Feedback on Sharing Experience - VA Loan in a Hot Market

[Brady Potts]

Hey BP community, this is the first blog post I've done and am interested in seeing if this type of writing is helpful. Any constructive criticism in how I'm presenting this info is welcomed. I have a passion for helping others get started, and I want to make sure I'm sharing my experience in a useful way.

Overview

Hello everybody. This is the story of how my wife and I purchased our first duplex in an expensive market, with a short time in our W2 jobs, little income, no previous rental income, creative qualification, using a VA loan and still securing a great deal. I hope this story helps those just starting out, specifically those facing similar circumstances, to start their journey and get into real estate.

The Beginning

At the end of 2016, I came home from my last deployment with the Army and joined the civilian world. I started working as a sales associate for an insurance company, while also going back to college full time. I would go to class about 4 hours a day, work the other 8 at the insurance company, and then head home to tackle life and homework. I was making okay money, probably about $2,600 before gross. Since I was going to school I could also tap into my GI Bill for another $1,000/month. My wife was managing a bar at the time but was still only paid minimum wage plus tips. She was probably making about $3000/month but on paper, and in the eyes of a bank, it was more like $1,000. I worked in this position for about 8 months before I got the bug to venture out and start something on my own. But first, we wanted to explore homeownership.

Getting Qualified (or not) with a Lender

At the time, we were living in a small mother-in-law apartment rented from a family friend. It was small with an awkward layout, but it was cheap ($350/month), came with great neighbours and worked for us at the time (we remodelled it ourselves to help the owner out and save on some rent). But, we were ready for our own place. We went to a mortgage lender who told us we were in bad shape. Our credit was fine, but the wife made minimum wage on paper, and about 30% of my income was commission. I'd only been it the job for 8 months and they wanted 2 years of experience to count that added income. We ended up squeezing a qualification in at around $200,000. Not bad, except the median home in our community at the time was pushing $275,000. We were also trying to use a VA loan so we couldn't buy a fixer-upper. That left us with two options: buy something way out of town and commute or keep renting. The cost to commute would double what we paid in rent in gas alone, not accounting for lost time of an hour a day and the wear and tear of the vehicles. So we kept renting.

During those conversations with the mortgage lender, I asked if we could buy a duplex and use the other side’s rental income to help qualify us for the loan. Most lenders will let you count 75% of the other rents to boost your qualification income, but with a catch. Government-backed mortgages only let you do this if you already have 2 years of “rental experience”. Most lenders equate this to owning other rentals and showing rental income on a K1 in your tax filings. That certainly was not our situation, so I asked if there was any other way to get qualifying “rental experience”. The lender laughed and joked, “Maybe if you were a licensed property manager and owned your own company.”

Getting Creative and Making a Blunder

2 months later in the fall of 2017, my wife had her property management license, I set up an LLC, and we opened a small property management company. The licensing process in Montana consists of a 4-day course costing $400 and a standardized test. Setting up an LLC cost $75. We were in business but still had to find some clients.

Now, if I were smart, I would have powered ahead working in my W2 job and built the PM business on the side. But I wasn’t. I thought, “Heck if I can sell insurance, I can find a couple of dozen properties to manage and make even more money.” So I quit my job to work on the PM company full time. Bad choice. Turns out finding property owners who want to let a 23-year-old newbie manage their biggest investment is harder than I thought. At the same time, and a major oversight on my part was that I now couldn’t qualify for a mortgage anyway since self-employed people have to be at their job for 3-5 years instead of 1-2 years before lenders will qualify their income (we’ll see how this changed later). So, there I was making very little money, going backwards in my qualification criteria, and still renting.

Asking Questions Leads to Surprising Answers

We struggled through this from the fall of 2017 to the end of 2018 before we realized waiting another 2-4 years to get our own place wasn’t going to work. So I started digging into the problem. I thought, “Who has the answers I need?”. Turns out, the insurance agent I used to work for was now a mortgage lender. We had a great relationship and I trusted him, so I called him up. Our conversation went something like this:

Me – “We want to buy a duplex, we have little to no qualifying income, no rental ownership experience, and have okay credit. But, we have been running a very small property management company. I know it's gonna take a couple of years, but what do we need to do to qualify for a house or duplex using a VA loan”.

Lender – “Both of you need to go get W2 jobs earning as much as you can on an hourly rate. Call me in 60 days.”

Me- “60 days? That’s it? Not 2 years?”

Lender – “Nope, call me in a couple of months”.

Well, that certainly wasn’t the conversation I was expecting to have. We were anticipating having to grind something out for at least 2 years. So we got to work looking for good-paying W2 jobs. I found work in the title insurance industry (which turned into a home-run employment situation with a stellar small business) and my wife started working in the office of a dentist (which also turned into the manager position for another rockstar employer). Three months later I called the lender back.

Me – “We’re ready to start. We’ve each been here for 90 days. She makes $15/hour, I make $19/hour.”

Lender – “Great, let's get all your docs in line. Oh, and you said you were licensed property managers right? Can you send me over those business returns as well? I’m going to push our underwriters to accept this instead of having K1 income in your tax history. This will let you count rental income from the other side and boost your qualification amount.”

That's just what we were looking for. He pushed that through underwriting and got it approved. Even more impressive, he got it approved on a VA loan. Time to go shopping.

Finding the Deal

We looked around for a couple of months waiting for a deal to come online. I wanted to make sure that after we moved out of one side, the property would at least pay for itself. My agent, and others I knew said that with $0 down that deal would be impossible to find, especially off of the MLS. Yeah, okay. I built my own property calculator in excel (see below) and ran all the potential deals through it. Finally, one came online and because I knew what I wanted, new how to analyze a deal, and was ready to put in offers we were able to snag it. Here's the breakdown:

List Price: $300,000.00

Property Description: Split level home with a full living room, full dining room, 2 beds, 3 baths, and 2 bonus rooms in the basement that didn’t have egress windows (which is perfect for adding value). It had a tenant in there for the last 6 years paying $1,100/month. The house is okay, nothing fancy but not run down.

Detached from the main house was a 2-car garage with a 1 bed 1 bath apartment above it. The garage itself was split down the centre to allow each unit to have its own stall. This was rented for $775/month and would be the unit we wanted to move into.

Purchase: We offered $295,00.00 with a $5,000 seller closing cost credit because it had been listed for $290,000.00 the summer before but the basement had been flooded and it had to be pulled off the market while it was rehabbed and French drains were installed. They accepted and we closed 60 days later. I also got a check back for $2,500 at closing because my lender’s a wizard.

Results: At close, our mortgage, taxes, and insurance totalled $1945/month. So, at the current rents of $1,100 and $775 that pencils us to lose $70/month before any other expenses (after we would move out). But, for $2,500 per egress window, for which we needed 2, and a light rehab to touch things up at about $10,000, we could turn the front house into a very nice legal 4bd/3ba. Rental comps in the area for that are about $1,500/month. Also, similar duplex comps for sale are roughly $450,000. That's almost $150,000 in forced equity off a $15,000 investment right there (remember, VA loans are $0 down). On top of that, the current market rate for 1-bed apartments right now is closer to $900/month. AND we refinanced to a lower rate to bring the mortgage down to $1,700/month. That brings current rents to $2,500/month. A detailed breakdown of the numbers for this project are posted below.

Lessons Learned

Ask "how" and "why questions. Just because something is usually done one way, doesn't mean its the only way.

Talk to more than one person in a position (agent, lender, etc.) and find one that can work with your situation, or at least guide you in the right direction.

Know what you are looking for and practice running the numbers. If you do, when something comes up you'll know whether its right for you or not.