Help with understanding purchasing homes

[Mike Lynch]

Some of the Real Estate YouTube channels are telling everyone that if you have $300,000 and you owe $300,000 on your home, do not pay it off...... Use that money and put down $50,000 each and buy 6 more homes........ That sounds really great, but how in the world do you get all of these loans...... I can probably get one home equity line and get one home, but how do you get the 5 other loans? ........ Am I totally missing something? ....... What is the strategy? .... Please educate me! ...... Thanks! :)

[Nathan Grabau]

So there are two main types of ways that banks look for loans to be paid, one is with your personal income, the other is with what is call a DSCR which stands for debt service coverage ratio. An example of a personal income based loan is an FHA loan, you can have up to 55% of your income going to debt payments. Banks will also let you count 75% of the revenue from a rental towards your income. Loans with lower down payments(3.5% to 10%) tend to be ones based off of your personal income plus 75% of rental income.

DSCR loans allow you to borrow money based off the net operating income (income minus expenses before mortgage) of the property. To put numbers to this, lets say I have a property that rents for $2000, my management is $200 a month, vacancy loss is $100, mainantence is $100, insurance is $200 a month, and property taxes are $150 per month, my net operating income is $1250 (2000-200-100-100-200-150). If my bank requires a DSCR of 1.25(all 3 of the DSCR loans I have require this ratio), then the maximum mortgage payment I can have is $1000 per month. On top of this, most DSCR lenders require that you put 20% down, so I could have a max LTV of 80% and mortgage of $1000. This is nice because private bank will essentially allow me to keep doing this over and over again, as long as I continue to meet their criteria.

This is where it gets fun, essentially I need to find deals that can generate a DSCR of 1.25. While that seems simple, it means that the property must cash flow 25% more money than the cost of the mortgage. This used to be easy to find, but now as interest rates are going up, but property values are not, this is becoming more difficult and we have to start getting creative with our deals. This is why people have become recently interested in subdividing properties or creating short term rentals, it increases the work we put in, but it also increase the return on our capital when we do not consider the cost of our time.