Investment Property Loans You’ll Wish You Knew About Sooner

have you locked down your first deal or maybe two deals and your lender has told you that your debt to income ratio is now maxed out has this stopped you from taking down your next property well today in the show we're going to discuss conventional and non-conventional ways that will help you scale your portfolio hey investors my name is Dave Meyer and today we have a bigger news episode for you we're bringing back A lender we had on the show last week Jeff welan and last week if you didn't listen yet he discussed firsttime home buyer programs that can help you get to that first deal if that's where you are in your investor Journey but today we're going to be talking about how investors who have already locked down one two or maybe three properties and are wondering how they can get financing to build their portfolio further and this is a really common issue for investors you get your first few deals and then no one really wants to lend to you anymore and it's one of the reasons why I think that getting from two or three Deals to five or 10 deals that part that like middle part of scaling is really one of the hardest parts of building your portfolio so that's why we're bringing on Jeff to help you navigate some of the Strategic decisions some of the Tactical things that you could do to make yourself more lendable and make financing easier as you look for your next property before we get into the show our bigger news episode today is brought to you by rent app the free and easy way to collect rent learn more at rent. apppp landlord all right let's bring on Jeff Jeff welum welcome back to the show thanks for being here again yeah thanks for having you back Dave Jeff to start off can you explain to us what debt to income ratio is yeah DTI basically to summarize it it means you know the acronym like you said stands for debt to income ratio it just means what is your buying power and so when we look at it from a lending standpoint we're looking at your total income and so if you're a W2 wage earner we can go off if your gross income meaning before taxes if you're self-employed we have to go off of the net income so after taxes so it's a little different the way the government requires us to do the income calculation and then we look at what is reported on credit so your total debt load we're not looking at you know cell phone bills you know water bills utilities stuff like that but we are looking at minimum payments on your credit report we're not concerned with what the balances are we're just factoring in the total minimum payments that are reported on your credit report for all of your debts including mortgages car payments student loans credit cards personal loans and then we do you know a calculation compared to the income calculation that we're required to use and that's how we come up with that ratio all right thanks for that helpful explanation Jeff and just to reiterate there basically DTI is a comparison of how much money you make to how much debt you are trying to take out to finance your property Jeff can you just tell us why this is important to investors and why this ratio sometimes maybe is a hurdle for people as they are trying to scale yeah because there's a lot of misinformation out there surrounding the the debt to income ratio and it really comes down to trying to crack that code as a real estate investor to scale efficiently and trying to figure out okay how can I maximize my buying power going into each next purchase and really the secret to all of this is strategic planning so having a plan in place going into this having the conversation early and knowing where you stand what your buying power is currently and then looking at ways to maximize your buying power for instance there's different ways that we can structure deals when we're looking at let's say a short-term rent for instance we have a lot of clients that want to use the 10% down vacation home loan well that 10% down vacation home loan has a full hit to your debt to income ratio so you have to fully qualify for that which will really limit your buying power the other alternative is the 15% down investment property loan through Fanny May and by putting that extra 5% down we can use the forecasted rent to help you qualify which general rule of thumb will double your buying power so that's just one instance of how it is very important to have a plan going into this and really understand on an annual basis you know what your vision your goals are and then you know really connecting the dots on how you're going to go from where you are currently to where you want to go and have that plan clearly laid out so you know how much you're going to have to come up with for each next purchase and um ultimately where your limit's going to be because the debt to income ratio is extremely important when you're scaling from property 1 to 10 because that is the maximum Finance property limit with Fanny May that's super helpful so it sounds like actually depending not just on the person and their debt to income but also what loans they take out is going to influence their DTI is that correct absolutely looking at it from a primary residents perspective you know there's no rent to help offset that payment unless you're buying you know two to four units so that's going to have a full hit to your debt to income ratio the same way that a 10% down vacation home loan will on the investment side when we're looking at you know the different investment property options we can use the forecasted rent so there's a way to actually you know factor that in to minimize the impact of your debt to income ratio in order to maximize your buying power got it okay so that means just for everyone out there that means that using