Cash out, rinse and repeat?

Question

Assume we are speaking of rental properties. Assume the rental properties are free and clear. Assume the rental properties have tenants and they have rent paid since day one.

I hear success stories about how people buy homes with cash, then refi to cash out, then the tenants rent pays the note and they can just move down the line buying homes....rinse and repeat, correct?

But people are not talking about the back end banking that allows this to happen. Speaking about the above set of assumptions, let's say the owner of these rental properties has a blue collar job making 45k a year. He has a small amount of debt, no car note but a mortgage for his primary residence. When you have a average joe six pack type of job, your debt to income ratios are not in favor or additional borrowing power.

My questions is if banks count into the lending scenarios the rental income when factoring in the applicants income. If rental income isn't allowed, then refi would not be allowed because DTi ratios would be outside the guidelines. But if the rental income is allowed banks would approve the applicant?!

I'm just realizing that in order to buy homes and refi and cash out and buy more homes and keep it rolling down the line, one must need a substantial salary in another line of work to show that the note created with a cash out refi would be easily absorbed with the income the applicant earns without counting the income earned from rentals.

Then how do people buy ten-twenty-thirty rental properties?  Do they wait the two year period to reflect the rental income on their tax returns and then use that modest rental income for lending purposes? Or are there such lenders that will lend on future rental income provided rent deposited monthly and lease agreements can be documented??

Steve Vaughan · Answer

Anytime the words cash-out and refi are put together, the process becomes difficult and expensive.  See Mike H's recent post of his multi-month PITA debacle.  He did a blanket refi on multiple free and clear rental and wished he did them individually.  Personally I think he wishes he didn't do it at all for the lousy $100k.  Wait until he tried to sell one out from under the blanket!

Personally, I am paying all of mine off. Not playing with banks, their requirements or their fees anymore.   I am still growing my portfolio through seller financing.  Running into a lot of tired landlords in their 60's (generally) with multiple free and clear properties.  Headache-free cashflow with tax benefits is attractive to them.  Good luck either way @Robert Hastings!

Bill Thompson · Answer

As others have mentioned, a commercial lender will have no problem loaning to joe six pack as long as the property produces sufficient cash flow to support the debt.  The commercial lenders I deal with tend to be fairly flexible with respect to seasoning requirements as well.  The downside to going the commercial loan route is higher interest rate, closing costs and prepayment penalties.

For cash-out refinance via conventional loan, joe six-pack needs to find a lender that is "investor-friendly".  These lenders typically have seasoning requirements of at least six months and count 75% of rent as Brian Otteson mentioned. Conventional financing is the way to go if Joe six-pack's loan pencils out using 75% of rent.  In addition to local lenders and credit union, he should see what the online banks have to offer.  From personal experience I have found Quicken Loans and Roundpoint Mortgage to be investor friendly.

JD Martin · Answer

This is a good post. I think you have correctly identified some barriers to moving forward. Thoughts in no particular order:

1. If Joe Six Pack bought this place for cash, he should really have no amount of debt other than a mortgage. If he's got small amounts of debt, as you noted - I'm assuming we're talking some small credit card debt, or other installment amounts - those should either have been paid off already, or paid off with the income from the rental property.

2. I think you have to talk to your banks to see who will do what. My bank will consider rental income as income once it appears on a tax return, so figure anywhere from a few months if you got something rented in the fall, to a year if you got it rented early in the year.

3. If possible, consider refinancing higher payment notes into lower payment ones, as that will lower your debt to income ratio. Consolidating credit cards can do the same thing. The key is getting rid of or lowering fixed payment obligations. At the same time, be sure that your monthly income includes *all* your monthly income. For people who are paid every 2 weeks, they often only figure 2 paychecks into their monthly income, when in reality they should be figuring 2.167 paychecks into their income (26 pay periods in a 12 month period), or for someone paid weekly, 4.333 paychecks into their monthly income. If you are the type that gets a big tax refund back every year, change your declarations so you get a small (or no) refund, and more money back in your weekly/biweekly check.

Bryan O. · Answer

Hi @Robert Hastings. Lenders will typically count rental income as income after you have been a landlord for 2+ years. They will usually count 75% of the rent. For new properties, the lenders I have worked with want 1 year leases and then they will count 75% of those as well (assuming that you are a 2+ landlord already). If you own them free and clear, that's a big bump to your income. Look to commercial lending, possibly a portfolio loan in particular to pull that equity out and buy more. The commercial side of lending is much more flexible in their requirements because it is about what the bank wants, not about following freddie/fannie guidelines. It sounds like you have a pretty enviable dilemma. Best of luck!

Cash out, rinse and repeat?

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