All Forum Posts by: Josh Young

@Elmer Wayne Fisher it depends on the rate/terms of your current debt on that property, but generally 3 options: cash out refi, home equity loan or HELOC. You should calculate Return on Equity to help you decide. Here is an article that I wrote that might help.

How to Become a Rental Property Investor

Talk to a lender and learn the rules of qualifying for a mortgage

You need to learn the rules that underwriters follow to be able to qualify for a mortgage. Once you learn the rules you can develop a plan to fit the lender's qualification requirements. Terms to learn and what lenders will need from you: Debt to Income Ratio (DTI), W-2, Pay Stubs, Bank Statements, Tax Returns, and PITI (this is your total mortgage payment including Principal Interest Taxes & Insurance).

Buy a primary residence to live in

Primary Residence loans have the best rate and terms, they also require a relatively small down payment (5% or less) making this the most affordable way to get started. You will be required to move into the property within 60 days and live in it for at least 12 months. You should buy in the best neighborhood that you can afford.

Buy a new primary residence to live in

After you fulfill the requirements of living in the previous home for a year, you are ready to turn it into a rental and move into a different house. Qualifying for the next house is the same as the 1st with one difference, you are going to have two mortgages. Good news, the lender will be able to offset the mortgage on the 1st house with 75% of the market rent since it is going to become a rental.

Example: your PITI (including HOA) is $1500 and market rent is $2000, this will cancel out the 1st house on your DTI and all you have to do is qualify for house #2. If market rent is only $1600, then that will hurt your DTI by $300 (75% of $1600=$1200), you can still keep it as a rental, you just won't qualify for as much on house #2.

Calculating your Return on Equity (ROE)

Say you paid $250k for a property and the PITI (including HOA) is $1500, current value is $330k and you owe $230k, so you have $100k in equity. Market rent is $2000 (expenses of: 4% CapEx, 4% Maintenance & Repairs, 4% Vacancy, 8% Property Management) these expenses equal 20% of rent (these vary a lot depending on the property, but this is a good starting point), so Net Rent after expenses is $1600.

This means you are getting $100 of cash flow; $1200 annually

Plus let's say your monthly principal portion of your PITI is $500; $6000 annually

Plus let’s say your property appreciates 3% on $330k value that's $825 monthly; $9900 annually

Total that’s a $17,100 return on your $100k (17% ROE)

Lets change this example so the property only rents for $1600, so $1280 after expenses:

Cash Flow -$220; -$2640 annually

Principal Paydown $500; $6000 annually

Appreciation $825; $9900 annually

Total that’s a $13,260 return on $100k (13% ROE)

Cash Out Refinance Example

Home is worth $400k and you owe $160k (Rate of 4%). PITI is $1300, Principal Paydown is $400 and Rent is $2000 ($1600 after expenses)

Cash Flow $300; $3600 annually

Principal Paydown $400; $4800 annually

Appreciation $1000; $12,000 annually

Total that's a $20,400 return on $240k (8.4% ROE)

In this example I would consider a cash out refinance, you could borrow up to 75% of the Value, so you'd take out a new loan for $300k (Rate of 5.5%), pay off the $160k loan, pay some closing costs and cash about $130k tax free that you could use to buy another property and add to your reserves. Your new numbers on this property would be worth $400k, owe $300k, PITI $1900, Principal Paydown is $300 and Rent is $2000 ($1600 after expenses)

Cash Flow -$300; -$3600 annually

Principal Paydown $300; $3600 annually

Appreciation $1000; $12,000 annually

Total that’s a $12,000 return on $100k (12% ROE)

This example might look like you went negative on cash flow, but remember you took $130k cash out of the deal, you were making $3600 per year in cash flow, so that’s over 36 years of cash flow that you took all at once and if rents increase by 3% annually you will be back to positive on your cash flow within 5 years.

Why you don’t want to pay a property off

Let's use the same example as above, but say its paid off, so $400k value, PITI is $200 (because you will always have Taxes & Insurance), Rent is $2000 ($1600 after expenses)

Cash Flow $1400; $16,800 annually

Principal Paydown $0

Appreciation $1000, $12,000 annually

Total thats a $28,800 return on $400k (7.2% ROE)

Other Key Considerations

This strategy can build equity and create wealth but managing the cash flow and reserves is essential. As you can see in the examples, the cash flow usually makes up the smallest portion of the overall return, but the cash flow is what you need to survive. Make sure you always have 6+ months of PITI payments as reserves. Appreciation and rent increases can really accelerate this strategy. The key to both of these things is buying in an area that has an increasing population and high paying job growth, tech jobs for example. Here in Arizona, Gilbert and Queen Creek are both great examples of this. Over time, rents increase, values appreciate and the principal portion of the PITI increases. As the amount of equity in a property increases the ROE decreases, when the ROE gets below 10% it's time to consider doing a cash out refinance or second position loan or sell the property. There are also tax considerations, such as depreciation and IRS Section 121 Exclusion.

