How co-borrowing impacts future debt to income ratios
Flipper · Member since 2011 · 5 posts · 0 votes
I recently purchased a triplex with my in laws. It is a shore property that we plan on renting two of the units seasonally and keeping one unit jointly for our own use over the summer. Both my wife and I as well as both my in-laws are on the loan and title. My question is around how my debt to income ratios will be calculated when i go to buy my next property soon. Since I am legally responsible for the full loan even if no one else pays, I assume under-writers add the full monthly mortgage payment to be debt. But they will use my tax returns to determine income (of which I'll only claim 50% since my wife and I file jointly and own 50% of the property).
So for example, lets say the annual debt payments equal 2500 monthly. Lets says the rental income is 3,000 monthly. So my debt side of debt-to-income will increase 2500 but my income will only go up 1500?
This seems unfair.
is this your 1st investment property? if so, you gotta have 2 years of tax returns in order to qualify the income. then, they'll count 75% of the rent - PITA.
Otherwise, yep, you gotta include the total payment as debt. With your wife & your income - assuming you have no other debt & not a monstrous primary residence mortgage payment - you may be able to get another investment loan (you can go up to 45 or 50% DTI).
You should discuss with your CPA exactly how this will hit your tax return. Properties that are both rental and personal use get complicated.
For purely rental property and a new landlord (no history of rentals on your tax returns), lenders will completely ignore the rental income. Since you're fully responsible for the loan, the full payment will be include in your DTI calculation. If you turn around and try to buy another property (rental or residence), they will include the full amount of the new payment.
Once you have two years history, lenders will usually being considering your rental income. For the existing property, they will look at the actuals on your tax return. Most sensible lenders will add back in the depreciation amount. Your tax return will show a deduction for half of the interest as well as all other expenses. It will show half the income. If the bottom line on the rental (Schedule E) is negative, its a debt. If its positive, its income.
So, you start with your DTI calculation, ignoring the rental completely. If the net rental income from above is positive, you add that amount to the income part and your DTI improves. If its negative, you add the amount to your debt payments and it hurts your DTI.
I don't know exactly how they handle the fact you're using it yourself part of the time.
If you have a landlording history, and you want to buy an additional rental, they will usually use a rule of thumb to estimate the effect of the new rentals. That rule of thumb is:
net rental income = (75% * rent) - PITI
That's then factored into your DTI as above.
Perhaps one of the CPA members like Steven Hamilton II will chime in and point out my errors.
Thanks. Yes I have three years history. My primary is a duplex. I understand why they would add the full payment to my debt calculation since I'm legally responsible. My quest was more about what percent of the income I get toward my income calculation. Seems like they are penalizing me for having a coborrower even though if I'm making the full debt payment I'm probably getting all the rental income too. I was curious if some underwriters would take that into account.
Thanks for the quick response
Albert Young you really do want to discuss this with possible lenders. Who really knows exactly how a specific lender might treat this. What should reasonably should happen isn't always what lenders actually do.
Albert Young,
Typically many lenders will look at 75% of Gross Rental income and then will deduct the expenses. This is to account for vacancy or a serious situation.
They then should be adding back in the depreciation and interest expenses. You will then see subtracted the payment amount. This is to calculate the true expense rather than the inflated depreciation amount.
My first question is how are you treating the property with your in laws? I Highly recommend filing a partnership return to keep things simple. Also make sure that you have a written partnership agreement in place in case things turn sour with them and/or your wife. That said: A partnership interest would pass through to your tax return the gross amount of income after expenses. and they would again do the calculation from above to figure out your portion.
This is where if your agreement shows you receive all of the rental income and pay the associated expenses they would in fact include both the income and the full expense. Otherwise it would be prorated based upon the percentage of income received.
I will second what Jon Holdman: "what should reasonably happen isn't always what lenders actually do".
-Steven
My first question is how are you treating the property with your in laws? I Highly recommend filing a partnership return to keep things simple. Also make sure that you have a written partnership agreement in place in case things turn sour with them and/or your wife. That said: A partnership interest would pass through to your tax return the gross amount of income after expenses. and they would again do the calculation from above to figure out your portion.
