How to Lenders figure DTI Ratio on Rental Units?

[Daniel Dietz]

So far I have only bought property within my SDIRA on a cash basis, so have not needed to work with lenders. Soon I will be buying one or more rentals outside of my SDIRA, using 'conventional financing'.

The question I have in regards to DTI Ratio's is this; say I have 1 or 2 rentals that I have held for a year or more with a good rental history etc.... and I would like to look into buying additional properties. I DO understand the 'personal side' of my regular income vs debt..... but not the rental business side.

Let's say I had a building worth 100K, with a 75K loan, 16.5K of income, 8,25K of Operating Expenses, 5K of Debt Service for a Cash Flow of about 3.25K a year.

How does a lender look at that? Is it as simple as 5K Debt Service / 16.5K of Income for a 30% Ratio? If so, is that a 'favorable ratio' as far as getting more loans that could create the same numbers, assuming I had 25% down for them?

Just trying to plan ahead :).

Thanks, Dan Dietz

[Ryan R.]

My lender lumps all my debt together, including rental property, and then performs a DTI using 80% (I recall) of the revenue generated from my rental income and inculudes that as regular income.

[Glenn Gray]

Take a look at this example transaction from a lender website:

https://www.efirstbank.com/products/credit-loan/retirement-based-real-estate.htm

[George Paiva]

Well if you are looking at property DTI then its as simple as

Net Operating Income divided by Debt Service = DTI Ratio.

Typically if banks are looking at only Property DTI then they want 1.5 or higher.

I believe last commercial loan I obtained they also didn't want personal debt greater than 40-45% of Income.

[Anthony Hornbeck]

I'm curious to hear answers as well. I'm currently in an owner occupied duplex, and I'm seeking a second property.

I called a mortgage originator yesterday that I used for conventional financing on the first duplex. She told me that my equity stake in the first property would not be looked into as much as the DTI. She also told me that the income from my duplex would not be counted until I had seasoned (owned) it for 2 years.

I believe this is because it is owner occupied, but confirmation from one more experienced is definitely welcome.

[Jon Holdman]

@George Paiva you're confusing DTI with DSCR. DSCR is debt service coverage ratio and that is indeed the NOI divided by the debt service. And lenders do look at that, at least on commercial deals.

The 1st Bank example is for a IRA loan.

For your personal DTI, I believe it works like this:

First, completely ignore the rentals. Add up all your debt payments. Add up your (non rental) income.

DTI = debt payments / income.

Now, account for the rentals. To do this you need the net rental income. For existing properties this is right off your tax return. Savvy lenders add depreciaion back in since that's non-cash. For a new property, lenders estimate net rental income as (rent * 0.75 - PITI). Now, is the net rental income positive? If so, add it to the income in the calulation, improving your DTI. Are you running at a loss? If so, add the loss to the debt.

Examples. Assume the you have $1000 a month in non-rental debt and $4000 a month in non-rental income.

DTI = $1000 / $4000 = 25%

Now, assume you have net rental income of $2000 a month. Now your DTI is:

DTI = $1000 / ($4000 + $2000) = 16.7%

New instead assume you have a net rental loss of $2000 a month. Now DTI is:

DTI = ($1000 + $2000) / $4000 = 75%

Also note that most lenders require at least two years of landlording experience before they will consider the rental income at all. Before that the debt payments from the rentals adds to the debt part of the DTI calculation and the rental income is ignored.

[George Paiva]

Oops after looking at my due diligence spreadsheet I do see its for Debt Coverage Ratio not DTI.

[Anthony Hornbeck]

Thanks for the explanation and example Jon!

That's the type of answer I always hope to get from a lender, but the answer is never so clear and encompassing.

[Chris Adams]

@Jon Holdman and @Daniel Dietz

There are 2 types a DSCR a commercial lender will look at.

A DSCR on the property your looking to acquire, in the current economy 1.20:1 is typical, but this will change based upon loan size and economy. 1:1 was actually common pre crash.

And what is called a Global DSCR, which includes, all forms of income, and all forms of debt, personally and corporate (if you have corps).

1.20:1 is what my banks wants me to show for both.

I actually have the exact spreadsheets he uses. I recently did a deal with another bank, and when i gave him my global DSCR spreadsheet he realized he was dealing with a fairly sophisticated investor.

On a side note, I suggest often that everyone wanting to be a REI understand what banks want, and how they underwrite loans. This way you can structure your deals accordingly and there will be less stress when approaching banks for financing.

[Chris Adams]

@Daniel Dietz Since I didn't answer your question here is a copy of a pro forma my banker uses to calculate DSCR, based on your numbers, I used a typical 5 yr Arm to figure payments, and I also went with your generic 8.25 Operating expenses.

If I was looking at this deal, I would pass because its DSCR is too low.