investor focused loans although they tend to require more D higher down payments could actually be beneficial to scaling in a different way because it'll be easier to get loans subsequent loans I should say absolutely and this is one of the things that varies widely in my industry some lenders have a 20% down or 25 or even 30% down minimum if you're hearing that shop around a bit because a lot of times what ends up happening is is that some lenders just don't have the licensing the Required licensing to do Fanny May and Freddy Mack loans which open up the lower down payment requirements or options so just a little bit of advice uh for any investors out there that there are 15% down investment property loans that are uh Fanny May loans that have lower rates and fees with no prepayment penalties versus the non-conventional products like the dscr where you could do as little as 15% down that program finally came back I mean it completely evaporated after March of 2022 and we are just now seeing the uh first uh guidelines coming out here of the last 30 to 45 days and so it's a um a sign of things to come I mean the market starting to open up a bit there's a little bit more of a risk appetite in this space again but as a general rule of thumb on the dscr side those loan programs are going to require a minimum of 20% down at the moment well I do want to dig into some specific loan types that you would recommend but I want to ask a broader question about using rental income for your DTI and just to make sure everyone understands when you're considering your debt to income ratio if you're not currently investor basically they'll just look at your W2 income or your 1099 income or however you make money and then compare that to the debt but as an investor ideally what you want is to if you have a property or two you want to take the rental income from those properties and show to the lender that look you know my income is actually higher than just my part-time job or my full-time job it should also include uh the rental income that I'm generating but from what I understand that is not always possible Right Jeff like sometimes rents are not considered for your income and sometimes they are are there any rules of thumb about when they are and aren't yeah so the the first year you buy the property we can use the lease agree like a long-term strategy we can use the lease agreement use 75% of that to help offset the mortgage payment the same way that we do at the time of acquisition you know when you're purchasing the property we're going to use the forecast and rents to help you qualify and we can use 75% of that figure so for the first year until you file that on a tax return we're able to utilize that you know the rent or the lease agreement um to help you qualify for the next purchase and this is one of the ways that investors will scale quicker um by using the you know true investment property loans versus using let's say like a 10% down vacation home loan for a short or midterm rental and so once the property has been uh in operation for over a year and you've reported it on a tax return then we have to go off of the schedule e and there's a calculation that we need to use um based off of Fanny May Freddy ma guidelines okay that makes sense so basically use a projection until there's actual data that you can use then you go off that that seems to create sort of this challenge or tradeoff for a lot of investors as they're trying to scale because on one hand using a traditional investment loan will help you with your DTI but they typically require 25% down so how do you advise your clients who are thinking about building a portfolio for this foreseeable future to balance those two competing interests yeah it's a great question the 25% down is on units on the investment side so as long if you're looking at you know one unit you can do depending on your strategy and which strategy you're doing um on short and Midterm rentals you can do 10% down and then for uh single unit investment properties it's a minimum of 15% down that's really good uh advice for anyone who is looking to scale and understandably is having a hard time reaching 20 or 25% down payments you can consider some of the asset classes that Jeff was just talking about Jeff do you have any other pieces of advice for investors uh using conventional lending methods that could help them scale absolutely so for um any business owners out there run all of your debts your business debts through your business bank account even if you personally guaranteed them and the reporting on your personal credit as long as we can show for 12 months that you have made those payments on time directly from a business account we can exclude those from your personal debt to income ratio and then when it comes to rental income any type of rental properties we're able to use the depreciation as an addback so just keep that in mind same thing with businesses if you have depreciating assets within the business we can use that depreciation as an addback and this is one of the ways that investors and business owners minimize their taxes while still being able to qualify for conventional financing because in the eyes of us as lenders and Underwriters depreciation is looked out the same way as income wow I I actually never knew that is that something that most people talk to a CPA about or can you just do it yourself I would definitely talk to a CPA you're going to want to talk to an investor friendly accountant that understands the space I can't tell you how many times I've had clients that run into issues that are working with tax preparers and not say anything bad about tax prepars but you need somebody especially as you're starting to scale your business that understands tax strategy when it comes to