Hello, my friends and welcome to another episode of Ask Marco where I answer your investing related questions.
Today’s question comes from Carlos and he says, Hey Marco, I recently found your podcast and have been eating episodes trying to get myself educated on real estate and passive income while following a lot of these episodes. There is one question that keeps popping into my head. How can I get financing for two, three, or say even six or seven properties? As the years go by and I save enough money to keep acquiring more houses, but my salary does not change much over the same number of years. Let me explain with an example and I am going to borrow your always easy to digest $100,000 example. To illustrate my point, let’s say I make $100,000 a year from my regular job’s salary. Let’s assume I already have a mortgage on my primary home and a second one on an investment house.
I am able to save $20,000 from my salary every year, which conveniently enough it represents the exact down payment needed to buy one $100,000 house every year. The problem is my salary doesn’t go up very much every year. To make things simple, let’s say it remained unchanged for the next five years. In those five years, I would be planning to purchase five $100,000 houses, which would bring the total count of mortgages under my name to seven. In addition, let’s say the first two houses I acquire have enough equity to tap into because of their growth in the last few years. At which point it could give me access to purchase another two houses, bringing the total number of loans needed to nine. The question is how would anybody lend me money for nine loans when my income is still just $100,000? Thank you for the great show.
Personally, you have opened my eyes to a whole new world and have given me a light to follow to get out of this dark and confusing place. I was regarding my finances for the first time. I feel it is possible to reach financial freedom.
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Carlos, thank you so much for submitting this great well-articulated question and I know that other people are thinking the same thing and also thank you for your kind words and I am incredibly happy and encouraged to hear that the podcast has been helping you and opening your eyes and providing a guiding light of sorts. Again, thank you very much for everything. So essentially what you’re asking is how is it possible to finance multiple properties with only one salary? Well, the answer lies in your rental income from your properties and your DTI ratio, and that means your debt to income ratio.
So lets at these two things. So you see rental income can be counted when you’re applying for a mortgage or refinancing an investment property. However, like all other sources of income, you must properly document it of course, and meet specific qualifying guidelines. If you already own the rental and you can document the income that comes from that rental, then your income is considered real rather than projected by the lender looking at your application and real rental income will be considered by the underwriters looking at your loan for rental properties, the lender will also look at the net cash flow and in most cases or most situations, net cash flow is represented by subtracting all your expenses from your income, the property’s income. However, when it comes to rental scenarios, it’s a bit more complicated because here lenders use 75% of your total rental income before subtracting expenses.
If the resulting number is positive, then that number is added to your income, your personal income. If not, it will be counted as a loss and you’ll need to make up for it from some other source somehow some way, and you should talk to your mortgage broker or loan officer on how they can do that. There are some creative ways that they can make the loan work for you. Just by looking at your total scenario and the big picture. Now that’s the income, so all rental income from properties count. Sometimes they can’t 100% sometimes they count only at 75% that depends on the type of lender that you’re talking to. Also, one other comment I’ll make about that is that with the right investment properties that have enough cash flow, the rental income, even though it may have been discounted to 75% ultimately becomes a wash of sorts in that if your annual gross salary is a hundred thousand dollars you are not essentially going backwards or in need of additional income because the income coming from your existing rental property portfolio will sustain that qualifying level that you’re at.
So the debt to income ratio is an important factor that lenders look at when deciding whether to approve your loan application. Your debt to income ratio is a matter of basic math and is essentially the sum of your monthly debt divided by your total monthly income. Now. Typically lenders look at a ratio that’s less than or equal to 43% a lower debt to income ratio is always better of course, but the lower your debt to income ratio is the better mortgage rate you’ll get and the easier it will be to qualify. Now all lenders use the same basic method of underwriting income property loans for the purchase of a smaller property, a one to four unit property. The lender will consider 75% of the market rent as income. They will then subtract the monthly mortgage payment including the taxes and insurance, what is also known as PITI Principal Interest Taxes Insurance.
Now if that number is positive, they will consider it to be part of your income picture. If it is negative, they will treat it as though it were another debt from there. The qualifying process is essentially the same as for a single-family home with your debt to income ratio of somewhere between 43 to 45% allowing for qualifying. Now that is the top end of it. Ideally, they want to see something below 40% and the sweet spot is really 36% but don’t be over 45% again, talk to your loan officer or mortgage broker in general though mortgage applications or applicants with higher DTIs have to show strength in some other way or aspect in their loan application. And this can include things like making a larger down payment to keep that DTI low, showing an exceptionally high credit score. So if you are a very strong creditworthy borrower that helps or having large amounts of reserves in the bank account and other investments.
So if you are cash-rich or equity rich, that also might work in your favor. Real estate investors who want to purchase real estate with debt should focus on having an acceptable debt to income ratio for a mortgage before you go and apply. It’s one of the most important factors that mortgage lenders look at before approving a loan for a borrower. And you could do one of two things. You can either lower your expenses and or increase your gross income to help lower your DTI ratio. So as you can see and as you can tell the DTI ratio is front and center in terms of qualification criteria as it relates to mortgage lenders. So you really need to know what that number is. If you don’t know, that’s okay. Talk to your mortgage broker or loan officer and have them calculate it for you. It’s really not that difficult, but knowing where you’re at will help.
So back to your question, the answer is having positive cash flow from all your rental properties and keeping your DTI ratio below 45% but ideally as low as 36% or less. That is how you can essentially finance multiple loans for your rental properties to build your portfolio while still having an income of just $100,000 I hope that helps. It really isn’t complicated. In other words, you don’t need to scale your income as you scale the acquisitions for your real estate investing. The important thing is using the income from your rental properties to help qualify by keeping your debt to income ratio in check. And you do that by making sure you’re buying the right properties with positive cash flow and of course increasing your income anytime you can. Okay?
So I hope that helps. Carlos, if you have any other questions, by all means, reach out or contact my team. That’s it. If you have a question about real estate investing or finance, and you’d like me to answer it on the show, go to passiverealestateinvesting.com or AskMarco.com and submit your question. Remember to subscribe, share the show with other friends and likeminded people. Visit us on iTunes. Leave us a rating and review. Thank you for listening. I will see you on our next episode.
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