How to buy a second property?

Question

First time poster, but definitely not my first time on these forums and I am never disappointed with the wealth of content on here.  I am 23 and just closed on my first property this week using an FHA loan. I will have roommates living with me that will be paying monthly rent. Naturally I am already looking forward to my second, third and fourth properties. My plan is to be an owner occupant at this property for 2 years and then look to purchase another property. Per my calculations, I should have 50-60K in two years to throw at a down payment for the new property. My issue will be debt to income ratio - current mortgage payment puts me at 44%. However, the rents will cover the mortgage payment and then some. What is the best way to finance the second property?

Elizabeth Colegrove · Answer

Welcome!

We have done well doing what you are describing since my husband is active duty navy. We are very transient and move a lot. We got started 3 years ago at 23 and 25. The key is to shop mortgage brokers. I have found that they will often times accept a lease. We put as little down for our personals and use the down payments for pure rentals.

Dave Foster · Answer

I agree with @Alex Agafonov your ratios and risk stress seem a little high.  You've made some great projections but take some time and turn the "wills" into "ares".  If you're looking at staying in this property for two years like you say then don't do a 1031.  Simply sell it and take the profit tax free under sec 121 exemption.  Now you've go tax free cash to get your next two properties.

Meanwhile work with those roommates and network.  Maybe there's something to be done with the couch sitters on your next properties.  Or maybe you find a creative deal.  Either way it's a great start but don't believe press clippings until they're from yesterday's newspaper.

Dave

Account Closed · Answer

@JT Spangler

First, I'm not a resident, lender, or landlord in Tennessee.  When I read your post you said "Maybe someone more experienced than me can chime in and verify that."  I'm more experienced.

Most lenders, regardless of where they are, use the Uniform Residential Loan Application Form 1003.  Here's a link to it:  https://www.fanniemae.com/content/guide_form/1003r...

There's a section in there called "Schedule of Real Estate Owned".  Notice they ask for gross rental income, and they ask for mortgage payment.  Then they ask for maintenance and net rental income.  After you have filled this schedule out, you're going to take the market value of your real estate owned, and put in the above section for "Assets and Liabilities".  Now perhaps you can tell me why they would be asking what your rental income is, if it's not a debt on your personal balance sheet?  The answer is that anything that's personal in nature goes into this application.  The first loan, and other loans, are going to be "personal" if you signed it.  In fact, I think you're going to find out that initially at least, its every unlikely that a bank is going to loan to any other entity than you personally.  Further, they're going to pull your credit report, and that mortgage is going to show there as a debt and payment.  So yes, they're going to count it for qualification purposes.

Now, if you did what I suggested above in terms of documenting your rental income, then they probably will count that rental income too.  However, they normally haircut your gross rent, so it's probably not going to be a complete offset to your mortgage payment.  In the past, they haircut your gross rent by 25%.

Now, is it possible that some lender someplace might do it differently?  Well anything is possible, but I'd say it's unlikely.  I say the 1003 is in widespread use.  Might there be different underwriting standards.  Perhaps, especially if you have gone to a portfolio lender.  Because the rest lenders are selling the loans, and those loans have to meet certain criteria.  That's going to start with the 1003.  BTW, lenders come under federal guidelines.

One other thing:  there's alot of misinformation that flies around about things related to real estate.  I had a recent dealing with a banker who assured me of several things that turned out to absolutely untrue when the underwriter took a look.  If I were you I would look over the 1003, maybe question those lenders again.

Robert Leonard · Answer

@Dave Foster  and @Bill Exeter are absolutely correct, no need to get into the complexities of a 1031 exchange for a personal residence.  My thinking went down a rabbit hole in the wrong direction on that one!  I stand corrected - thanks guys!

@Alex Agafonov  I would recommend going to Memphisinvest.com's website and for the price of your name and email address, you will get access to Chris Clothier's video tutorial on "how to build a bank book."  (Be prepared to take notes, it's gold.)  This is what will set you up for success when you want to deal with a portfolio lender.  I would do that in about a year after you can show some proof of your ability to manage tenants and then you can begin to have the conversation with portfolio lenders to establish the relationship(s) that you'll need when you are ready to pull the trigger.

I have no affiliation with the company or website I mention here. I just find their information helpful and I'm sharing my opinion. :-)

Alex Agafonov · Answer

My apologies for not making this clear in my original post, but  I would specifically be looking to purchase a second property without selling the one that I just bought as I want to pursue the traditional buy and hold strategy with my investments.

The strategy that is most attractive to me is @Brandon Turner blog post "A Slow, Boring, Incredibly Awesome Strategy for Building Wealth Through Passive Real Estate Investing" where a couple can purchase 8-9 homes in a 10 year period. My personal monthly savings are $1200 and the property cash flows at $1000/mo, leaving me with approximately $26400/year in cash that I can put towards a second property. This seems like a better financial situation than the hypothetical case study, so my question is how would one find financing in a situation like that...is it worth attempting to secure a conventional loan or should I just go straight to a portfolio lender when I am ready to buy again in 2 years?