real estate investing and really that's part of the strategic planning aspect of this that we do on an annual basis with our clients we sit down every year at the beginning part of the year before tax time discuss our clients goals with them and see what they you know what their goals are for the upcoming year and then we work backwards and um put together a plan on how to really connect those dots so they can scale effectively and efficiently every year and then what we ultimately try to do is going into tax time find that equilibrium point you know where they're not overpaying in taxes and not giving the IRS any more money than they have to but uh still showing enough net income and depreciation to where they're meeting their goals for the upcoming year and I have to be very clear about this because I am not a CPA I cannot give specific tax advice but what we can do is based off of you know A draft copy of the return that you and your account put together we can then put together a plan coming out of that saying based off of your income uh for the Year this is what you qualify for and then if you want to scale up past that then we look at non-conventional options like the dsvr loan well having taken an embarrassing long time myself to move from a traditional CPA to a real estate focused one I can attest to what Jeff just said that it is extremely helpful and worth the time and effort and uh actually Bigger Pockets recently just created a free tool to help introduce you to uh investor friendly CPAs so if you want to find one for yourself you can go to biggerpockets.com taxpro and check that out Jee let's switch to maybe some less conventional lending options for people who are looking to scale do you have any recommendations for us there yeah so like the dscr loan I'm sure your audience is all familiar with it it means debt service coverage ratio it's a mouthful uh basically what the it's a fancy acronym for does the property cash flow and so from a lending standpoint we're just looking at the cash flow analysis of the property and we look at the property like a business I mean this is the closest thing we've had to stated income loans since uh before the Great Recession and this is the program that's used on the commercial lending side that's been adapted to residential real estate for business purposes only so the important part with this is you can't buy primary residences or second homes with it and this is the preferred method to scale once you get past the 10 Finance property cap or there are times for tax reasons where let's just say between that s and 10 property range where depending on your strategy it may make more sense to start putting larger down payments down versus giving the uh IRS more money um and have to pay a higher tax rate in order to hit those last few properties and so with this program specifically this is the one that you can scale up to you see everybody that has you know 10 20 30 40 100 properties this is the preferred method to scale past 10 but there are other options so for business owners for instance there's a business bank statement program that doesn't get a lot of publicity or doesn't get out there as much uh with this program specifically you know it's for business owners you know one of the you the benefits of being a business owner is you get to write everything off pay very little in taxes problem is is a double-edged sword from a lending standpoint because it doesn't always put you in the best position to qualify for conventional Finance in and so with this program specifically we can use 12 to 24 months business or personal bank statements if you run your business income through a personal statement and what we do is we add up all the qualified deposits through the business we average them out and then we're required to depending on the type of business uh back out an expense Factor so for instance you know a realtor that's working out of their house you know uh working from home has very little overhead versus let's say a restaurant that has very high overhead so there's different expense factors once we determine the expense fa factor for the business then we back that out and then use that average as income instead of looking at their tax returns okay got it that I think I'm following that so basically is that applying to dscr loans specifically great question so these are two totally different programs the then I don't understand yeah the DCR loan the dscr program this is the one that's the closest to stated income financing we are just looking at the uh cash flow analysis of the property does the rent cover the all-in Piti payment you know principal interest taxes and insurance if it does by a dollar or more it's cash flowing and the minimum TI at the moment is 20% there is that 15% down option on a limited basis in strong markets um that's coming back so with the dscr loan let me just clarify for everyone so basically this is similar to commercial underwriting it's not based on your personal income your personal credit worthiness and that's why it's such an attractive option for people who are trying to scale because if you're budding up against limitations with your DTI rather than having the bank or your lender look at your personal income just say hey I'm buying a deal that's going to pay for itself so what I make as an individual doesn't really matter and so that's why DCR loans are so attractive to people who are trying to scale and can find cash flowing deals now just to I just want to explain that the way this is calculated like you said is can the C the property cover The Debt Service and you said that as long as it's a dollar over you can get a loan on that is that right because I've I've looked at these types of loans and a lot of times I've seen it at 1.2 that DSR