Using new construction to fund new deal

[Lauren Alpert]

Hello BP Community,

My husband and I just built a new 5-unit apartment in the Los Angeles area. For the two years it took to construct the units, we were unable to close on any new deals due to the high cost of the construction and the high interest construction loan we had to take out. Our debt to income ratio was wayyyy off.

Now that the units are fully rented and we are refinanced into a much lower interest rate, our current DTI is around 22%, Much better! The caveat is our taxes don't reflect this at all (the units have only been rented for 4 months).

My question is: would we be able to use the new rental income to purchase a new Conventional loan 2-4plex? Not interested in hard money for this venture since we want to keep the holding costs low / we plan to build a larger apartment and potentially demolish the existing structure in the future. I would ideally like to take cash out of our existing 4plex and use that as a down payment for the next one, while interest rates are still somewhat low.

I’m trying to get creative to keep scaling and moving forward. Any lender advice is welcome and appreciated.

[Daniel Hennek]

Even with conventional the mortgage payment on a rental is offset by rental income and you come up with a net figure.  It might work, you should talk to someone who knows the math.  I'll explain in more detail.

Lots of people in the industry, including many underwriters unfortunately do the math wrong until they actually start putting it into their system because they don't see how it makes such a big difference doing it the way they scratch it out on paper.  This is a common error.

The thing these people do is to add up all debts, add up all income and then divide the debts by the income.  So if you've got 10,000 in debt servicing and 20,000 income you are at 50%.  But when you're talking about a rental with a mortgage you don't add the mortgage payment to debts and the income to income.  You subtract the mortgage payment from the rental income and come up with a net figure instead.

So, if you have a mortgage payment of 2000 and rental income of 3000 then you're net rental income is 1000. In this case you add $0 to debts and the $1000 as net income. You don't add 2000 to debts and 3000 to income.  By doing it the right way you're debt to income is lower, and it is the CORRECT way according to Fannie and Freddie.  

I've set up plenty of loans for people who told me they didn't qualify because their "dti was too high" because they spoke with people doing their math wrong. One guy recently told me a local bank said he only qualified for a $250,000 loan. I qualified him up to a million. Just closed a loan for him over 600k because I did the math the right way and his DTI was 33%.

Here's the math again in more detail.  If you have 10,000 debt and 20,000 income by adding 2000 to debt and 3000 to income you're at 50%.  If you take those out and rework the math correctly you'd have only 8000 debt by pulling the 2000 out.  Then take your 20,000 subtract the 3000 income you used, but add back the 1000 net rental income.

That gives you 8000 debt out of 18,000 income which equals 44.44% DTI. Not saying this is happening to you but it's very common so worth looking into since you're talking about refinancing a property that already has rental income established.