Can't get a loan due to debt to Income... Ideas?

[Callum K.]

Hi!
I have been lurking around BP for a while and am very much appreciative for all the insightful information.

I recently sold one of my businesses and have plenty of cash to go buy multiple properties. I already own two properties and am about to rent out my primary residence as well. My problem is that despite the fact that I can pay for my new home outright (which will be owner/occupy) multiple times over I am trying to only have to tie up as little capital as possible, however I have been told that I cannot be pre-approved for a loan due to my debt to income ratio (DTIR).

My income is representative in the form of two W2 incomes, a 1099 source from the acquiring company as a consultant during the transition and one home that has been producing rental income for 2.5 years and another home that I bought in July that is producing rental income. My problem is that these homes are more pricey than typical rentals and I have mortgages on them which has brought my debt to income (especially now that one of my businesses has been sold) to levels just over 50% DTIR. I have struggled to find a lender willing to lend to me and I am thinking I just need to rent a place until my rental income from my home I bought in July and my soon to be rental income from my current primary home can be seasoned. That unfortunately puts me into spring of 2014 before I can do anything. Below are a couple questions I am struggling to get answered:

1. I have read here about the "buy and bail"program that should allow me to utilize my current (future rental) home income so long as I meet strict standards. I have seen the reference documentation on fannie mae's website, but no bank I have spoken to has even heard of this. If I can get them on board with that, then I can reduce my DTIR to reasonable levels. Has anyone had experience in using this program and/or does it still exist?

2. I keep hearing that you must have tax returns for 2 years showing the rental income and as of Oct 20th, it is only going to get worse. If I rent my home out in December of this year, will December's rent allow me to meet that requirement for the first year of showing it on my taxes or will they average the total rent out over the other 11 months or will they calculate it in some other form? I guess what I am asking is by "2 years on your taxes" does that mean 2 tax returns or a full 24 months of rental income on your tax returns?

Thanks in advance for any input!

[Dale Osborn]

Welcome to BP! Quite a post for your first question. Welcome to the banker's world of hoops and hurdles to get over so you can reach your set goals. Tomorrow at 10:00 Am I will finally be closing a refinance on a MHP that was started in July. In order to get around these hoops and hurdles - you will probably need to hit up friends and family to loan funds to you at a reasonable interest rate without all of the garbage fees that gets added on through the institutional lenders. When you have the additional items needed - lower DTI, higher credit score, 2-years rental income, etc.

Once upon a time I was shopping for a home and went through basically the same issues. I had military retired pay, was a real estate agent and had an apartment that paid all the bills with anywhere from $3K-$7K/month left over. We offered $300K for the home with $100K down. I thought with that much down it was a slam dunk to finance. We were disapproved - had just been licensed so commissions did not count, apartment income - did not have 2 yr history so could not count that. That only left my military retired pay which they deemed was not enough to pay for the $200K financed. Instead of buying a house - we went and bought a 2nd apartment (43 units). Two years later we did buy the same house - paid $350K; put $70K down (Got $10K back as commission) and financed $280K for 10 years. With all the extra income from the apartment, we made advance principle payments and had the home paid for in 6.5 years. Only home we have ever lived in that was free and clear.

Moral of story: Hang in there and things will work out for the best!

[Callum K.]

Thanks for the input Dan! Based on the posts I have seen, everyone seems to have the same struggles with the banking industry!

[Dale Osborn]

Same struggles and same solution - find a way to bypass the stumbling blocks in the middle.

[Jon Holdman]

"Buy and bail" that I'm familiar with works basically in reverse from what your thinking. You own and expensive house that you're going to turn into a rental. You buy a cheaper house, using the rent from the converted previous rental to help qualify. Then, having secured the new loan, you stop paying the old loan and let it fall into foreclosure. Banks are wise to this and will want you to qualify for the old and new ones without the rental income.

The two years, as I understand it, means two years experience with landlording. If you have rental income on two years tax returns then you should meet that hurdle. So, I would think all your rental income would count.

