How is DTI Ratio Calculated for Buying Second Househack?

Question

I bought my first househack last year, and I am getting ready to make an offer for the second one. My question is about how the DTI ratio is calculated when I apply for the second mortgage. My understanding is that assuming that one has no debt other than the mortgage for the first househack, it is calculated as

(PITI1 + PITI2) / (Monthly Paycheck + 0.75*Rent1 + 0.75*Rent2)

Rent1 is the total rent collected from the first property assuming that you have moved out and have fully rented it, and Rent2 is the rent collected from the other units in the new multi-family property that you want to buy.

Is this correct?

The reason I ask is that a new prequalification letter from the lender has listed the maximum purchase price that results in a DTI ratio of 60% if I follow the above equation. I can't figure out how they are running the numbers so that I can put it in my spreadsheet and can figure out if each property on which I want to make an offer makes sense. I am looking at 2- and 3-family properties in towns closeby, where the taxes and rents are different, and do not want to ask the lender to run the numbers for every option.

If anyone can help me figure this out, I would greatly appreciate it.

Doug Smith · Answer

It depends on the type of loan you are applying for. If you're applying for a Conventional/FHA/VA/ or USDA loan, then they will do a "global cash flow" where they take into account your PITI (Principal + Interest + Taxes + Insurance (hazard and flood) on all properties (second mortgages included), HOA payments, car payments, student loan payments, credit card payments, and installment loan payments in the numerator and your gross income in the denominator. This produces a Debt to Income Ratio (DTI)...the lower the better. Different lenders will treat rents differently, but Freddie Mac just put new guidance on Rent (see below). Even though lenders will tell you there is only one way to do it, different lenders have different interpretations of the rules. I know this might be confusing, but I do hope it helped a bit.

Some "commercial" oriented loans such as the DSCR loan will put the property's gross rent in the numerator and the PITI + HOA in the denominator while ignoring all other debts. In this case, it's the higher the better. The way the first type of loan calculates DTI, people struggle to scale. The DSCR helps with that.

Mohammad Fanaei · Answer

Hello @Derek Brickley! Thank you very much for your response.

I will use lease agreements from both units of my first 2-unit househack property (including the one where I currently reside). 75% of the total rent collected from the first property will cover its PITI completely.

Your comment was very helpful in clearing up my confusion. Thank you!

Derek Brickley · Answer

Hey Mohammad!

Doug is spot on with the fact that it really does depend.  Will you be using a vacating residence lease or just the lease from the other unit(s)?  For rental properties in general maybe looking at (debt+proposed PITI)/(wages+(75%*rent-current PITI)) might be the formula that would be more accurate.  Note that this is only if 75%*rent>PITI.  If 75%*rent is less than PITI then that difference would be added to the top portion of the DTI calc.

For a situation of moving from one househack to another, there really are some strict rules for vacating residence but you can't use it as income even if 75%*rent > PITI.  The best it can do is wash out your current payments from the DTI calc.  For the unit you are vacating, you will need a one year lease signed ahead of time as well.

Devin Peterson · Answer

Hi Mohammad, I work and live in the Boston market. Extremely saturated. It's a great place but super tough when it comes to finding good deals and scaling. How much % are you putting down? Have you checked with your lender to see if you qualify for any mass housing or DPA programs? A grant would be best, to avoid adding more ingredients to the DTI mess. Usually, when people are in a market such as Boston, that scaling is easier is DSCR loans because there is not DTI. The downside of course is that you cannot take advantage of the lower down payment option. Happy to connect and strategize some more!

Mohammad Fanaei · Answer

Hello @Devin Peterson! Thank you for your response. I am looking to make a 15% to 20% down payment. The high down payment is necessary so that the DTI ratio is within the range to be qualified for a conventional loan. I have not asked the lender specifically about the Mass Housing programs but the last time that I checked, I was not qualified for them.

I will connect with you for further conversation. Thanks again!

Mohammad Fanaei · Answer

@Doug Smith Thank you so very much for the detailed explanation. It was very helpful. I am looking at conventional loans, and as you said, scaling becomes very difficult based on the first method of calculating DTI, especially if you are in an expensive market.

How is DTI Ratio Calculated for Buying Second Househack?

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