Can’t Qualify for Another Mortgage?

Dave:
Have you locked down your first deal or maybe two deals and your lender has told you that your debt to income ratio is now maxed out? Has this stopped you from taking down your next property? Well, today on the show we are going to discuss conventional and non-conventional ways that will help you scale your portfolio. Hey investors. My name is Dave Meyer and today we have a bigger news episode for you. We’re bringing back a lender we had on the show last week, Jeff Welgan, and last week, if you didn’t listen yet, he discussed first time home buyer programs that can help you get to that first deal if that’s where you are in your investor journey. But today we’re gonna be talking about how investors who have already locked down one, two, or maybe three properties and are wondering how they can get financing to build their portfolio further.
And this is a really common issue for investors. You get your first few deals and then no one really wants to lend to you anymore. And it’s one of the reasons why I think that getting from two or three deals to five or 10 deals, that part that like middle part of scaling, is really one of the hardest parts of building your portfolio. So that’s why we’re bringing on Jeff to help you navigate some of the strategic decisions, some of the tactical things that you could do to make yourself more lendable and make financing easier as you look for your next property. Before we get into the show, our bigger news episode today is brought to you by Rent app, the free and easy way to collect rent. Learn more at rent.app/landlord. Alright, let’s bring on Jeff. Jeff, welcome. Welcome back to the show. Thanks for being here again.

Jeff:
Yeah, thanks for having me back, Dave.

Dave:
Jeff, to start off, can you explain to us what debt to income ratio is?

Jeff:
Yeah, DTI basically to summarize it, it means, you know, the acronym, like you said, stands for debt to income ratio. It just means what is your buying power? And so when we look at it from a lending standpoint, we’re looking at your total income. And so if you’re a W2 wage earner, we can go off of your gross income, meaning before taxes if you’re self-employed, we have to go off of the net income, so after taxes. So it’s a little different the way the government requires us to do the income calculation. And then we look at what is reported on credit. So your total debt load, we’re not looking at, you know, cell phone bills, you know, water bills, utilities, stuff like that. But we are looking at minimum payments on your credit report. We’re not concerned with what the balances are. We’re just factoring in the total minimum payments that are reported on your credit report for all of your debts, including mortgages, car payments, student loans, credit cards, personal loans. And then we do, you know, a calculation compared to the income calculation that we’re required to use. And that’s how we come up with that ratio.

Dave:
All right, thanks for that helpful explanation Jeff. And just to reiterate there basically DTI is a comparison of how much money you make to how much debt you are trying to take out to finance your, Jeff, can you just tell us why this is important to investors and why this ratio sometimes maybe is a hurdle for people as they are trying to scale?

Jeff:
Yeah. ’cause there’s a lot of misinformation out there surrounding the, the debt to income ratio. And it really comes down to trying to crack that code as a real estate investor to scale efficiently and trying to figure out, okay, how can I maximize my buying power going into each next purchase? And really the secret to all of this is strategic planning. So having a plan in place going into this, having the conversation early and knowing where you stand, what your buying power is currently, and then looking at ways to maximize your buying power, for instance, there’s different ways that we can structure deals when we’re looking at, let’s say a short term rental, for instance, we have a lot of clients that want to use the 10% down vacation home loan. Well that 10% down vacation home loan has a full hit to your debt to income ratio.
So you have to fully qualify for that, which will really limit your buying power. The other alternative is the 15% down investment property loan through Fannie Mae. And by putting that extra 5% down, we can use the forecasted rent to help you qualify, which general rule of thumb will double your buying power. So that’s just one instance of how it is very important to have a plan going into this and really understand on an annual basis, you know, what your vision, your goals are. And then you know, really connecting the dots and how you’re gonna go from where you are currently to where you want to go and have that plan clearly laid out so you know how much you’re gonna have to come up with for each next purchase. And um, ultimately where your limit’s gonna be because the debt to income ratio is extremely important when you’re scaling from property one to 10 because that is the maximum finance property limit with Fannie Mae.