A lender will use their rule of thumb for new rentals and actuals for ones with data. The rule of thumb is "net rental income = (rent * 75%) - PITI". If that's positive, the net rental income goes into the denominator of the DTI calculation and helps. That is, it increases your income. If that's negative, the value goes into the numerator and hurts your DTI. That is, its debut you must support with your income. Not to mention if that rule of thumb gives you a negative number its probably truly a loser and really is hurting your net financial position.

If you have real history for a property, banks will look at your tax return and do the same calculation, but with the actual numbers.

If your rentals are truly profitable (all too many are not, unfortunately), then there will be income. But even profitable rentals don't generate large amounts of net income, especially if they're mortgaged. So, three rentals with no other income may not help all that much in the quest toward buying the forth. And the criteria for buying a residence (as far as DTI) is usually tougher than the 50% number you might find for investment loans. The total ratio for a OO loan is more typically 40% +/-.

Ultimately a house you live in is just an expensive doo-dad. Same as a car or boat. There have been discussions here of the relative merits of paying down a residence vs. mortgaging it to the hilt. I remain of the opinion that, as an expensive doo dad, you should just pay cash for a residence, if you're able. I suspect I'm probably in the minority in that opinion. But if you can "pay for my new home outright multiple times over", this price must be a small portion of your cash on hand. If you really want the new residence, just buy it. A few years from now you'll be in a position to refinance it and get your money back out, if your rentals are profitable or you have some other source of income.

[Lynn McGeein]

Like Jon said, the "buy and bail" rule we encountered hurts you, not helps. We just went through this back in March/April. If you turn your primary residence into a rental (even if you have a valid reason for moving, like transfer for employment), your entire mortgage payment counts against you as debt and none of the rental income for that property counts towards your income for at least 2 years, some lenders told us could be longer than 2 years. Also, for any investment property that has less than 2 years of Schedule E, we had to provide proof of a minimum 1-year lease and proof of deposits of that rental income, or they would not count that, either, even though we have several other properties and a history of being a landlord for over 10 years. I believe the only help of already having history of being a landlord was that they would take the 1-year lease and proof of rent deposits instead of making us wait the full 2 years to count that as income as well.

[Tracey Williams]

As everyone has said, the banks will not count your rental income untill you have 2years of rental history. Take note, you will have to give explanation for the source of your large down payment!

My experience with the banks earlier this year was very bitter but am encourage by Dale story. Some local banks were willing to help but still want to see the two years history.
Your other option maybe private money or HML.
Good luck.

[Tim M.]

Agreed with Jon Holdman - since you have the cash to buy mortgage free, just buy it. After your landlord seasoning (2 yrs) hits, you can start including rental income in your DtI (per Jons calculations). At that time you can refi or get an equity line and start to leverage the property.
Alternatively, if you didn't have cash to purchase outright, or maybe only enough for 25% down - you could get a cosigner. You'd essentially be 'borrowing' that persons good credit and DtI. Obviously this comes with inherent risk, and doesn't offer any advantage if you're able to do the first scenario.

[Callum K.]

Thanks guys for the info! It looks like my perception of the buy and bail program has absolutely nothing to do with my objective.

I too have felt the same way about owning a home and viewing it as essentially a waste of money which is really why I wanted to downsize and let my current home generate some income for me.

Thanks again!

[Steve Babiak]

If you do buy the house to live in with cash, you can probably get a HELOC on the equity portion for an amount that will fit within acceptable DTI. That HELOC money could then serve as some cash with which to invest, or to serve as reserve funds just in case ...

[Ann Contorno]

Hi! I agree with Steve. Buy the house cash and then just take a HELOC - you should be able to pull about 70% out with a HELOC which is a pretty good amount for liquidity sake. If the market comes back and we experience this hyper inflation that the pundits keep talking about you will end up paying a lot more for this property if you try to go back and buy it in two years time when you have all of your tax returns up to where the banks want them.

Have you looked into private lenders at all? That might be a good way for you to go - no hoops to jump through but you will have to put down a healthy percent as a downpayment in order to make it appealing to them. Which then you are back to where you would be at paying cash and then taking a HELOC.

You might want to look at private lenders for your acquisitions also rather than depleting your own cash reserves. OPM - other people's money!!!

