The Investor’s Guide to Qualifying for a Conventional Loan

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“It’s easy to get a loan unless you need it.” — Norman Ralph Augustine

Can I purchase an investment property with a conventional loan if I already have a mortgage on my primary residence?

Short answer, yes — but do you qualify? That’s another question.

A majority of the readers here have a full-time job and a mortgage on their primary residence, but they don’t know if they qualify for another mortgage. Being that I like to keep investing simple, I suggest newbies focus on conventional financing for their first investment property purchase and set a healthy down payment of 20-25%. Rather than bore you with the minutiae of mortgage lending, it’s better to have a general understanding of loan lending requirements instead of becoming lost in the technical details.

VA loan

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Lending Requirements

Conventional loans have lending requirements created by Fannie Mae. Your banker uses a few different data points to determine if you qualify for another loan:

  • Your current salary
  • Current debts (short term and long term)
  • Employment history
  • Credit history
  • Payment history for current mortgage
  • And most importantly, your debt to income ratio (DTI)

Related: The Simple Strategy to Get Your Loan Approved (Almost) Every Time [With Example!]

Debt To Income Ratio (DTI)

Bankers use DTI to determine how much money they can safely loan you without risking a potential default.

The banker will determine your DTI cap by multiplying your gross monthly income by the maximum debt percentage (I’ve decided not to included the front and back end ratio because I want to keep this simple).

First, the banker will determine Fannie Mae’s maximum DTI ratio, which is 36%. (It can go up to 45%, but Fannie Mae requires additional capital reserves and a higher credit score. Most banks like to stay below 40%.)

To calculate your DTI, multiply your gross monthly income by 36%.

Example: Michelle’s gross income is $10,000 factored by a 36% DTI, which means her debt cap cannot exceed $3,600.

Once the DTI cap is determined, the banker will subtract Michelle’s current debt obligations from her debt cap number.

Example: Michelle’s debt cap is $3,600. She has a current mortgage of $1,000 per month (sound of Bay Area and NYC residents rolling their collective eyes), and she pays $600 per month in student loans. So $3,600 minus $1,600 leaves Michelle with $2,000 for additional mortgages.

Excellent. Michelle knows she can afford another mortgage. Time to find a property!

first-property-student-loans

Related: Confessions of an Ex-Banker: How to Get Your Next Loan Approved, Guaranteed.

Not so fast. For an investment property, Fannie Mae requires that Michelle has a reserve set for two months’ worth of PITIA ( Principal Of Mortgage, Interest, Taxes, Insurance, and Association Dues) for the property she intends to purchase.

Example: If Michelle’s desired property’s PITIA is expected to be $1,000 per month, she will need to have $2,000 in reserve to meet Fannie Mae’s requirements.

Luckily, the money doesn’t have to be parked in a low interest bearing account. It can be held in stocks and bonds (bonds aren’t advised due to the time it takes to convert the bond into cash — typically, banks will value the stock and bonds at 70% of their market value), index and money market funds, cash value of a vested life insurance policy, or retirement account (Roth or IRA).

Personally, I like to hold six months of PITIA for each investment due to my conservative nature because I don’t want to be knocked out of the real estate business due to an unexpected event.

Now that you know the 80/20 for qualifying for a loan, you will be prepared for your conventional loan application.

Have any questions about this process? Any advice to add?

Leave your comments below!

About Author

Jordan Thibodeau

Jordan Thibodeau is a contributor for BiggerPockets.com blog. He works a full time job and invests in Buy and Hold Real Estate in the Sacramento Area. Jordan is dedicated to helping people become better real estate investors by helping them clarify their investment criteria and goals. He was also featured in BP Podcast Show 74. Also, Jordan is the author of a personal development blog titled Growwithjordan.com. You can learn more about Jordan here or reach out to him in the BP Forums.

8 Comments

  1. Scott Thomas

    I plan on using a traditional mortgage to finance my first few investment properties. I’ve read a couple different places that some lenders will require a reserve of 6 months PITI for every mortgage you have, including your primary residence. In your experience, you’ve only been required to have 2 months set aside?

