Maintaining Credit While Using the BRRRR Method
Flipper/Rehabber · Houston, TX · Member since 2016 · 77 posts · 19 votes
So I threw the idea out to my father about BRRR'ing out his home to get a jumpstart with his investing career. He's got a very nice home in a Cleveland suburb that he owes roughly $55k on and it would appraise probably around $135-150k (my conservative guess based upon a comp up the street from him selling for $170k that has newer updates and finishes). He renovated the home fully in 2009/2010 and does a very good job keeping it up, adding new things periodically, etc. He's looking to rent the home out and move in the near future.
He's interested but highly apprehensive because he fears what the refinance portion will do to his DTI%. He definitely has a valid concern about refinancing and how it will lower his credit score for anything he needs to use credit on. Unfortunately I couldn't answer how it's possible to BRRRR and maintain your credit for him so I'm hoping someone here can give some insight in how to BRRRR and maintain a decent credit score. Or at least something on your experiences. Anything is appreciated. TIA!
Hey @Thomas J. Clifford, DTI is a measure of your debt obligation against your monthly income. What creditors do is add up your total monthly debt obligation divided by your monthly income. For example if you have $1000 of monthly payments and you get paid $2000, you have a DTI of 50%. So if you purchase a cash flowing asset that pays you $200 a month after debt service now when the same creditor looks at your file you look like $1,000 a month in debt payments and $2200 a month in income. The rental income offsets the debt! now your DTI is 45% thus improving. The lower this number the better. Don't quote me on this but I think that most lenders need you DTI to be 45% or lower to get approval. Essentially once you qualify for the first refi you qualify indefinitely. Well assuming that you always buy properties that cash flow and that you don't increase your debt that shows up on your credit report (personal home mortgage, car notes, credit cards, etc) I hope that makes sense!
That maybe an over simplification of the process, so hoping a mortgage guy can jump in on this!
@Ryan Collins as a mortgage broker I can tell you people get way too caught up in their credit score. If you have solid credit habits a hard inquiry is not going to effect you that much and once you make your first payment in that new debt you will notice it stabilize. The probable is when people have bad credit habits and end up effecting their score much faster than a hard inquiry for a refinance. Keep your revolving credit low and payments on time, that’s the formulae for success. Credit is meant to be used, you build it up to use it for a purchase and then you wait again to build back up for the next use.
I have done 15 or so Brrrrs and my credit does not ever take a hit! Most lenders will include the rent as income on the debt so buying more properties actually improves your debt to income ratio as more properties lead to more income! As far as your actual score, I never noticed my score going down after purchasing a property but my score did drop a tad when I went out and bought my brand new truck! Lol
I've wondered the same things @Ryan Collins, thanks for posting this. Still learning about the BRRRR strategy....
@Stephen Akindona, I'm a little confused I guess by how the DTI% improves, and if you could briefly break it down I'd appreciate it. If you are doing multiple BRRRRs where you cash out 65-75% of a property's equity and create a long-term line of debt, how does the amount of debt you accrue not vastly outweigh the monthly income you bring in?
Is it offset by the 25-35% equity you still have in the property, or does that even matter? Is the DTI% more based off of the monthly cashflow after ALL monthly costs are paid?
T.
Hey @Thomas J. Clifford, DTI is a measure of your debt obligation against your monthly income. What creditors do is add up your total monthly debt obligation divided by your monthly income. For example if you have $1000 of monthly payments and you get paid $2000, you have a DTI of 50%. So if you purchase a cash flowing asset that pays you $200 a month after debt service now when the same creditor looks at your file you look like $1,000 a month in debt payments and $2200 a month in income. The rental income offsets the debt! now your DTI is 45% thus improving. The lower this number the better. Don't quote me on this but I think that most lenders need you DTI to be 45% or lower to get approval. Essentially once you qualify for the first refi you qualify indefinitely. Well assuming that you always buy properties that cash flow and that you don't increase your debt that shows up on your credit report (personal home mortgage, car notes, credit cards, etc) I hope that makes sense!
That maybe an over simplification of the process, so hoping a mortgage guy can jump in on this!
@Stephen Akindona - Thanks for that explanation - if I could give it 100 upvotes, I would!
If we're scaling that concept and using a 2nd property with the same exact figures, your DTI% would stays the same, since that ratio hasn't actually changed - is my math on that right?
If that's the case, why do lenders like conventional mortgages stop at 10 properties? Is their expectation at that point that you resolve some of the debt and pay off one of the properties before they will consider doing another loan with you?
T.
@Thomas J. Clifford you are correct! As to why lenders make you stop at 10, that I can’t explain! The beautiful thing about this strategy is, if you have a wife or significant other and they qualify, they can have 10 in their name and you can have 10 in your name! Then once you hit 20 you can use a portfolio lender to redo these into a commercial loan and thus start again building 10 loans each! So you can always free up your Fannie Mae loans to acquire more properties.
