Financing...?

[Garrett Wenetta]

Hello All... New to this game... Having some capital
to start out with, but with a lower income, what are som recomendations for financing an income property. (thinking multi-family)

[Jon Holdman]

Start small. If your available cash, credit score, and income will let you buy a SFR and rent it, start there. Once you have two years experiece as a landlord (i.e., the rentals are on two tax returns), that income helps your to qualify for more loans. It helps in two ways. Initially, you'll have to qualify for the loan based on your existing income. Lenders basically assume you're going to fail as a landlord so they want to be user your existing income will cover you. Once you have the experience, the income will offset the loan payment. Second, once you have the experience, lenders will look at the expected income from the new property.

When calculating your DTI, start with your income and debt other then the rental. You have your total debt payments (the numerator) divided by your total income (denominator). Do the calculation. Now, factor in the rentals. What's the bottom line from Schedule E, which is where you report rental income. Savvy lenders will add back depreciation, which is not a cash outlay. You want a lender that's at least that savvy. Now, is the bottom line negative (a loss) or positive (you have rental income)? If its negative, it adds to the numerator. That is, it hurts your DTI. If positive, and that's what you want, it adds to the denominator and helps your DTI. Then, for a new property (once you have experience), a banker will take 75% of the rent and subtract the PITI payment on the new loan. Profit or loss, it works the same as above. Hopefully, you're picking profitable properties.

If you have no experience and little money (i.e, less than a 25% down payment plus closing costs and reserves), getting into a real multi family (apartment building) is tough.

Now, if you mean a duplex, tri or quad, you have other options. One is to try to get into an owner occupied loan. That will have a lower down payment. It requires you to live in one unit, though. And you will still have to qualify without the rental income.

Trouble with this is you're highly leveraged. When you sell a property, its costs you a minimum of 8% of the sales prices in commissions and closing costs. More if you have to give seller concessions or make repairs. So, if you buy with, say, a 3.5% down FHA loan, and then have to sell, you'll have to bring your "deferred down payment" to the table to sell.

Rentals are, to a large extent, a cash-on-cash return game. When you have little of your own cash invested, you don't get much, if any, return. All cash is low risk, but that often generates a lower rate of return, too.