Want to quit W2 but don't want to lose ability to get loans

42 Replies

Hi BP.

I'd like to set a goal for self-employment after I hit the 2 year mark with my W2. That's a little over 14 months away. I have a side hustle that's growing faster than I expected, and I also want to get my RE license. I'm working with SCORE to build business plans for both these and my REI endeavors.

But I also wanted to start BRRRR-ing this summer after I sell a property. Is there anything I can do to prepare for the transition to self-employment that will keep me from becoming a pariah amongst lenders, or do I have to choose between my BRRRR goals and my other business goals?

Thanks in advance!

Do you include your side hustle money on your taxes?  You will need at least a 2 year history for your self employed income as a requirement for traditional lenders.  Lenders take a 2 year average of the income, and that is what they use as your income to debt ratio for figuring how much you can borrow.  You could start that clock now, while you are still a W-2 employee.  That way, when you are ready to become self employed full time, you already have a good history established and can start from day one.
Also, lenders will count rental income against the property debt, so if you write offers on properties that already have Tenants in place, that would also work for you, especially if your debt to income ratio is low in the beginning.  The property rental income can offset that for you.  Some lenders can also estimate a rental income on a property that isn't currently Tenant occupied.  However, this is usually a percentage of the average rental rate for the area, and you better believe the lenders are conservative on what number they use.
So, the answer is....Yes, it can be done.  Start now by establishing your self employment income by including it on your taxes so that it can be documented, and the 2 year clock can begin.
Best of luck to you!

@Cara Lonsdale I did not include my side hustle money last year because it was only $15, and my CPA told me it wasn't necessary. It will be reported this year, and I've always reported my rental income and expenses since I became a landlord in 2016.

I will be buying properties and rehabbing them with cash and/or lines of credit I've already established. They would be rented before refinancing. Would that make the process any easier?

Thank you for the input! It's very helpful.

I have been in the predicament you describe for about 2 years now with at least one year to go. The short answer is: hard money typically does not ask - or care - about DTI ratios. Asset-backed lenders will be your new best friends.

Originally posted by @Darius Ogloza :

I have been in the predicament you describe for about 2 years now with at least one year to go. The short answer is: hard money typically does not ask - or care - about DTI ratios. Asset-backed lenders will be your new best friends.

So you're suggesting I find private/HM lenders? Have you found ones that offer reasonable rates on long-term holds?

I processed too late your focus on BRRRR hence my follow-up re: "we do flips."

The best solution I have found for access to long term hold type funds is a bank willing to do cash out refi's on investment properties based almost solely on analysis of the asset. 

EastWest Bank out here in California does these in certain select counties (including San Francisco). 

 

  

@Nicole Heasley - I wouldn't base your career on whether or not you can get loans from a traditional bank.  They are the worst.  I work with investor friendly lenders that focus on the financials of the property instead of the borrower.  If you have decent credit, down money and the property cashflows you're golden.  You'll pay a little higher rate but the loans will be A LOT easier.  Message me if you want some direction.

Originally posted by @Nicole Heasley :

@Cara Lonsdale I did not include my side hustle money last year because it was only $15, and my CPA told me it wasn't necessary. It will be reported this year, and I've always reported my rental income and expenses since I became a landlord in 2016.

I will be buying properties and rehabbing them with cash and/or lines of credit I've already established. They would be rented before refinancing. Would that make the process any easier?

Thank you for the input! It's very helpful.

I like your model. It's a solid plan. The lender will be able to count the rental income on the refi. It will be a percentage of the actual rental rate because you don't have tax reporting history for the rental income. So, be prepared for that. It is usually about 75% of the rental income that they will use. However, once you have a 2 year history of the rental income on your taxes on your schedule E (and it is a positive number), they can add that to your income to qualify you.

So to clarify, before 2 year history on the Schedule E, the lender can figure 75% of the rental rate.  After the 2 year history, the Lender can use the average of the 2 years listed on the Schedule E of your taxes.


Also, someone mentioned the hard money lenders. They are a great asset for acquisition, as they qualify the project, and not you, or your $$. Some people like to acquire the property with the HML, then rehab it if necessary, and place a tenant and THEN refi using a traditional lender to either do a rate and term refi or a cash out to recoup some of the out of pocket rehab expenses. Again, the rental income would help you qualify if you were short on showing income from your side hustle (turned permanent self employment income) for the first few years when your averages are lower.

