General advice on a financing plan for first deal/Interest rates

[Andrew Lapham]

I am a complete REI newbie looking to gain some knowledge on the financing side of a potential first deal. I was looking for some advice on the following financing plan, plus have what I am sure will turn out to be a very simple answer to an interest rate question on loans.

Plan: Borrow the complete purchase price of a SFR or MFR (under 200k) from family and friends. Structure the family loan with an attractive interest rate (family special, hopefully around 6%) and a repayment period of 13 months. After the property has shown a positive rental cash flow and a great new ARV, refinance at 12 months with a conventional lender on a 30-year loan for 70% to 80% of the new ARV, paying back family and friends and pulling out whatever profits are left for the down payment on the second investment property. The BRRR strategy I have read so much about.

Questions/Concerns:

• If 200k is borrowed from family how would the hypothetical 6% interest be calculated?  For example, could the 200k be divided by 360 payments (30 years x 12 months = 360 payments / around $550 a month) plus 12k divided by 360 (6% of 200K / around $30 a month) for a monthly payment of around $580 be the structure of the loan? Again, I am sure this a really basic question and I am also sure that these are really attractive lending options that aren't really realistic, but I am just looking to better understand the process.
• Any suggestions or templates on how to write out a lending contract with family and friends?  I know that borrowing from family can be extremely tumultuous if the things go wrong and want to cross my t's and dot my i's.  Any great lessons learned from family and friends lending?
• Will a conventional lender refinance on numbers that look roughly like this? I know this is pretty general and fully depends on the new ARV, but what are some potential hiccups with this plan? Our current family DTI is around 28%, solely from the current mortgage on our primary residence. We have no other debt, but I am worried that a lender will think we are over leveraged and we won't be able to refinance.

This is my general plan with lots of future knowledge to be gained before the deal.  I truly appreciate any advice, knowledge or harsh criticism on the plan.  Thank you for your time and I look forward to the discussion.  

Best Regards,

Andrew

[Jared Bouzek]

@Andrew Lapham When you refinance an investment property, there are two primary ways of calculating your income from that property. 

1. If you have owned the property for less than a year and it does not appear on your tax return, you take 75% of the gross monthly rents and then subtract your monthly PITIA (Principle, Interest, Taxes, Insurance, & Association Dues). If the resulting number is positive, it adds to your monthly income. If it is negative, it is included in your monthly liabilities.

Example: 

$1,800 Monthly Rent * 75% = $1,350
$1,500 PITIA Payment
$1,350 - $1,500 = ($150)

So you would carry $150 to your monthly liability payments.

2. If you have owned the property longer and are declaring it on your tax returns, there is a slightly more complicated way of calculating your income. A loan officer should use your Schedule E of your tax return and take your Net Income or Loss and add back to this number the following deductions: Mortgage Interest, Insurance, Taxes, HOA payments, Depreciation, and any major one-time event expenses. Note that you need to be able to justify adding back the one-time expenses (documentation, separate line items, etc.). Once the deductions have been added back in, divide this number by the months the rental was in service to get your monthly income and then subtract your PITIA payment back out. Once again, if the resulting number is positive, add to your monthly income. If negative, include in monthly liabilities.

If you want to see this laid out in a spreadsheet format, google: Fannie Mae form 1037

What I just spelled out is the exact Fannie Mae guideline. Yes, lenders can add their own overlays on top of those guidelines, but the key is finding a lender who doesn't have overlays and a loan officer who knows what they're doing.

And yes, you're correct that valuation will be done based on comparable sales, but let's say you're refinancing 6 months after your purchased a property. You purchased for $250,000 and did extensive repairs and now your appraised value six months later is $325,000. Within that time frame, the appraiser is likely to note your purchase price from six months earlier. Some underwriters may question this steep valuation climb. It just helps your case to be prepared to show invoices for the work you did to increase the value that much in a short time period. We try to make underwriters feel warm and fuzzy about what they're doing.