've dealt with simply counts rental income beyond the PITI as income (sometimes with some deductions for expected maintenance/etc), and ignores the debt completely. Any rental that cash flows even a tiny bit should (in my experience) *improve* your DTI no matter what the mortgage balance is.

Once you've had rental properties for a couple of years it gets stupidly easy (again, my experience only here) to get further loans.

I would go to the bank (or call the mortgage broker) and get a clear explanation of how they are calculating this. Something is not adding up.

-W

[arebelspy]

Didn't you have another thread about this same thing?

This is the answer:

Any rental that cash flows even a tiny bit should (in my experience) *improve* your DTI no matter what the mortgage balance is.

If and only if the debt of the property itself, by itself (and only counting the 75% the bank does) is under their guidelines.  Then it will "drag" your DTI towards that number (like adding an extra number in an average, it weights it towards that number).

When I add rental house #1, the bank only count 75% of the income because of vacancy and repairs.

So even if the bank only counts 75% of the rental income (due to vacancies, repairs, taxes and insurance, etc.), your DTI should hopefully get better, or at least stabilize low, below their threshold.  because your debt added (the numerator in DTI) is smaller than the income added (in the denominator).

If this is not the case, the mortgage is probably too close to the debt (for example if the mortgage is half that 75% income, it'll "weight" your DTI towards 50%).  The smaller proportion the debt is, the more it helps your DTI.

The bank doesn't care about your equity across other properties, because they don't want to have to sue you personally for debt on this property.  They want to see: 1) Equity on this property (i.e. a down payment) and 2) Income to show you can service the new mortgage.  Equity in another property can't do that.

The rent itself though will help service it, and that's what should improve your DTI.

Rental #1

Rent = $2000/month
Mortgage, Taxes & Insurance = $953
Owe= $115,000
Worth = $320,000


Rental #2

Rent = $1700/month
Mortgage, Taxes & Insurance = $670
Owe= $76,000
Worth = $225,000


Debt to Income for myself only

My monthly income is $5416. Our apartment is 1,100/month and I have $240/month in student loans. Without any rental real estate my debt to income ratio is $1340/$5416 = 24.74%

When I add rental house #1, the bank only count 75% of the income because of vacancy and repairs. My new debt to income ratio is $2293/$6916 = 33.15%

When I add rental house #2, my new debt to income ratio is $2963/$8191 = 36.17%

So let's look at this math. 

Rental 1, on its own (and only taking 75% of the income), is a DTI of 953/1750 = 54.4%.
Rental 2, same assumptions, is a DTI of 670/1275 = 52.5%

So adding those rentals in of course ups your DTI.  If you added in a bunch like that, your DTI would trend towards that 53%ish number.  (Think of an average of, say 10 and 20.  It's 15.  Now imagine I add in 18, 18, 18, 18, 18... that average will trend towards 18.)

If you're now adding in a similar 3rd property, again it will up that average.

If, on the other hand, the DTIs of an individual property were around 20%, they'd be bringing down your personal DTI.

Does that make sense now why your DTI is going up with each property you buy?

To propose a potential solution: If you have so much equity, you may want to consider refinancing one to pay off another.  That could help improve your DTI, given you likely have trapped equity in both.