Effect of rental properties on getting a primary home loan?

Question

I currently have 1 rental property, and a primary residence in my wife's name. I am close to purchasing a 2nd rental property, and hopefully another by the end of next year. My wife and I both have reliable full-time jobs. I already have over 2 years of landlord experience, so the rental income would be used towards our income, but I am concerned about our debt-to-income ratio when we are ready to upgrade our primary residence? Will the bank require more from me because I have so many properties and high debt compared to income?

Julie Falen · Answer

Another strategy to consider is using hard money or private money to finance the purchase if you can make it cash flow at the higher payment, which is typically interest only anyway. If you have the 30% down anyway, purchase the property, then refinance it in a year after you have a rental history on the property. This is especially true for 2-4 unit properties but also good for SFR. It is typically easier to refinance a property than to qualify to purchase it.

Joshua Hernandez · Answer

Is two years landing experience required to have the positive net cash flow count towards your income? If so, will the PITI on rentals count towards your debt servicetill tthen?

Mike McKinzie · Answer

Jon and David are correct. Another way to look at it is to consider each rental as a BUSINESS, including any debt on the rental. Do not add the "Business Debt" to your "Personal Debt." Now, either your business MAKES money or it LOSES money. If it MAKES money, you have more income and if it LOSES money, you have more expenses. All of your rentals whether you have 1 or 1,000, will add just ONE NUMBER to your DTI ratio.

Jon Holdman · Answer

As David Beard points out, this isn't how it works. Lets assume that actual expenses exactly hit 50% of rents. In Example 1, lets assume the interest part of the PITI number (which is NOT part of the 50%) is $300. Monthly income of $1500 implies $750 in expenses, which include taxes, insurance, maintenance, vacancy, property management, etc. So, $1500 - $750 - $300 leaves you $450 a month or $5400 a year. That increases you income in the DTI calculation, so owning this (very good) rental lowers your DTI. Same calculations and sames assumptions on example 2 gives $200 a month income, $2400 a year. That also helps. Lets do a third example with rent of $500 a month. That implies $250 a month for expenses. With the $300 in interest, you're $50 a month in the hole or $600 year. That adds $50 a month to the debt side of the DTI calculation. In other words, you have to qualify for that $50 of debt payment with other income.

Josh James · Answer

Hey David Beard, you are probably right. I am in a smaller town, quite far from a large market. The banks here have been very difficult for me to work with. Some refusing to allow any rental income at all. I literally just went through a round of searching for a bank to work with me on this exact problem. I found one local bank, not a national brand, that would give me financing. I am looking at acquiring new properties, not financing existing ones with two years good numbers in place. All that said I have great records on the few properties I do own and rent out. Most have only wanted my personal income, and have not been interested in counting the rental income.

John Horner · Answer

Josh James, that sure would be ideal wouldn't it! At least in the Columbus market, it would be tough to get that number to 33% without putting 50% down or more. You're right about the creative financing though, I would love to find some deals like that as well!

David Beard · Answer

Josh James - that is not the way banks typically compute DTI ratios. If you have the requisite two years of landlording experience, then they compute Net Cash Flow (NCF) on a rental property. As Jon said, if it's positive, then NCF is added to income. If it's negative, it's added to debt. There is typically no "splitting" of the debt and income as you suggest, except in defined instances such as when you are an owner-occupant of a multi-family property such as a 4-plex. The NCF is computed most readily by going to the tax return from the prior year, start with the bottom line for the property, then add back depreciation, interest, taxes, and insurance. From that figure, subtract off the current PITI as indicated on the loan statement for the rental property. If the property was only in service for a portion of the tax year, you will annualize the NCF. In some cases, particularly if the property has been purchased recently and there is no tax return data yet available, banks may use a simplified formula of (Gross Rent * 75%) - PITI, where the 75% represents vacancies, maintenance, property management, and miscellaneous expenses. However, the preference is to use tax return data if available.

Josh James · Answer

Just a quick numerical idea to throw your way. If you are looking for hitting a certain debt to income ratio, then aim your rentals there as well. Your debt incurred from owning the property to property income ratio should be the same as your DTI ratio. So lets look at that in numbers: Example 1: Monthly PITI on rental: $500 Monthly Income: $1500 DTI: One-third, or ~33.33...% Owning this property would have almost no effect on your DTI, assuming you are targeting a 35% DTI. Example 2: Monthly PITI: $500 Monthly Income: $1000 DTI: One-half, or 50% (see 50% rule for rentals) Owning that property would hurt your DTI, moving your closer to the 50% point. Some ideas to help? Pay down and refi at lower payments, increase property rent, purchase with seller financing, partner on some deals, there are lots of ideas out there to help you keep on investing!

John Horner · Answer

Thanks Jon Holdman, that helps a lot!!!

John Horner · Answer

I understand that, but my concern is that standard for loans I believe is 35% of your income should cover the PITI. As I acquire more rentals, even though I will increase my cash flow, my Debt to Income will increase because the odds of my rent being only 35% of my PITI is slim to none. Probably more like 50%, which will bring the DTI ratio up.