How To Get Mortgage on 2nd Investment Property?

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How To Get Mortgage on 2nd Investment Property?

Craig S.
Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes

Hello All,

I am currently in the process of buying my first rental OO property -- a duplex that I will live in one half and rent out the other side. I am using FHA financing.

My ultimate goal is to quickly build as many investment rental properties (multi-family then on to apartments). My duplex mortgage application has been submitted and now it's just a waiting game on the 1st property.

Now I am starting to think about my 2nd property. I am self employed and had just enough income to qualify for my 1st mortgage on this duplex. So, I am wondering what is the best way to qualify for a mortgage on my 2nd property?? -- probably a 2 to 4 unit property. Next year I forecast that I will make about double the $$ (on paper) that I made this year. My expenses will be much less, revenue higher, and therefore net income higher.

1) Will I still have to qualify for my 2nd property using my same amount of current income (for this year) as reported on my taxes? If I had just enough income to qualify for my 1st property, how can I qualify for a 2nd property this year, or will I have to wait until next year's tax returns are much higher? (This is all assuming traditional financing, no owner financing, etc.)

2) Can banks use the rental income on the 2nd property (probably non-owner occupied) to help financially qualify for the 2nd property? If yes, what percent of the current rental income can they use -- 75%??

3) When I move on to my 3rd investment property, when and will they use my rental income from my 1st and 2nd properties that I already have to help qualify for the 3rd loan?

I am confused about what income banks will use in determining my worthiness to qualify for my 2nd, 3rd, 4th...... investment properties/mortgages.

Obviously not many people have enough income (not from rentals) to qualify for 5 or 10 properties. When and how much of the income from current rental properties can banks use to qualify for your 5th home, etc?

Please help!

Thanks,
Craig

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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y

Until you have rental income appearing on two tax returns, lenders will ignore the rental income and include the full amount of outstanding mortgages in your DTI calculation. If the additional income is from the rental, it won't be included. If its from some other source, it will help your DTI.

Once you have rentals on two years taxes, lenders will look at the actuals from your schedule E. If that's positive, it helps the income side of the DTI calculation. If negative, it goes on the debt side and hurts. Usually, depreciation is removed, but not all lenders do this. For the new property, they typically take 75% of the rent and subtract the new PITI payment and handle that the same way.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Until you have rental income appearing on two tax returns, lenders will ignore the rental income and include the full amount of outstanding mortgages in your DTI calculation. If the additional income is from the rental, it won't be included. If its from some other source, it will help your DTI.

    Once you have rentals on two years taxes, lenders will look at the actuals from your schedule E. If that's positive, it helps the income side of the DTI calculation. If negative, it goes on the debt side and hurts. Usually, depreciation is removed, but not all lenders do this. For the new property, they typically take 75% of the rent and subtract the new PITI payment and handle that the same way.

    1Reply
  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Hi Jon Holdman, thanks for your response. Also just so you know, they (lender) are actually using 100% of the current rental income (one side) on this 1st property duplex for FHA OO financing. By one side, I mean they are using the rental income from the only one side of the duplex as I will be living in the other. Maybe you are referring to "investment mortgages" on future properties?

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Yes, I'm thinking of "conventional" loans that play by the Fannie and Freddie rules. FHA OO isn't going to be relevant for most of your investment purchases.

    That said, I wasn't aware FHA would consider the rental income right off the bat.

    I also wonder if we are perhaps about to see a loosening up of some of these rules. Investment lending was much more liberal during the boom, and was clamped down a few years ago. Many areas now seem to be seeing a shift to more of a sellers market.

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  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Jon Holdman, yes they may (hopefully) be loosening up! In fact, my lender/loan originator initially told me that the rental income could NOT be factored in to help qualify for the loan. It turns out that he said it must be a new rule/change--that FHA is now actually allowing current rental income to go towards my income to help qualify.

    I am looking to get into my 2nd property as soon as possible. So from what I understand so far, and from what you have said as well, it seems that I will have to put down about 20-25% on my 2nd property, have a higher interest rate, and will need to use ONLY current personal income to qualify for the 2nd property mortgage, correct? The banks will NOT use the rental income from my 1st property nor will they use the current rental income from the 2nd property in consideration to qualify?

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Craig Sturgill, yes, that's consistent with my understanding. Once you have the rentals on two tax returns (2013 and 2014, I'd guess from what you write), you will be able to include the income from your rentals and you'll be able to include any income from the new rentals using the 75% rule of thumb. That's based on what I believe to be the current rules.

