How to overcome debt to income ratio

Question

We’ve been real estate investors very part time for about 15 years. Currently have 3 long term rentals with a commercial loan not in an LLC.

About 5 yrs ago we bought land. The plan was to sell our existing house, move into one of our rentals, use all the cash to build and then use the equity to invest in real estate again.

Fast forward about 4.5 yrs and we’re living in the new build. Value conservatively $1.5M and we owe $200k on the land at 5%. We were aiming for a $900k equity line but finally got a local bank up to $750k. It would be a line of credit with a check book where you only draw when a deal comes up and pay on just that amount. That would allow us to pay cash for a property, rehab it and then get financing on it while paying back the equity line.

But now we’re running into debt to income issues. This same bank approved our land loan with approx $9k gross per month, a $2,500 house payment and $3500 rental payment. Now income is around $13k gross per month, $2000 land payment, $1000 van payment (that we will pay off with cash when equity line is open), and $3400 rental payment. They have this at almost 80% debt to income…I assume with taxes and insurance but counting no rental income.

Is there another avenue we should be looking at the use our equity?

Our first plan is to convert space over our 4 car garage (approx 1200 sq ft) to an Airbnb space on our farm for about $80k which would generate $40k+ a year at 50% occupancy. We’re also working on a VW bus to Airbnb conversion and we have a 40x24 space in our barn plumbed and framed for a 3 bed/2 bath barndo Airbnb.

Stephanie Medellin · Answer

@Andrea Castor Is the 13k gross only rental income, a combination of rental income and other types of income, or solely other income?  This will make a difference in how your debt to income ratio is calculated.

When your goal is to maximize borrowing power, you always want to keep all other payments as low as possible.  How can you achieve this?

If the lender allows debt to be paid off in order to help you qualify, the $1000 van payment (assuming this is a loan and not a lease) could be omitted by paying it off at closing.  The escrow or title company will issue a check directly from your credit line proceeds at closing, so the lender can ensure the debt is paid.

If the land loan is a shorter term loan, such as a 15 year loan, it may make sense to roll that into your credit line too, resulting in a smaller payment for that remaining 200k.

Alternatively, you could do a 1st lien cash out refinance, paying off the land loan and the van, and any other monthly liabilities while taking out the initial cash that you will need for your first project(s).  Again, the goal is to reduce your overall monthly payments by refinancing any outstanding debt into a longer term loan.  Once your first project is completed and refinanced, you could re-use that cash to complete your second project.

Andrea Castor · Answer

$13k is all W2 income.

We do have cash to pay off the auto loan but it’s 2.9% so I wasn’t going to do it until this was completed. It definitely wouldn’t make sense to roll the van into this equity line at 7.5%

The land loan is $200k balance, on a 3/1 ARM with 1 year left at 5%. Again it really doesn’t make sense to move this to a higher interest rate for a slightly lower payment.

The product we have done previously for many years is an equity line checkbook. It’s available when needed but we wouldn’t make payments till used. Minimum is $10k at a time. So it’s a great vehicle for short term.

Patrick Roberts · Answer

More than likely, the bank that is underwriting the credit line is basing the calcs on a draw period followed by a relatively short amortization/repayment period, such as 15 or 20 years. For instance, $750k @ 8% on 20yrs is $6,273/month, which is almost 49% DTI by itself. Add in $2,000/month on the land payment and you're well over 50% on the backend.

One option would be to settle for a lower limit on the line that would make the DTI work as is. Another option is to look at a cashout refi 30 yr FRM rather than a credit line. This would probably shave around $2k/month out of the payment.

I would ask for details on how they are calculating DTI and what they are including/not including. It may be as simple as waiting until the next year's tax returns are out to include more income (most banks base on Helocs on income reported on tax returns, and most have different guidelines for how it's calculated).

Jesse R Wien · Answer

Love where your head is at trying to make this work.  It's really the best solution.  I just got done explaining to an investor this gameplan.  If this was not a primary, we could do a DSCR HELOC.  Heck, we even can do a no ratio primary cash out, but not a line of credit.  I feel I would want to know everything you got and try to see if there is a creative way to move things around to see if there is a solution here.  I know some private lenders that might cross-collateralize, but not at HELOC rates, closer to hard money.  If you want to get on a call, I would be happy to hear you out and make some calls.

Andrea Castor · Answer

We did a cash out refinance of the 3 rentals around 2 years ago to get cash for the build. Not enough meat for that to make sense.

Kyle Deutschmann · Answer

As others have mentioned, bridge/residential transition loans might be your best bet for fast acquisition and rehab financing. You can use it either just for purchase financing or you can include both purchase and rehab financing, up to 100% of the deal if it's a high enough loan to ARV. If you have access to a HELOC, I have clients who will use me just for the acquisition financing and then use their HELOC for the renovations, and then come back to refi the property into a 30 or 40 year fixed rate DSCR loan once the rehab is complete where we don't consider your personal DTI. Happy to chat if you're still looking around for new options!

Andrea Castor · Answer

Hard money may be where we have to turn next. It just seems silly to borrow at 10%+ when we should be able to use our money at 7.5%

Erik Estrada · Answer

Have you looked into asset based lending options, such as a DSCR / Private Money Ground -Up Construction Loans?

Randy Halverson · Answer

Have you thought about doing a cash out refinance on your rentals?  Are you working on transitioning your business to LLCs?

Stephanie Medellin · Answer

If the 13k is all W2 income and they approved up to $750,000, they may already be counting your rental income.  Calculating rental income is not as straightforward as adding gross rental income to your income column and the PITI payment to your liabilities column.

Let's assume a 50% debt to income ratio, and rental income  that completely offsets your rental PITI.  That leaves you with roughly $6500 to spend on all other monthly expenses.  This means that $6500 must cover:

-Housing (mortgage/land loan, property tax, property insurance, and HOA if applicable) and

-Any other monthly debt obligations (vehicle, credit card minimums, installment loans)

With $2000 going toward a land payment, and another $1000 toward an auto loan, that only leaves $3500 to spend on your new HELOC payment.  $3500 isn't enough to cover $750,000 @ 7.5%, which works out to $5244 fully amortized over 30 years (and that's not likely to be the calculation they are using).  This makes me think you have good cash flow on your rentals that is being added to your monthly income.

I'd recommend asking their maximum DTI, then working backwards from there.  Find out the income they are counting, as well as the debts.  Also find out how they are calculating your qualifying payment on the HELOC.  From there, you will be able to see if there's room to adjust any of the numbers to increase your borrowing power.

Another option is a credit line against any brokerage accounts you may have.  These function similar to HELOCs, but are secured against your other assets.

How to overcome debt to income ratio

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