@Oscar Adams

You can buy a distressed property for cash, you can find these under market value because banks won't finance them, so the buyer pool is much smaller since it has to be cash/hard money loan; do a cosmetic rehab in cash, and then do a cash out DSCR loan that is asset based, so you don't need income to qualify. This will allow you to get some/most of your money back and you will have a cash flowing rental property. You need to speak to a Mortgage Broker about requirements on the cash out DSCR, especially being from outside the US there may be additional requirements.

Quote from @Jordan Budke:

Quote from @Josh Young:

@Jordan Budke

You need to talk to a lender and create a plan, it might be a 12 month plan that requires your wife having w-2 income on your 2023 tax return and you having the same employer, pay off any bad debt that you have (basically any debt that's not your primary residence), this will help your credit and DTI. After you file your tax returns next year you might be ready to take out a HELOC on your condo and/or buy a new primary residence to move into, if you keep your condo to rent out long term they should be able to count 75% of the rent to help you qualify for the house; and honestly it might have to be another condo before you get to the house, but talk to a lender they will help you develop your plan. I know a year sounds like a long time, but even if it's two years you will look back and be glad you made a plan, a lot of people have a dream of owning rental properties but they never make the plan.

 Thanks, brother. Does my wife need a W-2 job for sure? Is there a way to do this without my wife having a W2?

Maybe, but maybe not, it might just mean that you have to claim her nannying income on your taxes for a year or two for it to count, so that would mean paying 15% self employment tax, just don’t write off a bunch of expenses since you are trying to show income. But a lender will be able to tell you for sure and they don’t charge anything for a consultation/advise, a lender has certain guidelines that they have to follow so that their underwriters will approve the loan and so they can sell it to fannie mae or freddie mac, there are lots of different guidelines for different types of loan, you just need the lender to educate you so you can reverse engineer your way to fit into the guidelines they have.

@Jordan Budke

You need to talk to a lender and create a plan, it might be a 12 month plan that requires your wife having w-2 income on your 2023 tax return and you having the same employer, pay off any bad debt that you have (basically any debt that's not your primary residence), this will help your credit and DTI. After you file your tax returns next year you might be ready to take out a HELOC on your condo and/or buy a new primary residence to move into, if you keep your condo to rent out long term they should be able to count 75% of the rent to help you qualify for the house; and honestly it might have to be another condo before you get to the house, but talk to a lender they will help you develop your plan. I know a year sounds like a long time, but even if it's two years you will look back and be glad you made a plan, a lot of people have a dream of owning rental properties but they never make the plan.

@Kyle Keane
If you have bad credit you can buy a rental property using a DSCR loan that is asset based rather than credit based. Or you could buy a distressed property using hard money (also an asset based loan) and rehab the property, then either cash out refi or sell for a profit. Another option would be a primary residence FHA loan if your credit isn't too bad, anytime you can get a primary residence loan it's a huge advantage even if you have the extra cash it's almost always better to hold extra cash. Either way you should talk to a mortgage broker, they will be able to give more specific advice. Good luck!

@Paul Sanchez

Hard to know without more detail about the property, but looks like you won't make much after 4% vacancy, 4% maintenance & repairs, 4% CapEx, and 8% PM. The good news is that's calculating on high interest and 15 year amortization, these numbers would look really good if the loan terms were 7% interest on 30 year amortization, but expenses could be double what I've estimated if it's a class C property. Either way make sure you have extra reserves to give yourself time to pivot if needed.

@Brett Brideau

The best way to learn is by doing. If you already own a home that’s a great start. Now you could buy another primary residence putting just 5% down on a conventional loan and turn your current house into a rental.  You can use 75% of market rent on your current house to help you qualify for the next. Once you have a rental you will really start learning.  Good luck!

@Julio Gonzalez

It's important to have a plan, looks like you are on the right path. I'd recommend speaking to a lender, borrowing money is a very important step and understanding the rules for a conventional loan is important. A lender will be able to inform you about specific requirements such as DTI, W-2, tax returns, etc; these will be an important part of your plan. Good luck!

@David B.

I would talk to a mortgage broker, I have heard the seasoning requirements only apply to cash out conventional, so you can do a cash out refi with a different loan product (non conventional) just make sure there is no prepayment penalty and then immediately refinance that loan into a conventional loan, the seasoning period won’t apply to the conventional refinance because it will just be a rate and term refi, not a cash out.