Vacation Rental. How To Get Financing With High Debt To Income?

13 Replies

Hi all!

This is my first post here and I'm happy to be apart of such a knowledgable community! Here's my situation...My wife and I currently own and manage 2 vacation rental properties. We would like to expand eventually buying several more but we're stuck between a rock and a hard place because after purchasing the 2 properties and having a mortgage on our primary residence as well, our debt to income is too high for our bank to issue additional financing for more properties. We've owned for 2 years and are claiming about $25,000 yearly profit on our tax returns (including depreciation) which means we can finally include this as income. The properties are doing better year over year and are earning between 20% - 55% cash on cash return. We'd like to expand adding a much larger property ($500k - $800k) to our portfolio and unfortunately, this additional $25,000 in income won't drop our debt to income enough to receive financing for said property.

I'm here to ask for advice on the next steps to take. Here's options I've considered but not pursued as I'm not sure of the best route:

-Create an LLC and use a quit-claim deed to transfer the 2 currently owned properties into it. Could this also transfer their debt into the business and lower my personal debt to income?

-Find a Commercial Lender. Is there a commercial loan in existence that offers 20 years payoff without a balloon?

-Create an LLC and find a partner to own a stake in the company for use of their money to purchase the property. Or even find a solid investor to co-sign a loan for a percentage of net income generated from the property.

Any help or advice is appreciated! My wife and I are in our late 20's and don't want this great opportunity of creating real estate wealth to slip away.

-Kendall

Kendall,

some people have had success with forming an llc then doing a quit claim deed, the only thing with that is it may trigger the due on sale clause in most mortgages, the banks consider that a sale of property and will want the loans paid off. forming an llc does not transfer your dept so that it does not show on your personal records, all money earned or loss in the llc is reported on your personal tax returns and is still part of your income or dept. I would seek out a commercial lender from a small local bank, go to them with profit and loss statements from the properties, 2 years tax returns and a complete form showing your Net Worth. I would also show them the numbers for the place/ places you want to purchase and show them that there is profit in it to pay the loan. one thing a commercial lender can do is put a lien for a certain amount on another property as collateral for the loan. i am not a CPA but you may want to sit down with one and discuss what you would like to do.

@Patrick Liska thanks for the response! I do know a good CPA that I will contact. The problem with my local bank is that it is in the state of my primary residence, not where the property is. Getting a conventional mortgage for the other 2 was no easy task but hopefully showing positive cash flow will help in my favor.

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I would seek a local bank where the properties are, open your business account there two, you can do your banking online. it will be better if you bank there then using a bank in a different state.

Kendall, 

First, welcome to BP, this is an incredible community with resources for every topic.

Second, I am an investor who is also a commercial banker by day. One thing to remember when talking about traditional banks is that they are all similar but they each have different policies. It is always good to build a relationship with the banker to discuss what loans they do and which ones they don't do. What their policies are and what they have for expectations also varies. 

An LLC puts you into commercial banking department in most institutions but not all. Some smaller banks handle these loans differently. If you do transfer deed to an LLC the bank will expect you to also finance on the commercial side. They may or may not catch it if you don't disclose this, but you should be prepared to deal with the consequences of the change if they do find out that you have switched from a personal name to an LLC.

Most banks will only do commercial funding for 20 years max but again there are some smaller banks who may do 30.

The partnership piece is good to consider if you have a money partner. I have done this on a few of my deals. Most banks will expect that money partner to own a 20% share in the "business" in order to consider them as a guarantor on the loan application. Again, there are some banks that are looser on this policy.

Best advice I can give is to shop around for your bank and banker. You want a banker who will look out for your best interests and can provide you with all details and what-if's so that you don't have any hiccups along the way in the financing process. 

Hope this helps, 

Bryce

Kendall, I'm in Knoxville. I've got a potential source, though not a great one. Message me and I'll explain. I am also looking for a local bank that does 20+ years fixed rate products on LLC owned rentals with a reasonable interest rate.

