Debt to income ratio when you have rental properties

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Debt to income ratio when you have rental properties

Frandizon John Reyes
Member since 2019 · 6 posts · 0 votes

How do you calculate debt to income ratio when you have rental property? Are we using gross rental incomes or net? I own two 3-unit buildings in the Chicago area and live in one of the units. Total gross rental income is $7,000/month. Mortgage for the two buildings are $2,450/month and $2,750/month for a total combined mortgage of $5,200/month between the two. My net rental income is $1,800/month. Are we using the $7,000 gross rental income number for the denominator in dti calculation or the $1,800 net income number. Any help would be appreciated.

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Cameron TopePro Member
Property Manager · Katy, TX · Member since 2015 · 1k+ posts · 1k+ votes
6y

@Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

Hope that helps!

[email protected]832-770-7090
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  • Derek Harris
    Investor · Austin, TX · Member since 2018 · 192 posts · 104 votes
    6y
    Originally posted by @Frandizon John Reyes:

    How do you calculate debt to income ratio when you have rental property? Are we using gross rental incomes or net? I own two 3-unit buildings in the Chicago area and live in one of the units. Total gross rental income is $7,000/month. Mortgage for the two buildings are $2,450/month and $2,750/month for a total combined mortgage of $5,200/month between the two. My net rental income is $1,800/month. Are we using the $7,000 gross rental income number for the denominator in dti calculation or the $1,800 net income number. Any help would be appreciated.

    Frandizon, my recommendation is to talk to the lender and ask how they calculate it. Not all of them calculate it the same way. Many lenders only calculate a fraction of the rental income (i.e. 75%). 

    0Reply
  • Timothy Hero
    Lender · United States · Member since 2020 · 1k+ posts · 499 votes
    6y

    If you work with PML's, they don't look at your DTI or income. :)

    0Reply
  • Cameron TopePro Member
    Property Manager · Katy, TX · Member since 2015 · 1k+ posts · 1k+ votes
    6y

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    [email protected]832-770-7090
    1Reply
  • Brie SchmidtBusiness Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
    6y

    @Frandizon John Reyes - They use what is reported on your taxes, see below, unless you just bought it they use 75% of gross rents mius PITI

    Net Rent Calculator
    Property Address:
    Rents received (Line 3b)
    - Total Expenses (Line 20)
    + Depreciation (Line 18)
    + Insurance (Line 9)
    + Interest (Line 12)
    + Taxes (Line 16)
    + Eligible Other Expenses (Line 19)
    = Gross Yearly Rental Income
    / by 12 = Gross Monthly Income
    - PITIA
    =Net Rental Income(Loss)
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    1Reply
  • Frandizon John Reyes
    OP
    Member since 2019 · 6 posts · 0 votes
    6y
    Originally posted by @Derek Harris:
    Originally posted by @Frandizon John Reyes:

    How do you calculate debt to income ratio when you have rental property? Are we using gross rental incomes or net? I own two 3-unit buildings in the Chicago area and live in one of the units. Total gross rental income is $7,000/month. Mortgage for the two buildings are $2,450/month and $2,750/month for a total combined mortgage of $5,200/month between the two. My net rental income is $1,800/month. Are we using the $7,000 gross rental income number for the denominator in dti calculation or the $1,800 net income number. Any help would be appreciated.

    Frandizon, my recommendation is to talk to the lender and ask how they calculate it. Not all of them calculate it the same way. Many lenders only calculate a fraction of the rental income (i.e. 75%). 

    Oh i see. Absolutely. I will find out what my specific lender uses. Thank you.

    0Reply
  • Frandizon John Reyes
    OP
    Member since 2019 · 6 posts · 0 votes
    6y
    Originally posted by @Timothy Hero:

    If you work with PML's, they don't look at your DTI or income. :)

     Not to sound like a noob, but how do i go about finding PMLs? 

    0Reply
  • Frandizon John Reyes
    OP
    Member since 2019 · 6 posts · 0 votes
    6y
    Originally posted by @Cameron Tope:

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    Ouch! I do however, have a decent W2 income to offset the high mortgages. Im trying to start off with a refinance to get a lower interest rate and thus lower monthly payment by removing PMI. Im hoping with the refinance i will have a low enough dti to try to buy again.

    0Reply
  • Timothy Hero
    Lender · United States · Member since 2020 · 1k+ posts · 499 votes
    6y
    Originally posted by @Frandizon John Reyes:
    Originally posted by @Timothy Hero:

    If you work with PML's, they don't look at your DTI or income. :)

     Not to sound like a noob, but how do i go about finding PMLs? 

     Google. All over Google.

    0Reply
  • Jeshua Patrick
    Rental Property Investor · Charlotte, NC · Member since 2017 · 298 posts · 232 votes
    6y

    It’s pretty simple as others have said. The formula is (debt/gross W2 income + 70-80% of gross rental income) OR (debt/taxable income) whichever is less. So it doesn’t matter if 75% of your gross rents plus your W2 income adds up to $120k/yr and you only have $1k/mo in debt if your itemized deductions reduce your taxable income to $20k/yr. In the bank’s eyes you only make $20k/yr and likely don’t qualify for that $500k loan.