[David Beard]

Maybe I didn't catch it in all of this, but per Fannie Mae the key to counting your former residence's rental income is that you have 30% equity in the property, 4 to 6 mths PITI cash reserves on your former and new residences, and a signed lease and proof of security deposit receipt from the new tenant. (The timing of securing a tenant and signing a lease to rent out your old house, at the same time you're trying to use that lease to get your new mortgage approved and closed admittedly sounds a little tricky, and I haven't been through it. I assume the underwriter approves your loan with a contingency that you have a signed lease of $x per mth, or the amount of rent needed to get your DTI where it needs to be, at which point you can sign your tenant for that much or more).

You're a 2+ year landlord, so you pass that test and should be able to count all rentals you own without seasoning as long as you have signed leases and proof of security deposit. If this is not what you're hearing from the lenders you've talked to, keep calling around to find one that follows Fannie's guidelines to the letter. You may have to call a national lender (big banks like Citi, Wells, Chase, etc.). I'm aware of a local bank in my area that says they're "direct" to Fannie and thus have no overlays/adjustments to stated guidelines.

Results of properties that you had "in service" for a partial year (from your Sch E where you state how many days you rented the property during the year) are annualized. If the purchase is newer and hasn't been on any tax return at all, the bank is supposed to use 75% of gross rent - PITIA, as John indicated above. Fannie even says that for a new subject property without a tenant, a "comparable market rent" form can be completed (by the appraiser, I'm sure).

[Luis Castillo]

Consider doing a lease option on a house you really like right now. Lock the price down for two years and you will easily qualify and hopefully the market has recovered by then. In the meantime use the money to buy a multi-family to generate even more income.

[Tim Delp]

The rental income from your current rental property is going to be obtained by looking at the past 2 years of tax returns (2011 and 2010). it is not going to be what you actually made but what you claimed on your tax returns after all expenses. Many times what an investor makes and what they claim are two different things. they will allow you to add back any depreciation. If you have claimed rental income on those two years they will average them to determine your positive or negative cash flow. It is a pretty simple calculation in looking at gross income, minus expenses plus depreciation.
If you've claimed this for the past two years that should establish your history of managing problems.
As far as renting out your current home and buying a less expensive home: that is at the underwriter discretion. There are multiple possible issues/red flags. Buy and bail being the first and then the 2nd is owner occupancy. Anytime someone is going from a more expensive larger home to a less expensive smaller home an underwriter wants it to make sense? Also how long have you owned your current home? If you bought it a year ago and are now wanting to buy another primary, underwriters don't want you buying a bunch of primary residences when your goal is simply to avoid getting an investment property loan for your acquisition of additional investment properties.
Next issue is you just sold your business and it sounds like your sole source of income is from the business you just sold. Most underwriters are going to assume they have kept you on for a period of time and this new position is likely to end at some point in the next few years if not sooner as the company no longer needs to retain you for the transition.

Just my thoughts on why you are seeing the difficulty you are facing.

[Callum K.]

Hi Tim Delp,
Thanks for the response. I have navigated through the lenders and have come up with a solution that seems to be working out. I am refinancing my current primary residence but it will be refinanced to an investment property while also lowering the interest rate plus I am going to pay a little more down on it to change it from an FHA home to a conventional loan. This will also help me increase the cash flow so that it remains positive for future properties. Given the equation that the bankers explained (as well as many people on this thread) I will be in the positive cash flow of about $400 per month. The tenant has signed a two year lease and he plans to be here for 5+ years so my investment in paying down the mortgage at the refi closing will have a payback of just over 2 years.

The business that was sold was actually a secondary source of income. I was fortunate in that it was a side business that grew to something far more valuable than ever expected. I still have my primary job now but the problem is that my secondary business (until we sold) was increasingly paying me more and more so I have lost that income, but still have 3/4 of my overall income which hasn't had any issues thus far.

I have lived in this home for 5+ years and I would hope that the fact that I am converting this loan to an investment property should provide the underwriter piece of mind, but then again my situation seems to be difficult for them to understand (i know its uncommon).