needs to be 100 like your your cash needs to be 120% of your expenses for example not just a a 1.0 on the dscr and it depends on the strategy so on the short-term side yes there are some restrictions for short-term rentals but on the longterm side it's one and we so when you look at commercial financing a lot of times they will have a minimum of a 1.15 or one and a quarter sometimes even higher and so it really just depends on how risky the property is so when we're looking at let's say just using air DNA and a you know short-term rental analysis at adltv uh they want a higher dscr so one and a quarter or above typically versus a property that we're taking the more conservative approach and looking at it from a long-term perspective there's more flexibility there because it is the more conservative approach and you know terms tend to be better you know on the longer term analysis versus the middle the short as well got it okay that makes sense yeah I've never looked at it for a residential property but that that makes sense and it's great that you brought that up too because a lot of investor lenders out there will have their own overlays so this is you know going back to the debt to income ratio conversation and this specifically if you're running into problems with certain lenders out there my best recommendation is to shop around a bit because a lot of lenders will have their own underwriting overlays like a minimum of 20 or 30 25 or 30% down thank you for for talking me through the dscr side now you were explaining earlier about a business bank statement loan can you clarify for me how that works again CU I'm not sure I fully understood yeah so to sum it up we're looking at 12 to 24 months business bank statements or personal um in lie of or instead of looking at tax returns and so can this be any kind of business or is this specifically a real estate investing business there are very few limitations to this the only limitations I've run up against over the last couple of years with these are we have you know short-term rental investors that have multiple properties and they have you know 20 different accounts you know one account for each property it's a maximum of two accounts uh with most okay investors on the secondary market so but as far as limitations from other types of businesses there really are no limitations it can be a realtor working out of their house it can be a restaurant and anywhere in between okay and if you go this route and use a business bank statement qualification process does that mean that you're putting a any collateral from your business not from the business no that's a great question so this is not collateralized by the business you can use business funds for your down payment reserves but where this really differs from the dscr loan the dscr is for investment properties only the business bank statement loan you can do a primary residence a second home investment properties and for instance on the primary resident side it's a minimum of 10% down so you can get in with better terms on these business bank statement laws with you know lower down payment better rates and different property types than you can on the dscr side so that's one of the big benefits of you know providing this additional paperwork because it shows your ability to repay it's a little bit less risky than the dscr loan when all we're doing is looking at you know the profitability of the property versus when we have an established business and business owner that can show they have you know the cash flow analysis of their actual business it looks a lot stronger from a l standpoint Jee now that we understand some of the conventional and some of the unconventional or let's just say less conventional they are increasingly popular ways for people to finance some properties do you have any guidelines on who should think about what types of loans you know there's no one siiz fits-all unfortunately when it comes to mortgage lending and everybody's Situation's different and so the again the earlier you can start having these conversations to figure out what options are available for you the better uh there are other programs out there if you want to talk about it there's an asset qualifier loan you want to touch on that sure what is it yeah it's another non-conventional product so with the asset qualifier loan this is a great product for investors that may not have documentable income but have reserves that have money in the bank have liquidity so what we do in lie of you know calculating a debt to income ratio the traditional way of through employment or retirement or things along those lines what we do is we look at the asset that client has liquid assets retirement accounts checkings savings uh investment accounts um you name it and there's a calculation that we can use to actually calculate that into a debt to income ratio without having to touch those funds or collateralize them that's pretty cool yeah I mean that that totally makes sense right like I can imagine perhaps people who are retired or who have a lot of assets or you know just got a big windfall but they're income is not so high but they're still able to pretty easily able to service debt it's just not in the traditional way yeah and it's tough because of the qualified mortgage provision of the Frank dot act that came out of the Great Recession to make that work on the conventional side because in order to use retirement accounts like that you have to be of retirement age so for instance I mean we have a lot of tech workers that we work with that have a lot of money but they either have been laid off or they've quit their W2 jobs to become full-time real estate investor and so this is a great way to bridge the gap where if you have a lot of money there's no age