    1Reply
  • Cameron TopePro Member
    Property Manager · Katy, TX · Member since 2015 · 1k+ posts · 1k+ votes
    6y
    Originally posted by @Frandizon John Reyes:
    Originally posted by @Cameron Tope:

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    Ouch! I do however, have a decent W2 income to offset the high mortgages. Im trying to start off with a refinance to get a lower interest rate and thus lower monthly payment by removing PMI. Im hoping with the refinance i will have a low enough dti to try to buy again.

    That's great to have a solid W2 to offset the negative cash flow from the properties BUT if you continue to buy negative cash flowing properties there will be a point when you'll hit your max DTI and won't qualify for any more loans. The goal is to add positive cash flowing rentals that continue to improve your DTI so eventually you'll qualify without your W2.

    Best of luck!

    [email protected]832-770-7090
    0Reply
  • Michael Facchini
    Lender · Chicago, IL · Member since 2017 · 438 posts · 193 votes
    6y

    @Frandizon John Reyes, as @Brie Schmidt mentioned above, lenders typically take the income/expenses reported on your Schedule E, adding back certain line items. If you purchased in-year and haven't had a chance to file taxes for said property, then most lenders will take 75% of gross minus the full PITI housing payment.

    0Reply
  • Nicolas Dib De Castro
    Lender · San Antonio · Member since 2020 · 15 posts · 5 votes
    6y
    Hi @Frandizon, the main reason an Investor likes to use Hard Money or private lender is because there are no DTI involved, just the DSCR on the property. With that said you can buy as many properties as you want using the appropriate leverage level. But always remeber, "money is made when you buy". 

    Originally posted by @Frandizon John Reyes:
    Originally posted by @Cameron Tope:

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    Ouch! I do however, have a decent W2 income to offset the high mortgages. Im trying to start off with a refinance to get a lower interest rate and thus lower monthly payment by removing PMI. Im hoping with the refinance i will have a low enough dti to try to buy again.

    0Reply
  • Jonathan R McLaughlin
    Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
    6y

    @Jeshua Patrick for banks that do a lot of real estate thats not really true, especially around depreciation (and capital investment) You can have a loss on your tax return and still have a very favorable debt coverage ratio. Banks like to see the properties generating 1.2-1.4

    0Reply
  • Jeshua Patrick
    Rental Property Investor · Charlotte, NC · Member since 2017 · 298 posts · 232 votes
    6y
    Originally posted by @Jonathan R McLaughlin:

    @Jeshua Patrick for banks that do a lot of real estate thats not really true, especially around depreciation (and capital investment) You can have a loss on your tax return and still have a very favorable debt coverage ratio. Banks like to see the properties generating 1.2-1.4

     I was speaking specifically to traditional mortgages that would be backed by Fannie Mae or Freddy Mac. As many of us know, there are many banks that like RE and think outside the box if you can show that the property is profitable.

    0Reply
  • Jeshua Patrick
    Rental Property Investor · Charlotte, NC · Member since 2017 · 298 posts · 232 votes
    6y
    Originally posted by @Cameron Tope:
    Originally posted by @Frandizon John Reyes:
    Originally posted by @Cameron Tope:

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    Ouch! I do however, have a decent W2 income to offset the high mortgages. Im trying to start off with a refinance to get a lower interest rate and thus lower monthly payment by removing PMI. Im hoping with the refinance i will have a low enough dti to try to buy again.

    That's great to have a solid W2 to offset the negative cash flow from the properties BUT if you continue to buy negative cash flowing properties there will be a point when you'll hit your max DTI and won't qualify for any more loans. The goal is to add positive cash flowing rentals that continue to improve your DTI so eventually you'll qualify without your W2.

    Best of luck!

     It is possible to have positive cash-flowing properties but still show a loss on taxes. 

    0Reply
  • Cameron TopePro Member
    Property Manager · Katy, TX · Member since 2015 · 1k+ posts · 1k+ votes
    6y
    Originally posted by @Jeshua Patrick:
    Originally posted by @Cameron Tope:
    Originally posted by @Frandizon John Reyes:
    Originally posted by @Cameron Tope:

    @Derek Harris is correct - most banks will take a percentage of gross rents (70-80%) assuming that 20-30% of gross rents will be used for expenses. 

    Therefore your rent income to offset your DTI would be between $4,900 to $5,600 ($7,000 x 70-80%). To some banks you would have a negative cash flow.

    Hope that helps!

    Ouch! I do however, have a decent W2 income to offset the high mortgages. Im trying to start off with a refinance to get a lower interest rate and thus lower monthly payment by removing PMI. Im hoping with the refinance i will have a low enough dti to try to buy again.