Dave:
That’s super helpful. So it sounds like actually depending, not just on the person and their debt to income, but also what loans they take out is going to influence their DT I, is that correct?

Jeff:
Absolutely. Looking at it from a primary residence perspective, you know, there’s no rent to help offset that payment unless you’re buying, you know, two to four units. So that’s gonna have a full hit to your debt to income ratio the same way that a 10% down vacation home loan will on the investment side, when we’re looking at, you know, the different investment property options, we can use the forecasted rent. So there’s a way to actually, you know, factor that in to minimize the impact of your debt to income ratio in order to maximize your buying power.

Dave:
Got it. Okay. So that means just for everyone out there, that means that using investor focused loans, although they tend to require more down, higher down payments, could actually be beneficial to scaling in a different way because it’ll be easier to get loans, subsequent loans, I should say.

Jeff:
Absolutely. And this is one of the things that varies widely in my industry. Some lenders have a 20% or 25 or even 30% down minimum if you’re hearing that shop around a bit because a lot of times what ends up happening is, is that some lenders just don’t have the licensing, the required licensing to do Fannie Mae and Freddie Mac loans, which open up the lower down payment requirements or options. So just a little bit of advice, uh, for any investors out there that there are 15% down investment property loans that are, uh, Fannie Mae loans that have lower rates and fees with no prepayment penalties versus the non-conventional products like the DSCR where you could do as little as 15% down. That program finally came back, I mean it completely evaporated after March of 2022. And we are just now seeing the, uh, first, uh, guidelines coming out here over the last 30 to 45 days. And so it’s a, um, a sign of things to come. I mean, the market’s starting to open up a bit. There’s a little bit more of a risk appetite in this space again, but as a general rule of thumb on the DSCR side, those loan programs are gonna require a minimum of 20% down at the moment.

Dave:
Alright, so we’ve covered what debt to income ratio is and why this is a hurdle for investors, but how do you get past it? We’ll hear from Jeff about both conventional and unconventional loan options to scale right after the break. Welcome back investors. I’m here with Jeff Welgan, breaking down how to keep buying properties past the debt to income hurdle. Let’s jump back in. Well, I do wanna dig into some specific loan types that you would recommend, but I wanna ask a broader question about using rental income for your DTI and just to make sure everyone understands, when you’re considering your debt to income ratio, if you’re not currently investor, basically they’ll just look at your W2 income or your 10 99 income or however you make money and then compare that to the debt. But as an investor, ideally what you want is to, if you have a property or two, you wanna take the rental income from those properties and show to the lender that, look, you know, my income is actually higher than just my part-time job or my full-time job. It should also include, uh, the rental income that I’m generating. But from what I understand, that is not always possible. Right Jeff? Like sometimes rents are not considered, uh, for your income and sometimes they are, are there any rules of thumb about when they are and aren’t?

Jeff:
Yeah, so the, the first year you buy the property, we can use the lease a, like on a long-term strategy, we can use the lease agreement, use 75% of that to help offset the mortgage payment the same way that we do at the time of acquisition. You know, when you’re purchasing the property, we’re gonna use the forecasted rents to help you qualify and we can use 75% of that figure. So for the first year until you file that on a tax return, we’re able to utilize that, you know, the, or the lease agreement, um, to help you qualify for the next purchase. And this is one of the ways that investors will scale quicker, um, by using the, you know, true investment property loans versus using let’s say like a 10% down vacation home loan for a short or a midterm rental. And so once the property has been, um, in operation for over a year and you’ve reported it on a tax return, then we have to go off of the Schedule E and there’s a calculation that we need to use, um, based off of Fannie Mae, Freddie Mac guidelines.

Dave:
Okay, that makes sense. So basically use a projection until there’s actual data that you can use, then you go off that, that seems to create sort of this challenge or trade off for a lot of investors as they’re trying to scale. Because on one hand, using a traditional investment loan will help you with your DTI, but they typically require 25% down. So how do you advise your clients who are thinking about building a portfolio for this foreseeable future to balance those two competing interests?