So I have convinced the lender to include the rental income from my second property (the one I bought in July) and now they are telling me that when I buy another property next year (which will be after I file my taxes) they will be able to include all of my sources of income except for my current residence. This is because there is not enough rental history with this property. What I don't understand is that they told me I couldn't use my second home as income (which yields positive cash flow and offsets its mortgage per everyone's comments) then they told me I could because I had two years of rental income experience (not two years rental income per property) and now they are telling me that next year I won't be able to use my current home's rental income. When I asked why they said: "the reason its difficult is because my current was once a primary residence and the home I bought in July was purchased as an investment property". My argument is that by next year when I go buy more homes, my current property will have been converted to an investment property as far as the mortgage is concerned, I will have 25%+ equity in the home, I have a contract on it, will have recorded taxes on one months rent (my current home lease begins Dec 1st), and received the deposit from the tenant so what/how can they make the case that this home is any different than my second home?

I caved in and let it be for now, but I think this might be a battle to tackle in April once the dust has settled. If you have any insight on whether or not they are right then I am all ears. So far the more information I am gaining from everyone on this forum the more battles I am winning with these lenders.

Thanks and sorry for the long response

[Tim Delp]

Callum Kerr;

Sounds like you are making progress. I'm in mortgage banking and as I understand the guidelines you need two years of history managing rentals which the evidence is typcially two years on claiming rental income on your tax returns. It appears you have passed that part of the equation. Now that you have that done each additional property you purchase or that you have a history of receiving rental income you should be able to offset any mortgage payment with a rental lease and proof of rental receipt. I would be as detailed as possible with the lease, make copies of the rent checks you receive and be able to match it up with the bank account where you deposit the rent checks.
The typical guideline is that they will allow you to count 75% of the rental income to offset the mortgage payment. I would think you can find a lender that will allow you to use that method for future purchases and any properties you do not have on the past 2 years of tax returns. This may cause you to get a little less rental income than you are actually netting but still should help overall dti.
The other thing is it is always a gray area when you start asking lenders about how this will be viewed in the future as they can only really talk about now but I would think that if you have the 1 month claimed as copies of all checks and corresponding deposits that match up with your lease and can really show detail they would allow you to count the 75% to offset some or all of the mortgage payment.

[Callum K.]

Excellent. Thanks for the feedback. I am keeping all checks and reconciling them with the bank statement for each property moving forward. I was a little nervous that next year they might try to do something like only account for 1/12 of my current rental income for 2013 since I only received one months of income from the home despite the contract and payments.

[David Beard]

Callum -- take a look at this Fannie documentation on rental income. Partial year income on your Sch. E is annualized, based on the number of days you specify the property to be "in service" during the tax year.

https://www.efanniemae.com/sf/guides/ssg/sg/pdf/sel051512.pdf#page=340

[Callum K.]

Hi David,
So If I am reading the correct section you are referring to, then you are speaking of page 316:

"If the borrower is able to document (per the table below) that the rental property was not in service the previous tax year, or was in service for only a portion of the previous tax year, the lender may determine qualifying rental income by using
• Schedule E income and expenses, and annualizing the income (or loss) calculation; or
• lease agreement(s) to determine the gross rental income to be used in the net rental income (or
loss) calculation."

If I understand this correctly, then when I apply for the loan after I have converted my primary residence to a rental home, then per the first bullet point I should be able to annualize (Gross Rental Income / # of days 'in service' x 365) the rental income next year when calculating my debt to income ratio because I will have had my soon-to-be renter in the home for the month of December 2012 (one months rent / 31 days x 365 = total rental income x 75% = allowable income). This would allow me to annualize this rental income as it will be on my 2012 taxes + i have an executed 2 yr lease agreement for additional documentation. Of course, the lender will have to still use only 75% of this income, but am I reading that right or were you referring to another section in this document?

[Scott W.]

I rented out my primary residence this past june & bought another home.

Unlike you, I couldn't count the rent vs the PITA. I showed 6 months' reserves in my 401K per property.

I put 20% down with Wells Fargo & they sold it off to Fannie or Freddie (can't remember who).

The 75% of rent - PITA = winner or loser is not always true. I have high principal each month plus some cash flow. No way I'm losing $ unless the value of my home continues to go down.