    That's great to have a solid W2 to offset the negative cash flow from the properties BUT if you continue to buy negative cash flowing properties there will be a point when you'll hit your max DTI and won't qualify for any more loans. The goal is to add positive cash flowing rentals that continue to improve your DTI so eventually you'll qualify without your W2.

    Best of luck!

     It is possible to have positive cash-flowing properties but still show a loss on taxes. 

     I don't understand what that has to do with the conversation? 

    [email protected]832-770-7090
    0Reply
  • Frandizon John Reyes
    OP
    Member since 2019 · 6 posts · 0 votes
    6y
    Originally posted by @Brie Schmidt:

    @Frandizon John Reyes - They use what is reported on your taxes, see below, unless you just bought it they use 75% of gross rents mius PITI

    Net Rent Calculator
    Property Address:
    Rents received (Line 3b)
    - Total Expenses (Line 20)
    + Depreciation (Line 18)
    + Insurance (Line 9)
    + Interest (Line 12)
    + Taxes (Line 16)
    + Eligible Other Expenses (Line 19)
    = Gross Yearly Rental Income
    / by 12 = Gross Monthly Income
    - PITIA
    =Net Rental Income(Loss)

    I apologize for taking so long to respond. What form can i find this information? is this all on the schedule E?

    0Reply
  • Frandizon John Reyes
    OP
    Member since 2019 · 6 posts · 0 votes
    6y
    Originally posted by @Jeshua Patrick:

    It’s pretty simple as others have said. The formula is (debt/gross W2 income + 70-80% of gross rental income) OR (debt/taxable income) whichever is less. So it doesn’t matter if 75% of your gross rents plus your W2 income adds up to $120k/yr and you only have $1k/mo in debt if your itemized deductions reduce your taxable income to $20k/yr. In the bank’s eyes you only make $20k/yr and likely don’t qualify for that $500k loan.

    Thank you. This is what i need. The 70-80% part does hurt me a bit. It's tough to maintain a decent DTI

    0Reply
  • Brie SchmidtBusiness Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
    6y
    Originally posted by @Frandizon John Reyes:
    Originally posted by @Brie Schmidt:

    @Frandizon John Reyes - They use what is reported on your taxes, see below, unless you just bought it they use 75% of gross rents mius PITI

    Net Rent Calculator
    Property Address:
    Rents received (Line 3b)
    - Total Expenses (Line 20)
    + Depreciation (Line 18)
    + Insurance (Line 9)
    + Interest (Line 12)
    + Taxes (Line 16)
    + Eligible Other Expenses (Line 19)
    = Gross Yearly Rental Income
    / by 12 = Gross Monthly Income
    - PITIA
    =Net Rental Income(Loss)

    I apologize for taking so long to respond. What form can i find this information? is this all on the schedule E?

    Yes, the line # correlates with the line # on the Schedule E.  I have it uploaded in the file place



    https://www.biggerpockets.com/files/user/chicagobrie/file/net-rental-income-calc

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    Second City Real Estate4.821 Reviews
    WebsiteView Page
    0Reply
  • Darrell Johnson
    Member since 2018 · 5 posts · 3 votes
    4y

    If the lender follows Fannie Mae guidelines, this is one of most interest to you. You may have to help the lender understand it if they are not following it correctly:

    https://www.fanniemae.com/content/guide/selling/b3/3.1/08.html#Calculating.20Monthly.20Qualifying.20Rental.20Income.20.28or.20Loss.29

    "Calculating Monthly Qualifying Rental Income (or Loss)" "When Schedule E is used to calculate qualifying rental income, the lender must add back any listed depreciation, interest, homeowners’ association dues, taxes, or insurance expenses to the borrower’s cash flow. Non-recurring property expenses may be added back, if documented accordingly." "Treatment of the Income (or Loss)" "If the rental income (or loss) relates to a property other than the borrower's principal residence: If the monthly qualifying rental income (as defined above) minus the full PITIA is positive, it must be added to the borrower’s total monthly income. If the monthly qualifying rental income minus PITIA is negative, the monthly net rental loss must be added to the borrower’s total monthly obligations. The full PITIA for the rental property is factored into the amount of the net rental income (or loss); therefore, it should not be counted as a monthly obligation."

    The last sentence clearly states that after including the net rental income in the denominator or loss in the numerator, that the rental property mortgage payments are not also supposed to be included in the numerator as monthly obligations. So if your DTI excluding rental properties is D/I, your existing Sch E rental income is $4000/month and ongoing Sch E rental expenses (do not include amortization of expenses already incurred or depreciation) plus current rental PITIA payments are $3,600/month, your new purchase rental income is 75%*$2,000=$1,500/month, and your new purchase rental PITIA is $1,800/month, your new DTI would be (D+($1,800-$1,500))/(I+($4,000-$3,600))

    "Rental Income Worksheet – Individual Rental Income from Investment Property(s) (up to 4 properties) (Form 1038)"

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