Jeff:
Yeah, it’s a great question. The 25% down is on units on the investment side. So as long, if you’re looking at, you know, one unit you can do, depending on your strategy and which strategy you’re doing, um, on short and midterm rentals, you can do 10% down. And then for, uh, single unit investment properties, it’s a minimum of 15% down. That’s

Dave:
Really good. Uh, advice for anyone who is looking to scale and understandably is having a hard time reaching 20 or 25% down payments. You can consider some of the asset classes that Jeff was just talking about. Jeff, do you have any other pieces of advice for investors, uh, using conventional lending methods that could help them scale?

Jeff:
Absolutely. So for, uh, any business owners out there run all of your debts, your business debts through your business bank account, even if you personally guaranteed them and the reporting on your personal credit, as long as we can show for 12 months that you have made those payments on time directly from a business account, we can exclude those from your personal debt to income ratio. And then when it comes to rental income, any type of rental properties, we’re able to use the depreciation as an add-back. So just keep that in mind. Same thing with businesses. If you have depreciating assets within the business, we can use that depreciation as an add-back. And this is one of the ways that investors and business owners minimize their taxes while still being able to qualify for conventional financing because in the eyes of us as lenders and underwriters, depreciation is looked at the same way as income.

Dave:
Wow. I I actually never knew that. Is that something that most people talk to a CPA about or can you just do it yourself?

Jeff:
I would definitely talk to A CPA. You’re gonna want to talk to an investor friendly accountant that understands this space. I can’t tell you how many times I’ve had clients that run into issues that are working with tax preparers and not to say anything bad about preparers, but you need somebody, especially as you’re starting to scale your business that understands tax strategy when it comes to real estate investing. And really that’s part of the strategic planning aspect of this that we do on an annual basis with our clients. We sit down every year at the beginning part of the year before tax time, discuss our client’s goals with them and see what they, you know, what their goals are for the upcoming year. And then we work backwards and, um, put together a plan on how to really connect those dots so they can scale effectively and efficiently every year.
And then what we ultimately try to do is going into tax time, find that equilibrium point, you know, where they’re not overpaying in taxes and not giving the IRS any more money than they have to. But, uh, still showing enough net income and depreciation to where they’re meeting their goals for the upcoming year. And I have to be very clear about this because I am not a CPA, I cannot give specific tax advice, but what we can do is based off of, you know, a draft copy of the return that you and your accountant put together, we can then put together a plan coming out of that saying, based off of your income, uh, for the year, this is what you qualify for. And then if you wanna scale up past that, then we look at non-conventional options like the DSVR loan.

Dave:
Well, having taken an embarrassing long time myself, , to move from a traditional CPA to a real estate focused one, I can attest to what Jeff just said, that it is extremely helpful and worth the time and effort. And uh, actually BiggerPockets recently just created a free tool to help introduce you to, uh, investor friendly CPAs. So if you want to find one for yourself, you can go to biggerpockets.com/taxpro and check that out. Jeff, let’s switch to maybe some less conventional lending options for people who are looking to scale. Do you have any recommendations for us there?