Hopefully that makes sense.  Sometimes when you are new to all of this, it is hard to grasp all of these moving parts.  I don't want to confuse you.  :)

 

@Nicole Heasley my 2¢ is to form an entity (I have a corporation and a board member of a non profit) where you are an employee while building business credit, increase your ability for future lines of credit.

If you're structured well and asset protection for your property/companies, you can acquire loans with the bank moving forward. Have you looked into private money as another option?

All the best.

Like @Cara Lonsdale mentioned, try to build up your 2 years of self-employment income while you are still in your W2.  That way you still qualify for loans after you leave your job.  It's also good that you have at least two years of being a landlord (in order to count your rental income).

Alternatively, you can get 30-yr asset-based LLC rental loans; a lot of HMLs actually offer this. The rates will be higher (usually in the high 5's), but they are much easier to qualify for and don't care about your personal income at all (and thus no tax returns, pay stubs, etc); they only care about the cashflow of the subject property.

The advice here is great. One advice is to have good book keeping. Make sure you understand where all your money goes and when you scale up in your BRRRR properties it will allow for you to do more. Best wishes you got this!

@Nghi Le in an LLC do you put just one property or multiple? We have 3 properties and are working on an LLC and debating whether or not to put them together or in separate LLCs. They're SFHs. I'm just wondering if it's more beneficial if we wanted to find a HML as you've suggested what would benefit Us more- all the rental income in one LLC ? Thanks!

@Nicole Heasley exactly!! It's not talked about enough on BP. We run a successful fix-n-flip and buy and hold business in Phoenix, AZ but I still work at a high end steakhouse 2-3 nights a week to qualify for my HELOC's, line of credits, etc.

@Nicole Heasley Have you considered using commercial loans?

Pros:

(1) Deals stand on their own

(2) Putting properties in LLCs insulate themselves from any legal liabilities - cheap insurance

(3) Lower or No Seasoning Period - Faster "Velocity" of Capital as you redeploy

Cons:

(1) High Interest Rates (0.5%-1%)

(2) More Equity Locked Up (75% LTV)

Originally posted by @Kerri K. :

@Nghi Le in an LLC do you put just one property or multiple? We have 3 properties and are working on an LLC and debating whether or not to put them together or in separate LLCs. They're SFHs. I'm just wondering if it's more beneficial if we wanted to find a HML as you've suggested what would benefit Us more- all the rental income in one LLC ? Thanks!

The question you're asking is more of a personal choice, i.e. risk tolerance. Some investors do like to put one LLC per property to completely separately the liability. But I think it's a little bit of an overkill (although with Series LLCs it makes it easier). My personal preference is about $250k worth of equity (not necessarily property value) per LLC. In CA where values are higher, this could mean one property, whereas in the midwest it could be 5 or 10. But it could also mean one free and clear property vs 5 leveraged properties. If the properties are in different states, then it could make sense to separate LLCs by state as well.

If you're going the HML/asset-based route, it doesn't really matter to keep rental income in one place. They don't tend to look at income from your other properties or tax returns. It might help if you're trying to maybe get a commercial loan or line of credit? But normally if lenders care about what other properties you own, they'll just ask for a real estate schedule.

@Cara Lonsdale thanks for the detailed response. I am facing a similar dilemma. My personal non-W2 income always appears as zero or there abouts on my personal returns. In reality, i use the depreciation of properties held in an LLC (which files taxes separately), and invests everything else back in the business. Do banks typically consider looking into a this depreciation as my personal income?

Originally posted by @Peter Forrest :

@Cara Lonsdale thanks for the detailed response. I am facing a similar dilemma. My personal non-W2 income always appears as zero or there abouts on my personal returns. In reality, i use the depreciation of properties held in an LLC (which files taxes separately), and invests everything else back in the business. Do banks typically consider looking into a this depreciation as my personal income?

There are a lot of things that lenders add back into your rental income. Depreciation is one of them.  Car expenses (miles) is another.  Some other expenses too  so best to consult with a lender to get the best picture of what they will use for income  

 

@Nicole Heasley

Pay taxes.

After reading a few of these posts it’s interesting that people will go through great lengths to write off everything, create entities, use hard money lenders, ect. When they could have just paid XXX in federal taxes and been able to buy whatever they want.

How much are you saving? What hassles is it creating? How much would one hard money loan cost in comparison to paying some income tax?

@Nicole Heasley

Getting those conventional loans is a big part of my strategy. Doing them in mine and wife’s names separately. Not really motivated to leave the W2 until those are maxed out. No rush. Employer matched retirement contribution and health insurance is tough to give up. Seems silly to walk away from such cheap fixed 30 year debt.