How do lenders view debt when looking at a 2nd investment prop?

[Lem Diaz]

Disclaimer: I live in the SF Bay Area (aka reallllly expensive to buy anything).

Help me understand how lenders view debt. So let's say I purchase a SFH for $800k and put down 160k (20%). So now I owe 640k. For that level of mortgage I'd be paying circa $3200/month.

If I want to purchase a second property for investment, while living in the first one, what are my options for financing? As I understand most "retail lenders" (Wells Fargo, Credit Unions, etc) will want a 43% debt to income ratio to qualify for another loan. So in this scenario lets assume I have a DTI of 50% or higher, but I can still manage to put down 20% on the next investment property...let's say it's another 800k house.

How do investors manage through these scenarios? I doubt a bank would want to give me a loan given how high the DTI would be across both houses.

Would the situation be different if the investment property had a zero dollar cash flow?  Meaning after all the capex, mortgage, insurance, property management, etc are all said and done I even out every month. What about the 3rd, 4th, 5th, etc property? Even if they even out from a cash flow perspective the debt starts to accumulate.

I guess in the end what I'm trying to figure out is how people can convince banks or lenders to give them these big loans when they're leveraged beyond a 43% DTI across all their properties.

[Chris Mason]

Hi @Lem Diaz,

Here's the basic way you qualify an investment property for a purchase mortgage when you do NOT intend to live in the property (ie, 'pure' investment):

[ Rent * 75% ] - PITI.

Rent used must be the lesser of appraised market rents, or current rent indicated on the current lease(s). 

Looks similar to the 50% rule, right? 

If that simple calculation yields a positive number, and you are working with an investor friendly lender, your calculated DTI (assuming the calculation is done correctly) will not go up. This is similar in concept to commercial loans with DSCR - "does the property service its own recurring expenses with money to spare?"

If that calculation yields a solidly positive number, I can actually add that to the income column of DTI and boost your qualifying income with it, and qualify you for more house than you otherwise might qualify for. Your typical landlord that owns a half dozen properties or so, their calculated DTI typically ends up extremely low, because it just keeps going down with each property they purchase - down around 15% is when a REI is approaching financial freedom.

If that calculation yields a negative number, you may or may not have DTI issues. We still don't have to hit you with the full PITI, however. The negative number will be added to the debts column of DTI, which is still better than hitting you with the full amount. So if the number comes out -$700, buying the house will have the same DTI impact as a $700/month car payment. Again, assuming you are working with an investor friendly lender, with minimal/no overlays, that does the arithmetic correctly.

Some lenders have overlays preventing all this. How lender overlays kill deals.