Jeff:
Yeah, so like the DSCR loan, I’m sure your audience is all familiar with it. It means debt service coverage ratio, it’s a mouthful. Uh, basically what the, it’s a fancy acronym for does the property cash flow. And so from a lending standpoint, we’re just looking at the cash flow analysis of the property and we look at the property like a business. I mean this is the closest thing we’ve had to stated income loans since, uh, before the great recession. And this is the program that’s used on the commercial lending side that’s been adapted to residential real estate for business purposes only. So the important part with this is you can’t buy primary residences or second homes with it. And this is the preferred method to scale once you get past the 10 finance property cap. Or there are times for tax reasons where, let’s just say between that seven and 10 property range, where depending on your strategy, it may make more sense to start putting larger down payments down versus giving the, uh, IRS more money, um, and have to pay a higher tax rate in order to hit those last few properties.
And so with this program specifically, this is the one that you can scale up to. You see everybody that has, you know, 10, 20, 30, 40, a hundred properties, this is the preferred method to scale past 10. But there are other options. So for business owners, for instance, there’s a business bank statement program that doesn’t get a lot of publicity or doesn’t get out there as much. Uh, with this program specifically, you know, it’s for business owners, you know, one of the, you know, the benefits of being a business owner is you get to write everything off, pay very little in taxes. Problem is, it’s a double-edged sword from a lending standpoint because it doesn’t always put you in the best position to qualify for conventional financing. And so with this program specifically, we can use 12 to 24 months business or personal bank statements if you run your business income through a personal statement.
And what we do is we add up all the qualified deposits through the business, we average ’em out, and then we’re required to, depending on the type of business, uh, back out an expense factor. So for instance, you know, a realtor that’s working out of their house, you know, uh, working from home has very little overhead versus let’s say a restaurant that has very high overhead. So there’s different expense factors. Once we’ve determined the expense factor factor for the business, then we back that out and then use that average as income instead of looking at their tax returns.

Dave:
Okay, got it. That, I think I’m following that. So basically is that applying to DSCR loans specifically?

Jeff:
Great question. So these are two totally different programs.

Dave:
The okay then I don’t understand . Yeah,

Jeff:
The DSCR loan, the DSCR program, this is the one that’s the closest to stated income financing. We are just looking at the, uh, cash flow analysis of the property. Does the rent cover the all in PITI payment, you know, principal interest, taxes and insurance? If it does by a dollar or more, it’s cash flowing and the minimum ti at the moment, 20% there is that 15% down option on a limited basis in strong markets. Um, that’s coming back. So

Dave:
With the DSCR loan, let me just clarify for everyone. So basically this is similar to commercial underwriting, it’s not based on your personal income, your personal credit worthiness. And that’s why it’s such an attractive option for people who are trying to scale. Because if you’re butting up against limitations with your DTI, rather than having the bank or your lender look at your personal income, just say, Hey, I am buying a deal that’s gonna pay for itself. So what I make as an individual doesn’t really matter. And so that’s why DSCR loans are so attractive to people who are trying to scale and can find cash flowing deals. Now, just to, I just wanna explain that the way this is calculated, like you said, is can the ca the property cover the debt service? And you said that as long as it’s a dollar over, you can get a loan on that. Is that right? Because I’ve, I’ve looked at these types of loans and a lot of times I’ve seen it at one point that DSCR needs to be a hundred and like your, your cash flow needs to be 120% of your expenses, for example, not just, uh, a 1.0 on the DSCR.

Jeff:
It depends on the strategy. So on the short term side, yes there are some restrictions for short-term rentals. Huh. But on the long term side, it’s one. And we’re, so when you look at commercial financing, a lot of times they will have a minimum of a 1.15 or one and a quarter, sometimes even higher. And so it really just depends on how risky the property is. So when we’re looking at, let’s say just using air DNA and a, you know, short term rental analysis at A-D-L-T-V, uh, they want a higher DSCR. So one and a quarter or above typically versus a property that we’re taking the more conservative approach and looking at it from a long-term perspective, there’s more flexibility there because it is the more conservative approach and you know, terms tend to be better, you know, on the longer term analysis versus the mid or the, the short as well.

Dave:
Got it. Okay. That makes sense. Yeah, I’ve never looked at it for a residential property, but that, that makes sense.

Jeff:
And it’s great that you brought that up too ’cause a lot of investors, lenders out there will have their own overlays. So this is, you know, going back to the debt to income ratio conversation and this specifically, if you’re running into problems with certain lenders out there, my best recommendation is to shop around a bit because a lot of lenders will have their own underwriting overlays, like a minimum of 20 or 30, 25 or 30% down.

Dave:
Thank you for for talking me through the DSCR side. Now you were explaining earlier about a business bank statement loan. Can you clarify for me how that works again? ’cause I’m not sure I fully understood.