[Pete T.]

@Daniel Dietz it all depends on the bank. Some will use 75% of rents, others will use the expenses and give a certain percentage of income. Find a bank that fits your criteria bc as regulated as things are, different lenders look at rental income differently.

[Pete T.]

Can you clarify on the type of property your looking at? I thought you were talking about DTI, but I am seeing post about DSCR, which would be a factor in a commercial property.

[Jon Holdman]

I believe, though I'm not a banker, that if you're buying SFRs with conventional loans they're going to do the DTI calculation. If you're buying commerical properties or apartment buildings, they're going to look at DSCR. I think, though this I really don't know for sure, that if you're buying SFRs with portfolio loans they're also going to look at DTI.

The way you can try to get an answer is to actually ask the broker or lender. Be specific: "could we please work through the calculations you will use to qualify me?" Asking vaguely stated questions will get you unreliable answers and ugly surpises later in the process.

[David J.]

My portfolio lenders stopped using DTI when I acquired a half dozen properties and look at appraisal and DSCR. They look at global DSCR (portfolio total) and DSCR for each property. If my global is good enough they let a negligible property slide through, but they have policy levels for both.

[Bryce Y.]

@Jon Holdman

Do you know exactly what gets counted as debt? Aside from consumer debt and mortgages for personal residence, do they count things like lines of credit, active credit cards, etc? For my personal situation, I have no consumer debt, currently rent an apartment, and have a conventional loan on an investment property that easily cash flows. So my DTI is .... zero?

The bank I am working with now calculated it differently. I think they counted PITI as debt, then took 75% of the gross rents and applied it to income. It didn't prevent me from qualifying, but after playing with the numbers for a bit you realize even if you keep acquiring rentals that cash flow, your DTI will keep increasing, eventually pushing you over the acceptable limit.

[Jon Holdman]

@Bryce Y. AFAIK they count everything. Another poster was saying that for a HELOC they assumed you drew out the full amount, for example.

I would think that even if a lender used (PITI / (75%*rent)) for a new property they would still use actuals from existing ones.

If you think about it, if the rental truly is cash flow positive (after all expenses, vacancy, and capital, NOT just rent > PITI) then owning the rental improves your personal income statement. Saying "sorry, no more loans for you" is the same as saying "you're making too much money". I have a friend with a couple dozen rentals, most financed by the same local portfolio lender. In chatting one day he said "the bank just keeps giving me money."

Now, it is entirely possible that a bank would cut you off at some point because they've reached some limit for what one person can borrow.

Your example, Bryce, is why I would really advocate sitting with your banker and saying "please help me work through these calculations".

[Jeff S.]

Wells did not use my loc's or credit card limits as potential debt payments when I went to be qualified for a potential investment property.

[Bryce Y.]

Originally posted by Jon Holdman:

If you think about it, if the rental truly is cash flow positive (after all expenses, vacancy, and capital, NOT just rent > PITI) then owning the rental improves your personal income statement.

Thanks Jon and I totally agree with the above.

[Ed Wood]

Many people are mixing DCR which is a commercial ratio vs a DTI being a conventional loan ratio. DCR is NOT used when calculating conventional loans. Here's IS how underwriters calculate income on 1-4 unit investment property.

1) If you own the property for less than 1 year (AKA not on your tax returns or is the subject property the formula is: rent x 75% - PITI = usable income. The property must already have a tenant and you will need to produce a rental agreement. So other documentation may be required.

2) For the investment properties you've held for 1 or more years where they are on your schedule E they will use the the income and expenses from this schedule. Good news is they add in any paperlosses like depreciation and any 1 time expenses such as a new roof, new kitchen, etc you can prove with organized receipts.

Schedule E Calculation:

Non-Subject Property:
Add
Line 3
Line 12
Line 18

Minus
Line 20

Divide by 12 - mortgage payment = net income

Subject Property:
Add
Line 3
Line 9
Line 12
Line 16
Line 18

Minus
Line 20

Divide by 12 - PITI = net income

If you've had the property on 2 years of returns and the income is increasing they will average the 2 years if the income is decreasing they will use the most recent. With loans underwriters will ALWAYS use worse case.

That's the scoop! Still not convinced? Starting on Page 323

https://www.fanniemae.com/content/guide/sel011713.pdf

[Daniel Dietz]

Thanks for all the responses. LOTS to comprehend fully.

The properties I am talking about would be mostly 1-2 units, and when I am referring to 'acquisition costs' that would be the 'all in costs' after any needed repairs etc....

@Chris Adams, I am coming up with a bit different numbers than you show. I will look things through in more depth and see where the differences are.