Although this works and I have built our current portfolio like this it is extremely hard to scale! After I bought my first coupe properties literally “0” out of pocket I was very excited but we haven’t been able to really scale this model! That’s why I am personally making the switch to commercial properties!
His credit shouldn't take a hard hit. He should do it now, while it is a primary residence as he will get better rates and LTV. When he decides to rent the property out, he will be able to count the rental income to improve his DTI's as well.
You all are awesome! Thanks for responding so quickly and for all the information. I couldn't find anything specifically related to this when searching the forum so I'm glad this was able to help you as well @Thomas J. Clifford
So, two other things I wanted to bring up and confirm is that ultimately the cash out from these refinances are non-taxable because it is just the increase of the loan. Right?
And then secondly, can anyone speak on the "seasoning" period required by most traditional banks when doing these refinances? This was something new to me I found out when asking a lender I've worked closely with. He told me at least 6 months is required after the purchase before I'd be allowed to do a refinance. Seems like it would obviously slow things up a bit for someone just starting out in the RE game.
@Ryan Collins, yes any cash pulled from a cash out refi is a non taxable event. No income tax to pay on this!
There are banks that require seasoning periods for refis but there are several that do not! It is called delayed financing and if your settlement statement is structured correctly you can pull out all of your investment capital on refi!
If you however are trying to get cash out above your investment amount (purchase price + rehab) then most banks do require a little seasoning for a cash out!
@Stephen Akindona I specifically remember one of the BP podcast guests in some episode mentioned that during his delayed financing cash purchases, he tells the closing company to just add a line item of "rehab/remodel cost" to the HUD, and since the closing company doesn't really care if you want to add money into the close, later when you initiate your delayed financing, your additional money will let your refi out more equity out of your property than if you hadn't put in that line item, because the amount you can refi out is based on what's on your HUD when you bought.
I always wondered how true this is, and if there are limitations.
@Stephen Chu, that's absolutely how it works! The only limitation is that the bank will only lend up to 75% of appraised value. For example if you buy a property that appraises for 100k for 60k and the rehab is 10k. If you fail to put the 10k on the hud as a line item then when you refi the max you can get will be the 60k! If you put the 10k on the hud then you can pull all the capital back out!
@Stephen Akindona - Thanks for that explanation - if I could give it 100 upvotes, I would!
If we're scaling that concept and using a 2nd property with the same exact figures, your DTI% would stays the same, since that ratio hasn't actually changed - is my math on that right?
If that's the case, why do lenders like conventional mortgages stop at 10 properties? Is their expectation at that point that you resolve some of the debt and pay off one of the properties before they will consider doing another loan with you?
T.
Just to clarify, the reason most lenders stop at 10 properties isn't because of DTI ratios it's because Fannie Mae and Freddie Mac won't back the loans after that point and the banks aren't able to sell them. If you find a bank or institution that holds their own notes and doesn't sell them (portfolio lenders) then they don't mind giving you as many mortgages as makes sense for them.
@Stephen Akindona hi Stephen, I'm interested to learn how you able to build BRRRR systems, process and leverages. What you did to start BRRRR? You build a teams, systems and process prior to buying your first property with BRRRR strategy? I'm curious about day to day habits of creating a BRRRR enterprise that is automate process of analyzing deals weekly/monthly. What is your role? I read the book by David Greene and he radically transformed how I do real estate investing before and after reading his work. I have been spending a lot of time building teams and networks. I'm also working to build a system to start with. What are your thought?
@Alex Jones we can discuss further but I essentially had to find and build relationships with all of the pieces you need to do a successful brrrr deal! I had to find and hire contractors, lenders, private money sources, and wholesalers. We do a lot of our own marketing for deals direct to sellers but I often use other wholesalers deals as well. There is a limitation to the brrrr strategy in that you can only have 10 fannie mae loans in your name at any given time! Once you build to 10 you can essentially use a portfolio lender to refinance all of your loans into one commercial loan and thus reset the counter!
My day is consumed with finding deals!!! I spend the good bit of my time talking with potential motivated sellers and making tons of offers on the MLS! Once we find a good deal we have to analyze it to determine if the brrrr strategy will work. I usually aim to pull all of our money back out so I have to be all in the deal, including private money fees, and refi closing cost at 75%. If I can achieve this and still cash flow every month then we will brrrr it!
I have several private lenders that I use and a couple of different lenders that I use as well. We hire contractors to do the work and have to manage the construction project. We aim to be out of the private money loan in 45 days so we immediately start the refi process as soon as we close on the property. While the rehab is in progress we get all of the initial disclosures and loan process out of the way up until appraisal. Once we are done with the rehab appraisal is then ordered and we are 2 weeks away from closing out the deal with long term financing in place.
It is important to note that I do all of this in my local market! I do not do this at distance but as long as you have these key team members it is absolutely doable!
@Stephen Akindona thanks so much for sharing your day to day operations and that was a great insights for me. It was very helpful!
Alex