Debt to income ratio

[Roger Devore]

Without outside investors (rare) how does one overcome debt to income ratios without paying in full for a properties? I have set a goal is to acquire 5 single family properties within the next 10 years. I have my first property due to a job relocation but am looking to future rentals purchases. I do have a savings plan in place that should allow me to save 20% for each home I would like to purchase. Is there an accountant or experienced person who could explain? If someone would like to PM about this for more details I would be glad to provide them.

Respectfully,

Roger

[Mike H.]

Couple of details I'd add to that.

1) Be careful whenever conventional lenders underwriters are calculating DTI. Most don't have a clue how to do it correctly. So if it seems off, ask them for the numbers on how they came up with it.

Here were the last two scenarios that I had to teach the bank how to calculate it after they said my DTI was too high
a) They were taking my net profit from my tax return and then deducting the mortgage payment amount from the credit report. I had to show them that the mortgage payment was already being deducted in the tax return to get to the net profit.   

b) This second wasn't as dumb but it was still a matter of knowing the rules. 
Keep in mind I have 8 loans on my credit report so those are the only ones they cared about (but I have 56 total houses). But I'll give a simple example of what they were doing:

Lets say my gross income was 5k/mo and I had debt payments on my primary and car of 1,500. My DTI would be 30%. And then lets say I had one rental property that I was getting 1400/mo in rent and I was paying $950 a month in PITI.

Under the percent rent guidelines, the bank is supposed to take 75% of the rent and then subtract the PITI (so 980 minus 950 = NET Profit of 30/mo). They are then supposed to add the $30/mo to my Income side and calculate the DTI off that.

Debt =  1,500/mo divide by i.e. 5k/mo plus 30/mo or $5,030 /mo  = 29.8%.

That rental should actually push your DTI ratio to a better amount.

Instead this crazy bank was doing this:

Debt = 1,500 plus 950 (PITI from rental) divide by 5k+980 (75% rent)
Their dti calculation was: 2,450 / 5,980 = 41%

Multiple that by 8 rentals on my credit report and you can see how that makes no sense. You could never qualify for a loan. But that was how their underwriter did it and I literally had to get the fannie AND freddie guidelines and show them how the calculation was supposed to work.

So beware. Banks and their underwriters on the conventional side sometimes have no clue how to calculate DTI. Just remember, you don't add debt payments to one side of your money and rent payments (75% of) to the other. You net the two amounts out and either add the small gain to your income side or the small loss to the debt side.

As long as your property has reasonable cash flow (400 to 450/mo), you should be getting a small bump to the positive in your DTI for each rental property you own.

2) Commercial financing.

Yep. You can go up to 10 with conventional. And I strongly recommend that you use your 10 spots. The first four can be had pretty easily. After that, you have to find the right lender or mortgage broker that can do the 5-10 loan program (conventional loans for houses numbered 5 thru 10).

You won't find better terms than conventional financing. Security because you can lock in a great rate for 30 years. And excellent cash flow because the rates are better and because they're amortized over 30 years.

That being said, if you do go over 10 homes, commercial financing is the only way to grow over that. I will add though, that you absolutely do not need to create any entity to do a commercial loan. At least I haven't needed to with any of the local bank I use.

However, I do have an entity (S Corp) that I use for all my commercial banks. It makes it easier for me since my hard money lender does require me to do the rehab loan in the commercial entity. But I've refi'd some of those houses into conventional loans and only needed to quit claim them at the closing......

But check with your local banks. I bet you'll find several will do commercial loans under your personal name. They don't care. If anything, I would think it would make it easier for them. They ultimately just want to go after the individual (unless you have an entity with a bunch of assets) as recourse.

You will still have to personally guarantee your commercial loans even if you put the loan into an entity (at least all of mine required it).

So if your goal is to simply buy 5 homes in the next 10 years, I wouldn't worry about setting up any entities. And I definitely wouldn't worry about qualifying for the loans because of the DTI and having rental properties.

As long as your properties cash flow reasonably well, the rentals should actually improve your DTI ratio for qualifying for the loans.