    Also, completely unrelated question, if you wanted the investment property to be owned and operated under an LLC for legal and tax reasons, would you try and secure financing through the LLC or get it personally and then transfer it. I don’t know which would be easier as far as paperwork and ultimately getting approved.

    Thanks for the post and the info.

  2. Olivier S.

    Jordan – how do you structure your reserve funds?

    * Do you use a single account where you add 6 months of PITIA for every new unit or do you have a separate account for each?
    * How liquid is your pool? Do you use “high-yield” savings account or some other vehicle?

    • Jordan Thibodeau

      @Olivier

      Great question. I set up Roth IRAs through vanguard (https://www.investopedia.com/terms/r/rothira.asp). The reason why I used Vanguard is because I have my 401k with them. This year you can contribute $5,500 or $6,500 if you’re age 50 or older. What’s nice is you can invest your principal in stocks or index funds. If you’re under 59 1/2 the gains must remain in the account or you will face a tax penalty. If you need the principal you can withdraw it any time, however, if you wish to redeposit the money back into the Roth, you have a time limit.

      You don’t have to use Roths, you could use a standard brokerage account or a savings account. The reason why I like Roth’s is the interest earned is tax free after the age of 59 1/2.

      You can use a single account for each PITIA or you can use multiple.

      I use Blue Chip stocks that pay high dividend yields or index funds. Both investment vehicles are highly liquid. The dividend paying stocks aren’t as volatile as growth stocks or tech companies with no earnings. HOWEVER past performance doesn’t guarantee future results, so please do your own research.

  3. Nancy Emineth

    Hello Jordan,
    Is there an industry standard with respect to the reserves required for a new real estate investor?
    For instance, we at now at the final phase just before the closing and was told we need to verify six months of reserves that includes both the P&I for our primary and our first investment property. Is this the standard requirement we should expect going forward?

    I was a little confused with this request since we are doing a 25% down. You advice is welcome…

    Thanks.

    • Jordan Thibodeau

      Hi Nancy!

      Congrats on getting close to your first closing! 🙂

      If this is your first mortgage, and you don’t already have a mortgage on your primary, you will need 6 months of PITIA in reserves.

      If you already have a primary mortgage on your first house, and this is your first investment property, you will need 2 months of PITIA in reserves.

      For each additional house, guidelines dictate 2 months PITI for each investment property financed up to 5. 6 months PITI from 5 to the maximum 10 properties allowed by Fannie.

  4. Daniel Fenn

    Hi Jordan,

    If you fulfill the DTI requirement and the other good credit requirements, will any bank give you a loan? Are there more conditions like there should not be major repairs on the home you are going to invest in?

    In what cases must you resort to a HELOC based on the equity in your primary residence?

    Thank you

    • Jordan Thibodeau

      Hi Dan,

      Great questions. If you meet the requirements for the 6 factors I mentioned, you have a great shot of securing pre-approval for a mortgage.

      Regarding if the lender will place a mortgage on the property you’re interested in, is another story. If you’re requesting 30 year financing for a house that has major structural issues resulting in near uninhabitability a bank probably won’t approve. In the event they need to foreclose on the home, they will have to fix it or sell it at a steep discount and take a loss. It would be a bad risk to take for the bank.

      If the house is habitable but requires TLC (fix a leaking roof, replace some fixtures, texture and paint some rooms) the bank will be more willing to set you up with long term financing. Some investors seek hard money financing, repair the house, get it appraised, and try to refinance into long term loan. I DON’T suggest noobies try this. Your first house should be relatively turn key so you don’t have to embark in a major restoration project.

      As far as Helocs, you can find a good discussion on the topic here: https://www.biggerpockets.com/renewsblog/2013/08/27/whats-better-home-equity-loan-heloc-home-equity-line-credit/

      I for one tell Noobies (such as myself) not to start with HELOCs, there’s no rush for RE investment. Don’t risk your primary house on a HELOC. I would wait, save your funds until you have enough for a down payment, and then pull the trigger.

      Once you have a deeper understanding of RE, then you can try the more advanced forms of RE investing. There’s nothing worse than using a HELOC to start investing, have the market turn on you, lose your investment, and then risk losing your primary.

      Speculate with what you don’t need, don’t speculate with what you do need.

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