Bill Exeter · Answer

Congratulations on your first purchase. The property is what we refer to as split use property where you occupy it and rent it out.

You can sell the property any time after living in it for 24 months (2 years) and qualify for tax-free exclusion of your gain under Section 121 of the Internal Revenue as long as your gain is not more than $500,000 for a married couple.  This would give you the ability to cash out on a tax-free basis without having to worry about structuring a 1031 Exchange.  If your gain happens to be more than $500,000, you can allocate the gain between your primary residence portion and your rental property portion and complete the 121 Exclusion and a 1031 Exchange.

The good news is that you have options to deal with your high debt ratio when the time comes.

Robert Leonard · Answer

@Alex Agafonov I have to say, I think you overspent if you're at 44% with your current mortgage.  If that 44% is not made up of some other debts that you can eliminate before the end of that 2 years, it appears that you put yourself at a disadvantage by overspending.

A way out might be to plan for a 1031 exchange.  If your income goes as planned and you experience a little appreciation (or even a flat market), you could plan to sell this high cost property after a year or two and move to another one that isn't such a burden on your borrowing ability.  You may have some difficulty keeping your room mates once you put the property on the market, but it will be part of what's necessary to lighten your financial load.

The goal would be to take any proceeds from that sale and roll it into another property that doesn't saddle you with debt that leaves no room for other leveraged investments.  Otherwise, you can start learning alternative financing methods that don't rely on your personal credit availability.

JT Spangler · Answer

My statements about the 30% equity came straight from lenders, two of them. In general, it's a good idea to consult with experts in areas where you are not an expert, as I have done. The lenders were right and you were mistaken, which is good for me in this case. Sorry you don't think my reference is as extensive; it does have the advantage of actually applying to the situation I was posting about, which to me is a fair trade off. I can see why it would make you cranky, though. I incorrectly relayed some of the details, and during the parts of your post where aren't acting like a jerk, I appreciate your clarifying. As I've both said and shown, I'm happy to learn from people who have experience I don't.

I addressed this in my previous post.

So, here you're just splitting hairs. I'm not talking about some nebulous what-if scenario -- this is my actual deal in progress. With 30% equity in the house, I'm allowed to use 75% rental income to offset the mortgage payment. 75% of the rent exceeds the mortgage (and then some!), meaning the mortgage debt is offset ENTIRELY by the rent. Which is almost exactly what I said. You're free to quibble with the wording, but I don't particularly find any utility in pedantic hair splitting, so I'll probably just pass on reading it. Enjoy the World Series, and may your team score many runs.

Account Closed · Answer

Glad to see you're actually out researching your statements.  That link you provided is to a document dated in 2008.  No problem though, it's just not as extensive as the actual underwriting guidelines.  Here's a link to the actual guidelines dated this year, just click on the part referring to conversion of principal residence.

https://www.fanniemae.com/content/guide/selling/b3...

In reference to your claim that you had all this right though, if you're still riding with your initial comments, I think you have misread the guidelines or perhaps just don't comprehend them.  They don't say what you think they say.

First, this business about after 2 years of claiming rental income the property could be removed from your personal balance sheet....nope.  The guidelines don't say that at all.

Next, you believe that with 30% equity that they don't count the mortgage payment, that's not exactly what they say either.  What they say is that IF you have 30% equity, they will allow you to count your rental income.  They're still counting the mortgage payment, it's just been offset by part of the rental income....75% of the rent as I mentioned several times above.  So it's entirely possible that this 75% of rent may not exceed the mortgage payment.  IF that is the case it's obviously going to affect your debt ratios.  Either way though, they are not removing it from your "personal balance sheet".  In fact, they want an appraisal so that they can determine whether you have 30% equity, meaning they are obviously looking at your existing debt compared to the market value.

If you'll look back up at my original post my original post to you said "Even if the house is considered an investment for tax purposes, that's not going to remove the debt from his personal balance sheet or his credit report."  I stand by that.  Nothing in the guidelines says anything like that.  I spent the rest of my post responding to the original poster about things that would be helpful to do regarding his rent, nothing to do with you at all.  So either you misunderstood your two bankers, or they don't know the guidelines either.

At this point you have a link to the complete guidelines.  In the future you don't have to rely on your bank friends, or guess.  Simply look it up.  There's no further need to continue to post about this, it's all in the guidelines.  BTW, use the guidelines, not a 6 year old letter.

Have a good evening, I'm getting ready to watch the World Series.

Account Closed · Answer

@JT Spangler

Here's a link to more Fannie Mae guidelines as applied to multiple properties.  If you read these carefully, I think you'll get the point that anything on your credit report is going to reflected in your debt ratio.  Also no comments at all about not counting a property with 30% equity.

https://www.fanniemae.com/content/guide/selling/b2...

How to buy a second property?

Most Popular Reply