Make sure they aren't double-counting the debt. I remember reading about someone here who had to educate their loan officer how to properly calculate your income with rental properties. Sometimes loan officers will do the following:

Current Debt Service: $300/mo

Current Gross: $700/mo

Current Net(gross less debt service): $400/mo

DTI: $300 / $400 => 75%

This is obviously wrong ;)

@Kendall Luelf , congrats on your progress to date. I would think that your Lender should ALSO take into consideration the (say, 75%) income already derived by the property you're wanting to buy - even though it's not been YOUR income so far. Has the Seller provide you with those ACTUAL numbers? Do they stack up as well as your current ones?

(Please tell me if I'm off base with that thought). All the best...

@Brent Coombs

This is something I'm not aware of.  To me it's not off base in the least but unfortunately, bankers think much different than me.  Most of the properties do have rental history upon request.  I don't often rely on this number but use it as more of a guideline.  My last property purchased did $12,000 per year in rental income.  I knew that it was mismanaged or something to that nature and I was sure based on the property, amenities I could offer, and location, that I could resolve the low rent issue and have a successful investment. Sure enough I found the problem rather quickly after purchasing and starting to rent it out.  Turns out the well on the property didn't yield a lot of water at random times and the guests would quickly run out of water until the well refilled.  The property was previously managed by a large rental company with hundreds of other properties.  They knew of the issue and instead of dealing with it, they sent potential renters to their other properties leaving this one vacant.  

There is a much longer story about this issue than stated but long story short, I installed a water storage system for a very reasonable price and increased rental income to $36,000 in the first year. 

I guess the point of that story is that numbers often lie and there could be a possibility that banks won't acknowledge previous rental income.  I surely hope a rental that has solid figures backed by proof on financial statements would be considered though.  I plan to keep the community updated on my progress with lending as I believe there are many like myself looking to expand but are stuck.

I've received some great pointers thus far and look to explore all of them!

Welcome, @Kendall Luelf ! BiggerPockets is a great resource when it comes to Real Estate investing.  These options have worked for me historically (in priority order):

  1. Buy personally as an investment property with 20% down. Sounds like this is what you are trying to do and are running into issues, but I wouldn't quit until you have talked with at least 10 banks. Local/regional ones are the best in my opinion and credit unions are good as well. If you have solid W-2 income, 2 years tax history on your current rentals and are under the 36% DTI (total monthly fixed payments), there is a bank out there that will do it. You just have to find the right bank. They will most likely take 75% (after PITI) of the historical rental amount for the new property and include that in the 36% calculation. I've found these rates to be the best and terms at 15, 20 or 30 years.
  2. Go the commercial route. If the numbers are profitable, then you shouldn't have a difficult time with this as your second option. Best approach is to have all of your ducks in a row and prepackaged before talking with the lender. My banker loves when I have a summary document prepared with all calculations and ratios already documented. I also have a folder with supporting documentation that I include. Basically put it together on a silver platter for them and all they have to do is say yes. I've found the rates to be within 1% of the personal investment option and terms to be 5/20 ARM.
  3. Find a partner. In your scenario, I'd suggest something like the following: You find the deal, the partner funds the downpayment and offset to qualify for the DTI on options 1 or 2 above. You manage the property management and split profits 50/50.
  4. Find a private lender. Same scenario as the commercial route, but rates/terms might not be as favorable. There are plenty of folks out there making 1-3% in their IRA and you could offer them something between 5-10% and have them do the self-directed IRA option.
  5. Wholesale the deal. If the deal is profitable and you can't line up options 1-4 above, take a cut of the deal and sell it to someone else.   

Hope that gives you some additional color.  I'm somewhat familiar with vacation rentals in mid and east TN if you have any additional questions. Good luck!

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Hi Kendall, I just noticed how old this post is, but BP ran it across my screen so I'll add my 2 cents worth. 

Our local lender, and even Wells Fargo, has given us substantial loans based on the determination that our purchases are a business. They look at how long you've been at it, how many you own (i.e. legitimate business or a hobby), and a base of $1.25 net income for every $1 of debt service. Add a slick and well-thought-out business plan and personal DTI becomes a non-issue. They want to know the performance of the property. You may have to educate an appraiser re: income potential. The income method of appraisal, separate from DTI, is typically only considered on a commercial loan. Many such loans can be amortized over 20 or even 25 years, but have a 5 or 10 year call. Nothing to be afraid of -- if the property performs at or above the originally calculated rate, the bank usually rewrites the note, or you find another to pick it up.