@Jon Holdman , if I follow you correctly, you are saying that I would add the rental income and expenses INTO my personal ones, not look at them as a 'stand alone' unit? Meaning if 'Income * .75 was $13,500 - PITI of $9000 that would NOT be a DTI of 66% (as far as how they look at it) but I would add that to my current non-rental figure of about 36K income and 12K debt (house cost with PITI) that is at a 33% DTI and it would then be 36K + 13.5K income = 49.5K and 12k + 9K =21K debt for a 'new ratio' of 42%? Hope that made sense ;-)

One other thing I was wondering is how much my personal net worth makes a difference when a lender evaluates these things? I have about 150K equity in my home, 150 K in an Insurance Policy (paying 5% and triple A rated) and about 120 K in my IRAs. Does this give lenders any 'peace of mind' as the evaluate the rest.

Thanks again for all the replies!

Dan Dietz

[Albert Bui]

Originally posted by @Daniel Dietz:

So far I have only bought property within my SDIRA on a cash basis, so have not needed to work with lenders. Soon I will be buying one or more rentals outside of my SDIRA, using 'conventional financing'.

The question I have in regards to DTI Ratio's is this; say I have 1 or 2 rentals that I have held for a year or more with a good rental history etc.... and I would like to look into buying additional properties. I DO understand the 'personal side' of my regular income vs debt..... but not the rental business side.

Let's say I had a building worth 100K, with a 75K loan, 16.5K of income, 8,25K of Operating Expenses, 5K of Debt Service for a Cash Flow of about 3.25K a year.

How does a lender look at that? Is it as simple as 5K Debt Service / 16.5K of Income for a 30% Ratio? If so, is that a 'favorable ratio' as far as getting more loans that could create the same numbers, assuming I had 25% down for them?

Just trying to plan ahead :).

Thanks, Dan Dietz

I wrote a couple articles that might help about the above that pertain to conventional financing but at the end of the day it depends on what time of financing you're looking for.

Conventional lenders and normal residential lenders use debt to income as a measure to qualify while commercial and portfolio lenders use debt service ratio.

10 Best Practices in 1-4 Unit Investing for Agency/Conv. Financing

Reviewing Rental Property Financials - Most Common Items I've seen

commercial and portfolio lenders use a different methodology to determine your qualification. If you have questions about that let me know.

[Albert Bui]

Debt to Income - DTI - is only use on FHA, conventional, Va and other typical residential transactions (consumer front).

If you're going to a portfolio lender they look at lending from a 1.25x DSCR point of view (industry standard) which in essence is a 80% Debt to Income if you think about it.

1 dollar of debt / 1.25 dollars of net operating income (NOI) = 1.25 X DSCR = 80% DTI

Never the less us bankers joke about it all the time because it might be crazy from a residential loan officers point of view but in the banks eyes its not from a commercial point of view.

The commercial bank views income property as a consistent sustainable source of reocurring income especially in stronger rental markets so having 1.25 dollars of net income coming in for every dollar of out going debt service payment is acceptable.

The mess with this 1.25x they will sometimes make you conform even while subjecting you to underwriting at higher rates, shorter amortization periods, and other income adjustments that make it harder to obtain 1.25x. So do not think that your 1.25x on your excel will be the same at the lender's 1.25x as they may be using 5% vacancy, 10% property mgmt, and other adjustments that you did not.

On the residential front, as mentioned before above, its pretty black and white you either use 75% of gross - PITIA  or you use the tax returns income.

Let me know if that helps.

[Scot Howat]

Also...

2-year history of managing 1-4 unit investment properties is required if using  rental income to qualify.

Make sure that you have this if you're doing an investment property.

[Caitlin Stein]

I do not work for Quicken Loans but I found some good info.

In other words, yes some conventional lenders will count potential rents if you are buying a home for the purpose of renting it.   But as someone mentioned earlier, you have to ask. Because Fannie Mae conventional lenders may have more conservative rules (overlays) than Fannie Mae rules.  But yes, Fannie Mae allows it.   

From Quicken Loans

How is the rental income counted?

For new investment property purchases, income will be calculated based on the lesser of the rental income stated on the lease agreement or the appraiser’s opinion of what can be expected for a specific market. Once that’s established, the lender will reduce that amount by another 25% to determine qualifying income. This provides the lender with a conservative amount that factors in potential vacancy periods.

Read more at http://www.quickenloans.com/blog/investment-properties-frequently-asked-questions-expect#0FYrTzxczOOpLhTW.99

Is it true that I must have two years of landlord experience? What if this is my first time?

Freddie Mac and Fannie Mae differ on this rule. Freddie requires a borrower buying an investment property to show two years of landlord experience, through tax returns, in order to count projected rent as income. Fannie Mae says it’s still possible to buy an investment property and use a portion of income to qualify without having a two-year history. Quicken Loans does not impose the two-year rule on the majority of investment property purchase transactions.

Read more at http://www.quickenloans.com/blog/investment-proper...