The Investor’s Guide to Qualifying for a Conventional Loan
“It’s easy to get a loan unless you need it.” — Norman Ralph Augustine
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Can I purchase an investment property with a conventional loan if I already have a mortgage on my primary residence?
Short answer, yes — but do you qualify? That’s another question.
A majority of the readers here have a full-time job and a mortgage on their primary residence, but they don’t know if they qualify for another mortgage. Being that I like to keep investing simple, I suggest newbies focus on conventional financing for their first investment property purchase and set a healthy down payment of 20-25%. Rather than bore you with the minutiae of mortgage lending, it’s better to have a general understanding of loan lending requirements instead of becoming lost in the technical details.
Conventional loans have lending requirements created by Fannie Mae. Your banker uses a few different data points to determine if you qualify for another loan:
- Your current salary
- Current debts (short term and long term)
- Employment history
- Credit history
- Payment history for current mortgage
- And most importantly, your debt to income ratio (DTI)
Debt To Income Ratio (DTI)
Bankers use DTI to determine how much money they can safely loan you without risking a potential default.
The banker will determine your DTI cap by multiplying your gross monthly income by the maximum debt percentage (I’ve decided not to included the front and back end ratio because I want to keep this simple).
First, the banker will determine Fannie Mae’s maximum DTI ratio, which is 36%. (It can go up to 45%, but Fannie Mae requires additional capital reserves and a higher credit score. Most banks like to stay below 40%.)
To calculate your DTI, multiply your gross monthly income by 36%.
Example: Michelle’s gross income is $10,000 factored by a 36% DTI, which means her debt cap cannot exceed $3,600.
Once the DTI cap is determined, the banker will subtract Michelle’s current debt obligations from her debt cap number.
Example: Michelle’s debt cap is $3,600. She has a current mortgage of $1,000 per month (sound of Bay Area and NYC residents rolling their collective eyes), and she pays $600 per month in student loans. So $3,600 minus $1,600 leaves Michelle with $2,000 for additional mortgages.
Excellent. Michelle knows she can afford another mortgage. Time to find a property!
Not so fast. For an investment property, Fannie Mae requires that Michelle has a reserve set for two months’ worth of PITIA ( Principal Of Mortgage, Interest, Taxes, Insurance, and Association Dues) for the property she intends to purchase.
Example: If Michelle’s desired property’s PITIA is expected to be $1,000 per month, she will need to have $2,000 in reserve to meet Fannie Mae’s requirements.
Luckily, the money doesn’t have to be parked in a low interest bearing account. It can be held in stocks and bonds (bonds aren’t advised due to the time it takes to convert the bond into cash — typically, banks will value the stock and bonds at 70% of their market value), index and money market funds, cash value of a vested life insurance policy, or retirement account (Roth or IRA).
Personally, I like to hold six months of PITIA for each investment due to my conservative nature because I don’t want to be knocked out of the real estate business due to an unexpected event.
Now that you know the 80/20 for qualifying for a loan, you will be prepared for your conventional loan application.
Have any questions about this process? Any advice to add?
Leave your comments below!