This is where if your agreement shows you receive all of the rental income and pay the associated expenses they would in fact include both the income and the full expense. Otherwise it would be prorated based upon the percentage of income received.
...
This quote is exactly what you should be doing. As a partnership, the income and expenses will be allocated to each partner in accordance with their share (or as given in the partnership agreement).
so if i create a partnership with my inlaws and we each own 50%, then the lender would only assign 50% of the monthly debt (as well as income) to my debt to income ratio?
thanks everyone for the insight.
Will the lender do that? You'll have to ask around at different banks to see - but that is likely your best chance of them looking at it as 50-50 split.
If you and your in-laws are co-borrowers, then you are jointly and severally liable for the loan payments. In the event your in-laws don't pay their share of the loan payment, you are responsible for the full amount. Lenders look at this as a liability and, assuming the worst case scenario, compute your DTI as if you are the only one making the full payment.
Putting the property in a partnership will not change this computation. You are still personally liable for the mortgage loan, and your DTI will still be impacted by the full amount of the loan payment.
Just how I see it.
Yeah I figured they assign the full liability. I dont agree with it necessarily, but I understand it. My question is what do they do with the income? To me if they are going to assign the full liability to my DTI then they should also assign the full rent roll to my income (or 75% of gross or whatever calculation they use). Did they do this in your case?
Yeah I figured they assign the full liability. I dont agree with it necessarily, but I understand it. My question is what do they do with the income? To me if they are going to assign the full liability to my DTI then they should also assign the full rent roll to my income (or 75% of gross or whatever calculation they use). Did they do this in your case?
@albert Young - did you ever get an answer on this? If they count the income for the full 100% (or the 75% calculation) or if they split it 50/50?
Hey Albert,
I think I can shed some light on your situation, but I will warn you that this is a very "inside baseball" explanation.
Basically the bank takes the most conservative approach unless you can prove otherwise. Therefore, they are hitting you with the full liability in case you simply have an extra property for your in laws. Unfortunately, in an underwriters eyes this is a all of nothing issue
Here are some potential solutions:
1. Are you paying the mortgage out of your account or are your in laws paying it? I ask this, because Fannie and Freddie are willing to exclude a mortgage if you can show that you are not the one who has been paying it. If you are able to show 12 months of payments from your in laws, the underwriting guidelines for conventional loans will allow you to remove this from your monthly debt. However, this can be difficult if the income is claimed on the schedule E of your tax returns and you will not be able to use the income from the property to qualify.
2. You may not even need to solve this problem! If you are paying the mortgage, you can offset the debt with the income the property generates. Basically, if the schedule E on your tax return shows enough income (after add backs such as depreciation), it will essentially nullify the liability in your DTI calc. Here is a link to the calculator that many lenders use to determine what the effective income of your rental property is: https://new-content.mortgagein...
This is more accurate than previous posts suggestion that you use 75% of the rents because the Fannie/Freddie guidelines state that you only do the 75% calc if you have rented the property less than a year. Obviously, tax information is personal and I would never ask you to share that info. However, if you are willing to send me the "theoretical" numbers on your schedule E without the rest of your returns...I am absolutely willing to do fill in the calc.
3. Quit claim the property into a non pass through entity and refi it into that entity. This solution can be a mine field because you would need to not personally garuntee the loan for it not to show on your credit report. The downside is that your would either not use the income generated from the property or go through the extremely laborious self employed process. Warning!!! I am not an account or lawyer.
4. Find a credit union or local bank to work with who is apprised of the situation and willing to take your unique situation into account. They would need to take your future acquisition on as a portfolio loan which likely means higher rates and lower leverage. These relationship are usually built over time, thus adding another hurdle.
5. Use hard money for your next purchase. Hard money can be scary, but if your next purchase is 100% a rental property, I know a lender that will lend just off the cash flow of the deal (and credit score) without doing a DTI calculation. Feel free to direct message me if you would like this info.
I know this is A LOT of information, so please let me know if you have any questions. The best weapon in your situation is having the knowledge to correctly present yourself to a lender. More often than not loans are ruined by the borrower giving too much information instead of the right information.