Jeff:
Yeah, so to sum it up, we’re looking at 12 to 24 months business bank statements or personal, um, in lieu of, or instead of looking at tax returns.

Dave:
And so can this be any kind of business or is this specifically a real estate investing business?

Jeff:
There are very few limitations to this. The only limitations I’ve run up against over the last couple of years with these are we have, you know, short-term rental investors that have multiple properties and they have, you know, 20 different accounts, you know, one account for each property. It’s a maximum of two accounts, uh, with mo Okay. Investors on the secondary market. So, but as far as limitations from other types of businesses, there really are no limitations. It can be a realtor working out of their house, it can be a restaurant and anywhere in between. Okay.

Dave:
And if you go this route and use a business bank statement qualification process, does that mean that you’re putting up any collateral from your business?

Jeff:
Not from the business, no. I mean, that’s a great question. So this is not collateralized by the business. You can use business funds for your down payment reserves, but where this really differs from the DSCR loan, the DSDR is for investment properties only the business bank statement loan, you can do a primary residence, a second home investment properties, and for instance, on the primary side it’s a minimum of 10% down. So you can get in with better terms on these business bank statement loans with, you know, lower down payment, better rates and different property types than you can on the DSCR side. So that’s one of the big benefits of, you know, providing this additional paperwork because it shows your ability to repay. It’s a little bit less risky than the DSCR loan when all we’re doing is looking at, you know, the profitability of the property versus when we have an established business and business owner that can show they have, you know, the cashflow analysis of their actual business. It looks a lot stronger from a lending standpoint.

Dave:
All right, we have to take one more quick break, but when we come back we’ll talk about how to know which of these loan types might be a good fit for you. We’ll also get into some tips for how investors and lenders can work together as a team to strategically set yourself up to buy more properties. So stick around. Welcome back. I’m here with Jeff Welgan talking about loan options for investors who might own a few properties but are trying to scale up further. Let’s pick up where we left off, Jeff. Now that we understand some of the conventional and some of the unconventional, or let’s just say less conventional, they are increasingly popular ways for people to finance some properties. Do you have any guidelines on who should think about what types of loans?

Jeff:
You know, there’s no one size fits all unfortunately when it comes to mortgage lending and everybody’s situation’s different. And so the, again, the earlier you can start having these conversations to figure out what options are available for you, the better. Uh, there are other programs out there if you wanna talk about it. There’s an asset qualifier loan you wanna touch on that?

Dave:
Sure. What is

Jeff:
It? Yeah, it’s another non-conventional product. So with the asset qualifier loan, this is a great product for investors that may not have documentable income but have reserves that have money in the bank, have liquidities. So what we do in lieu of, you know, calculating a debt to income ratio the traditional way of through employment or retirement or things along those lines, what we do is we look at the assets that client has, liquid assets, retirement accounts, checking, savings, uh, investment accounts, um, you name it. And there’s a calculation that we can use to actually calculate that into a debt to income ratio without having to touch those funds or collateralize them.

Dave:
That’s pretty cool. Yeah, I mean that, that totally makes sense, right? Like, uh, I can imagine perhaps people who are retired or who have a lot of assets or you know, just got a big windfall, but their income’s not so high, but they’re still able to pretty easily able to service debt. It’s just not in the traditional way.

Jeff:
Yeah, and it’s tough because of the qualified mortgage provision of the Frank Dot act that came out of the great recession to make that work on the conventional side because in order to use retirement accounts like that, you have to be of retirement age. So for instance, I mean we have a lot of tech workers that we work with that have a lot of money, but they either have been laid off or they’ve quit their W2 jobs to become full-time real estate investors. And so this is a great way to bridge the gap where if you have a lot of money, there’s no age restriction with this. I mean, we have people that are in their twenties and thirties that are taking advantage of this. And um, you know, it’s a great way to also bridge the gap where let’s just say you may not have enough documentable income and your debt to income ratio doesn’t work traditionally and you have money in the bank, we can then use or supplement or subsidize the debt to income ratio with the asset calculation.