restriction with this I mean we have people that are in their 20s and 30s that are taking advantage of this and um you know it's a great way to also bridge the gap where let's just say you may not have enough documentable income and your debt to income ratio doesn't work traditionally and you have money in the bank we can then use or supplement or subsidize the debt to income ratio with the asset calculation okay that's great so yeah I I think generally speaking it sounds like you know if you can do conventional often times that does make sense uh because you often get favorable terms but the theme it seems to be between these less conventional options is just finding ways that you can reduce the risk of the loan in the eyes of the bank right because that's really what it comes down to is whether you're providing business bank statements or cash flow Pro ejections or summary of your assets the bank is basically just trying to figure out are you going to be able to repay this loan or not and conventional loans just have this very rigid sort of way of evaluating that question and these unconventional ways they're not shady they're not necessarily bad they just have a little bit more flexibility in evaluating you or your deal for potential for risk and ability to service your debt and I'm glad brought that up because when it comes to conventional financing and government financing it's very black and white you know the guidelines are the guidelines They do change occasionally but it's not very frequently in the non-conventional space it's a land of gray so there's a lot of room for exceptions the guidelines are constantly changing depending on the es and flows of the market and you know at the end of the day it's important to remember that these are this is pools of money on the secondary Market on the non-conventional side that's lending in this space And depending on what's going on you know with our economy and you know with all the geopolitical issues that we're having like for instance it's the 16th of April 2024 we've had a rough week and the mortgage industry rates are going back up again and now we're starting to see guidelines tighten up on the secondary Market in this non-conventional space because they're becoming a little more risk adverse well Jee you've given us a ton of really helpful information here but I can imagine that most investors are like all right those are great options which one is right for me there is no as you said there's no one siiz fits all rule but how do you recommend investors work with their lender and perhaps also with their CPA based on this conversation to sort of chart out not just what loan is right for them next but trying to develop sort of a longer term plan so that they don't run into these DTI issues or that financing comes relatively easily as they scale their portfolio you know with investors that are just starting out you know say anywhere between zero and five properties you're going to want to look at the conventional options because the conventional options are always going to give you the best cash flow you're going to maximize cash on cash return because the fact that you're coming in with lower down payments and uh getting much better terms than you will on the non-conventional side and there's no prepayment penalties on any of these loans that's one of the big considerations in the conventional space you can refinance or sell anytime you'd like on the non-conventional side most of these products have a prepayment penalty that range anywhere from 1 to 5 years so make sure you're asking those questions and then as far as the planning side goes you really need to find an investor focused uh loan officer and account like we've talked about that understand the space I always recommend ask a lot of questions there's no stupid questions and if you ever feel like the questions you're asking are not Landing or you're not getting the answers that you like move on there's plenty of great loos's and accountants out there that you guys can work with but um when you're looking at it from you know let's say property 5 to 10 that's where you really need to you know have a clear plan and let's say you don't need one from 1 to five but it's easier to go get into properties to through let's say four or five and just land in them and without any kind of a a solid plan and but once you get past that point that is really where you need to have a strategic plan in place because every decision you make is going to impact the next one and if you don't get off on the right foot and create a solid foundation any of the small problems you have early on are just going to get potentially worse as you scale that's a great advice Jeff I couldn't agree more thank you so much for joining us if you want to connect with Jeff we'll put his contact information in the show notes below or if you want to connect with an investor friendly lender you can do that for free on BiggerPockets as well just go to biggerpockets.com lender finder and you can do that there Jeff thanks again and all of you thank you for listening we appreciate you and we'll see you next week for more episodes of the Bigger Pockets podcast [Music] w [Music]

Channel: BiggerPockets

Views: 24,934

Keywords: investment property loans, investment property, investment, loans, rental property loans, dscr loans, dscr loan, dscr mortgage, debt service coverage ratio, debt service coverage ratio loan, dscr loan real estate, mortgage loans, rental property loan, investment loan, investor loan, rental property financing, income property, rental property, real estate investing, best mortgage, financing rental properties, biggernews, biggerpockets, biggerpockets podcast, podcast

Id: BUkvZIEnqFs

Length: 28min 18sec (1698 seconds)

Published: Fri Apr 26 2024