Debt/Income Ratio Question

7 Replies

I'm in the process of purchasing my first property.  It is currently a rental property that rents for $1400/month.  My current plan is to buy the property and occupy it myself for the next 6-18 months.  It could use some updating and I don't want to enter into a lease while I could be building equity.

My question relates to debt to income ratio and getting approved for multiple properties.  I'll be in a position to rent this property in 6-18 months.  While I'm looking for renters, I'll concurrently be looking for another property.  I'm assuming the debt, or mortgage, from this property will be counted against me as I am getting approved for another property.  My fear is that my debt to income ratio will be too high for the type of property I would be looking for.  In fact, it may be too high to get approved at all.  

I'm looking for some insight from anyone that owns, or has owned, multiple properties on how to make that jump from property 1 to property 2 outside of a cash deal for property 2.

Thanks for your time and insight!

Roddy

@Roddy Wekkin - Do you already own a residence that you are planning on renting when you purchase this new property.  Or are you currently renting and plan to buy your first place.  I ask because I'm wondering if you are picking up extra debt payments without any new revenue coming in from your prior residence.

You are correct that the debt payment on this property will count against your debt to income ratio when you apply for future loans.  It's best to have as little non-income producing debt as possible.  IE.. if you take a loan out to buy something, make sure it generates cash.  

One other good tip with getting financing is to seek out your smaller local banks in your town and go talk to them.  They are going to be able to be more flexible with you than the big banks.  I work exclusively with about 3 hometown banks on all my loans.  They are MUCH better to work with than the big banks and they have plenty of money to lend to borrowers with good credit.  I'd go ahead and go meet these banks and establish a relationship before you need the money.  Good luck

@Michael Rogers - Thanks for the reply.  I have just transitioned jobs (well 6 months ago) and have been living back at home while I look for a property.  So I currently don't have that much debt.  Student loans and car payment are about the extent of my debt.

My concern is that my student loans, car, plus the addition of the mortgage would limit my ability to turn this 1st property into a rental while I transition to a more permanent living situation.  So I will be picking up extra debt without extra income until I rent out this property.  However, I can't necessarily rent this property while I'm living in it.

Do you know when the rental income will begin to count towards my personal income? I'm sure there has to be some rental history for it to apply.

Thanks for the info on the banks.  That's what I've heard and have begun to establish a relationship with a local lender.

@Roddy Wekkin

Sure thing.  There is usually a lag of about a year on when the rental income starts counting toward your debt-to-income.  (At least the way my bank does it.)  They count the mortgage payment immediately toward debt-to-income, but don't count the rental revenue until they see it come through on my tax return.  Not sure every bank's credit department calculates this way, but mine does.

The next lovely surprise to all of this is that once you do have rental income established on your tax returns (most banks want to see 2 years of rental income) they then only consider 75% of that income to offset your debt to income ratio. Developing that small bank/credit union portfolio lender relationship may allow for better results. 

Good luck! 

Hello Roddy,

What @James Vega said is correct, most banks will use 75% or gross rents and subtract the obligations you have (mortgage payment, taxes, insurance) and this counts as your income from the rental property.  They will want to see income from this property on your tax returns for 2 years prior to counting it towards your income.  I was told they wouldn't approve any loan that causes you to exceed the 43% debt to income.

However, if you find a lender that can choose to use Freddie OR Fannie for underwriting, these rules relax a bit.  If you find the right lender, they can use the income from the property a lot sooner (same year possibly, but maybe that's just if you already have experience renting under your belt) and they can look at your financials and calculate what you are ACTUALLY making from the property and use that on the income side of the ratio.

I thought the 2 years on the tax return was a hard and fast rule, so after our first 2 purchases pretty well limited our borrowing ability we waited until now to begin really going after another property.  I'm a little annoyed that we may have missed opportunities during the last 2 years, but we were also using that time to save for the next down payments so it it working out ok.  I am working with Quicken Loans on this next purchase, and from the questions they have asked it sounds like it is possible to use the income from the property we are purchasing to qualify, though we don't need to at this time.  I found a lender on here (I will pm him to look for you) that I will be working with on the next purchase, maybe he will be able to help you out as well.

Kelly

@Kelly N.

Are you financing mainly with secondary market loans; Fannie, Freddie loans where the interest rate is fixed for 30 years? These type loans are much stricter than getting a loan from a local bank that holds the loans in house. Since they hold the loans themselves the underwriting is much more flexible. The trick is to find a smaller size bank  to work with that is in your community.  Typically this bank will have less than $500 million in assets. The larger banks aren't really interested in these smaller loans and they have a fixed template that they don't tend to deviate from.  I have a great local banker that I work with and it's so much better than trying to work with the big banks.

Purchasing a multi unit like a duplex or triplex will allow you to begin establishing rental history/income as soon as you purchase it and as you are living there.

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