Dave:
Okay, that’s great. So yeah, I, I think generally speaking, it sounds like, you know, if you can do conventional, oftentimes that does make sense. Uh, ’cause you often get favorable terms, but the theme it seems to be between these less conventional options is just finding ways that you can reduce the risk of the loan in the eyes of the bank, right? Because that’s really what it comes down to is whether you’re providing business bank statements or cashflow projections or summary of your assets, the bank is basically just trying to figure out are you going to be able to repay this loan or not? And conventional loans just have this very rigid sort of way of evaluating that question. And these unconventional ways, they’re not shady, they’re not necessarily bad, they just have a little bit more flexibility in evaluating you or your deal for potential for risk and ability to service your debt.

Jeff:
And I’m glad you brought that up because when it comes to conventional financing and government financing, it’s very black and white. You know, the guidelines are the guidelines. They do change occasionally, but it’s not very frequently in the non-conventional space. It’s a land of gray. So there’s a lot of room for exceptions. The guidelines are constantly changing depending on the ebbs and flows of the market. And you know, at the end of the day, it’s important to remember that these are, this is pools of money on the secondary market, on the non-conventional side that’s lending in this space. And depending on what’s going on, you know, with our economy and you know, with all those geopolitical issues that we’re having, like for instance, it’s the 16th of April, 2024, we’ve had a rough week in the mortgage industry, your rates are going back up again. And now we’re starting to see guidelines tighten up on the secondary market in this non-conventional space because they’re becoming a little more risk adverse.

Dave:
Well, Jeff, you’ve given us a ton of really helpful information here, but I can imagine that as most investors are like, all right, those are great options, which one is right for me? Mm-Hmm. There is no, as you said, there’s no one size fits all rule, but how do you recommend investors work with their lender and perhaps also with their CPA based on this conversation to sort of chart out not just what loan is right for them next, but trying to develop sort of a longer term plan? Mm-Hmm, so that they don’t run into these DTI issues or that financing comes relatively easily as they scale their portfolio.

Jeff:
You know, with investors that are just starting out, you know, say anywhere between zero and five properties, you’re gonna wanna look at the conventional options because the conventional options are always going to give you the best cash flow. You know, they’re gonna maximize cash on cash return because the fact that you’re coming in with lower down payments and, uh, getting much better terms than you will on the non-conventional side. And there’s no prepayment penalties on any of these loans. That’s one of the big considerations in the conventional space. You can refinance or sell anytime you’d like. On the non-conventional side, most of these products have a prepayment penalty that range anywhere from one to five years. So make sure you’re asking those questions. And then as far as the planning side goes, you really need to find an investor focused, uh, loan officer and accountant like we’ve talked about that understand this space.
I always recommend ask a lot of questions. There’s no stupid questions and if you ever feel like the questions that you’re asking, you’re are not landing or you’re not getting the answers that you like, move on. There’s plenty of great los and accountants out there that you guys can work with. But, um, when you’re looking at it from, you know, let’s say property five to 10, that’s where you really need to, you know, have a clear plan and you, let’s say you don’t need one from one to five, but it’s easier to go get into properties two through let’s say four or five and just land in them and without any kind of a, a solid plan. And, but once you get past that point, that is really where you need to have a strategic plan in place because every decision you make is going to impact the next one. And if you don’t get off on the right foot and create a solid foundation, any of the small problems you have early on are just gonna get exponentially worse as you scale.

Dave:
That’s great advice, Jeff. I couldn’t agree more. Thank you so much for joining us. If you wanna connect with Jeff, we’ll put his contact information in the show notes below. Or if you want to connect with an investor friendly lender, you can do that for free on BiggerPockets as well. Just go to biggerpockets.com/lender finder and you can do that there. Jeff. Thanks again and all of you, thank you for listening. We appreciate you and we’ll see you next week for more episodes of the BiggerPockets podcast.