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  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Ok Jon Holdman, thank you much for the help! Being new to this process, learning all FHA rules vs. Conventional, I was very confused on all the rules, DTI calculations, qualifying procedures, etc. You have helped clear it up!

    In my current situation and having had just enough income to qualify for my 1st property, it seems that it will probably be best for me to sit tight for 1 year until 2014. At that time I will have more income to show on my tax returns for 2013 and can use that to qualify for my 2nd property purchase sometime in 2014. Then I can sit tight on that for the year of 2014, save the $$ from both properties, and starting in 2015 I will be able to use the rental incomes from all of my properties to qualify for my 3rd and beyond mortgages.

    One last question: Do they make you wait 2 years on EACH property before you can use the rental income of THAT property to qualify for another mortgage? Or do they just want you to be in the "rental business" for 2 years overall before they will start to count rental income on any current property?

    For example, say I wait 2 years from today (2013) to count my first property rental income (on the property I purchase this year). Then I buy another rental property in 2014. Will I have to wait until 2016 (2 years) to count the rental income from the 2nd property, or do I just have to be in the "rental business" for at least 2 years overall--then I can count any rental income 100% on any property I own from that point on?

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Don't think so. Once you have the two years landlording experience under your belt, you're good to go.

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  • Harry M.
    Real Estate Investor · Dallas, TX · Member since 2010 · 449 posts · 173 votes
    13y

    Jon Holdman - I have a couple of questions about this, as we've just hit our 2nd full tax return with rentals, and we're shopping right now. Craig Sturgill - hopefully this adds for you, as I definitely don't mean to threadjack!

    Anyway, just to confirm I've got it straight based on your first post above: Investor X earns 5000 (gross, right?) per month, and has commitments of 1000/month. This is outside of the rentals he owns. So the DTI calculation looks like this:
    1000/5000 = 20% DTI

    He hits the 2 tax return mark with his rentals. Lets say he's in the black 200/month. So, the 200 would be added to the denominator, right:
    1000/5200 = 19.2% DTI.

    If he's in the red, then it would be added to the numerator?
    1200/5000 = 24% DTI.

    This is the bit I'm most unsure about, because until your post, I wasn't sure if that was the case or if it was subtracted from the denominator.

    One more question. Suppose, you have 2 year's worth of returns, and in the first year, you were in the red for one of the properties, because there were initial fix-up expenses. These were after the rental was in service for us. We inherited a tenant (and learned an important lesson about this), and it was only after they were out that the expenses occurred. The property shows a profit the second year. Do you know how this likely to be interpreted by a lender? The property in question doesn't have financing. Would they exclude it from the DTI altogether in that case?

    Thanks for any help you can give!
    -Harry

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  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Hi Harry M. I would like to know to know how this works as well. Maybe Jon Holdman or someone else can give us their input...

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  • Johann Jells
    Rental Property Investor · Jersey City, NJ · Member since 2011 · 1k+ posts · 876 votes
    13y

    I'd be fascinated to know if there's a rule change. I've been a landlord 15 years and I was just told they couldn't use income from a property I've owned only 6 months. Having a $225k mortgage with no income from it blows a hole in your DTI!

    0Reply
  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Hi Johann Jells, so you are saying that a bank told you that you cannot use the income from a current property you have owned for 6 months to qualify for another new investment?

    And, why did you invest $225k into a mortgage with no income/cashflow? Did you have a large CapEx?

    Jon Holdman--you seem to be pretty knowledgable, do you have any insight on this?

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  • Johann Jells
    Rental Property Investor · Jersey City, NJ · Member since 2011 · 1k+ posts · 876 votes
    13y
    Originally posted by Craig Sturgill:
    And, why did you invest $225k into a mortgage with no income/cashflow? Did you have a large CapEx?

    Is that serious or ironic? Of course I have income from that property, but they won't use it for my DTI on a different refi even though they used it when I purchases that property. Bankers have lost their minds.
    0Reply
  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    Johann Jells, it was serious, the way you worded it sounded like you literally had no income/cashflow. :)

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  • Mehran K.
    Investor · Wichita Falls, TX · Member since 2010 · 3k+ posts · 603 votes
    13y

    Jon Holdman Quick question while we are on this subject.

    Starting on May 1st 2012 I rented two spare rooms in my personal residence. I had to claim this as rental income on my schedule E. I wrote off 33% of my homes expense (mortgage interest, taxes, utilities etc) & depreciated the value of the home by the same 33%. According to the IRS it is 33% a rental property. This is all on my 2012 tax returns

    Now It's 2013 and I am set to close on my first deal (yes!) on 04/05/13 so I will definitely have rental income from this property AND my primary residence tenants on my 2013 tax returns.

    At what point will the lenders start to consider my rental income?
    My thoughts are:
    At the beginning of 2014 I will have 2 years Schedule E rental income according to the IRS.
    The loan processor working on my current deal said she can't use primary residence income unless it is a separate unit. She didn't specify as to whether or not this will income will start the 2 year Schedule E Requirement.

    I don't see why it wouldn't and I'm hopeful because even with just the extra income from this rental property I'm closing on AND the next property (75% gross rents - PITI) I will be able to qualify for atleast 2 or 3 more properties in my price range.

    I hope what I just typed made sense.
    What do you think?

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  • Mehran K.
    Investor · Wichita Falls, TX · Member since 2010 · 3k+ posts · 603 votes
    13y

    I think I will start my own thread to get more exposure/perspective in the Lending sub-forum.

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Craig Sturgill and Harry M. sorry for the delay in answering.

    So the DTI calculation looks like this:
    1000/5000 = 20% DTI

    He hits the 2 tax return mark with his rentals. Lets say he's in the black 200/month. So, the 200 would be added to the denominator, right:
    1000/5200 = 19.2% DTI.

    If he's in the red, then it would be added to the numerator?
    1200/5000 = 24% DTI.

    Yes, this is exactly how I understand it.

    I have also been told that if you're now trying to get a mortgage on a new property, and you meet the two year threshold, they will estimate the income on that new one as:

    net income = (75% * rent) - PITI

    Positive and it adds to the denominator, negative and the absolute value adds to the numerator. So if we start with DTI = 1000/5200 = 19.2% and have net rental income from the new one of +300, then the calculation is 1000/5500 = 18.2%. If the net rental income is -300 then the calculation becomes 1300/5200 = 25%.

    Now, any particular lender may have their own way of doing these calculations. They might have an "overlay" rule that says you have to treat the entire new payment purely as debt. Seems its pretty common for lenders to treat depreciation as if its real cash out the door. Who knows what any particular lender will do? You really have to have a conversation and understand how they are going to do these calculations.

    1Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Mehran Kamari I'm not sure how they handle the income from renting rooms in your primary. I have seen people post that lenders will not count this income. Not sure I understand why. And I've not actually heard that from a broker, where I have heard the above description of DTI calculations from a broker.

    As far as when, it would be sometime in 2014, once you've done your 2013 taxes. I don't think though this is fuzzy, that you have to wait until two full years have lapsed from when you start generating landlord income. You just need two years with income (or losses) on Schedule E. Now, if your income started in December in one year and you only had a month's income on that year's schedule E, would they count it? I don't know. It may depend on how much they want to make you the loan. I just don't know.

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  • Mehran K.
    Investor · Wichita Falls, TX · Member since 2010 · 3k+ posts · 603 votes
    13y

    As long as it's 2014 and not 2015 I"ll be happy! I hope to get some clarification as to whether it will be right when I've done my taxes or have to wait until May 1st 2014 when it will be 2 full years. Maybe someone in the thread I started can chime in.

    I think I may be able to squeeze in investment property #2 and still be at 50% DTI (fannie max with strong borrow profile). I'll have to apply/run the numbers after this loan closes to find out.

    Thanks Jon, once again for sharing knowledge.

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  • Harry M.
    Real Estate Investor · Dallas, TX · Member since 2010 · 449 posts · 173 votes
    13y

    Jon Holdman - thanks for the response. I appreciate it.
    -H

    0Reply
  • Craig S.
    OP
    Rental Property Investor · Cleveland, OH · Member since 2012 · 110 posts · 13 votes
    13y

    @Jon Holdman -- thanks for your clarity and help in answering our questions! Very much appreciated.

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  • Tim M.
    Rental Property Investor · Lake Hopatcong, NJ · Member since 2011 · 37 posts · 3 votes
    13y

    Jon Holdman is spot on as usual. I'd just add a point - FHA and Conventional financing are different in regards to including rental income. With FHA you are able to include rental income right off the bat PROVIDED you have at least 25-30% equity in that rental income producing property. So if you could refi your current 2 unit to conventional, buy a new 2-4 unit and OO using FHA financing, AND you had 25% equity in the 1st property = bingo, you will be able to include ALL that rental income(per Johns formula) in your dTi formula. In fact, you'd be able to include both sides rental income with signed leases.

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