Real Estate Investing Terms: DTI

First off, what is Debt-to-Income? The Debt-to-Income ratio is one used by lending institutions when underwriting your loan (for almost anything – car loan, mortgage, HELOC, etc). DTI is a calculation they use to  measure the risk on which you’ll be able to pay back the loan you’re seeking. The lower your DTI, the less risky you are to a lender. Think of it as your golf score, lower is better.

If you have just one source of income, DTI is fairly simple to calculate. Take your recurring monthly debt divided by your gross monthly income. Expenses like groceries, utilities, gas, insurance are not usually involved in this calculation. For example, let’s assume your current situation looks like this:

  • Reoccurring Monthly Debt: $2,030
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
  • Gross Monthly Income: $6,000

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $2,030 / $6,000 = 33.8%

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BUT WAIT, there’s more! What about the loan your seeking? Let’s say hypothetically the loan your seeking will add $700 more in monthly debt. Let’s recalculate as the lending institution certainly will.

DTI = $2,730 / $6,000 = 45.5%

Most lending institutions will consider you an acceptable risk if your DTI is less than 43%. Remember the lower your golf score, I mean DTI, the less risky you are to a lender.

BUT WAIT, there’s EVEN more! You and I are both here because of buy & hold real estate investing. So let’s assume you’re relatively new, have 2 properties in your portfolio and are seeking a loan for a 3rd property. DTI becomes increasingly more complicated to calculate the more properties and the more loans you have in your personal name but one of the reasons why I encourage you to build your team AND a solid relationship with a local bank is because it makes this process much easier as you start acquiring more and more properties. Using our original example, let’s do some more math!

  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
  • Gross Monthly Income: $9,625Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,258 / $9,625= 33.8%

Making up the debt/income numbers as I go along, I found it extremely weird two of these examples both came out to 33.8%

By the way, check with your lending institution to ensure you understand their seasoning time frame. In this example, “seasoning” is how long a rental property has to be occupied to count the gross rents toward your DTI calculation. Most seasoning periods fall between 6-18 months but best to ask your lending institution what they require. In my examples, all properties are seasoned, except for the 3rd one you’re wanting to purchase.

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  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
    • Potential Rental Property #3 Mortgage: $722
  • Gross Monthly Income: $9,625
    • Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250
    • Gross Rents Property #3: $0 (once seasoned will be $1,700)

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,980 / $9,625= 41.3%

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Still under that 43% mark we’re striving for and if you have a great relationship with the bank and all other items check out, you should be on your way to close.

Also, gross rents minus the mortgage on a rental property does not equal cash flow. This is a common misunderstanding of the term and if you’re investing for cash flow, you need to ensure you’re calculating it accurately. More detail on cash flow here: REI Terms: Cash Flow.

In closing, DTI is just one factor a lending institute will consider when evaluating you and underwriting your potential next loan. Make sure your properties are seasoned properly when doing your own calculations but more importantly work on the relationship with your local bank to understand what all they require.

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How To Prepare for a Residential Loan Application for REI (spreadsheet)

I’m eventually going to find the right lending partner(s) to have a long lasting relationship with and as we focus on our next acquisition, I selfishly wanted to create this punch list for my own future reference.

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In recent posts I’ve expressed my horrible experiences with a couple of unorganized lending institutions. As we invest in more and more real estate (#HelmsREI), I don’t want to keep having these stressful experiences. I’m eventually going to find the right partner(s) to have a long lasting relationship with and as we focus on our next acquisition, I selfishly wanted to create this punch list for my own future reference. I hope it helps you too.

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A general list of what you’ll need to gather in order to start the loan origination process:

Initial Documentation:

  • Tax Returns: 3 previous years worth
  • W2: 3 pervious years worth (to match up with those tax returns)
  • Current Mortgage Statement (on any and all properties)
  • Current Insurance Statements (on any and all properties)
  • Pay Stubs: at least 60 days worth
  • Savings & Checking Account Statements: 60 days worth
  • Net Worth Calculator or Personal Financial Statement: If you don’t know how to calculate this, I have a spreadsheet I’ve massaged over the last few years. Email me @ jay@HelmsREI.com and I’ll share it with you. 
  • Copy of Earnest Money Deposit (EMD) check
  • Copy of your Driver’s License
  • Copies of any/all current leases for all rental properties
Closer to your tentative closing date (AND it is tentative until you have a Closing Disclosure provided by your lender) you’ll potentially be asked for more info.
Additional Documentation:
  • Copy of Bank statement showing the EMD was cashed and cleared your account
  • Explanation and bank statements showing any large deposits or purchases. Don’t make any large purchases or transfers from the time you start the loan application until after you close.
  • Insurance Documentation – a quote that will be bound to your mortgage. Be sure your insurance broker for your new property and lending institution are talking. If not, closing will be postponed. Side note: Once the insurance policy is bound to the property, you’ll need to sign more documentation for your insurance broker. 
No Surprises.  A List of Don’ts.
  • Don’t be surprised if…1 week before closing you’re flooded with information request to explain any and all transactions that accompany the above documentation.
  • Also, don’t be surprised if you have to explain certain transactions or line items 2-3 times. Even possible you have to sign official documents verifying these verbal statements that are continuously repeated.
  • Don’t make any large transfers until a day before your closing. If this shows up on a statement you’ll have to report on it which can cause a delay in closing. As with my latest experience, I moved around monies (let my loan originator know what I was doing way ahead of time) prior to having a Closing Disclosure. Those movements/transfers showed up on required statements for underwriting. These statements were requested by the “underwriter” <1 week prior to our original tentative close date. New transactions, especially big ones, require further explanation, resulting in a delayed closing.
  • Ensure your loan originator doesn’t have any PTO scheduled between now and your tentative closing date (or weeks after in case your closing is postponed) – just makes things easier.
  • Bank mergers / acquisitions create a slue of inefficiencies with new policies and procedures. Regardless of how great their rates are, if you’re in a rush to close, best to stay away from lending institutions who are going through or been a part of a merger/acquisition in the last 12 months.

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The go forward plan for improvement: 
Besides avoiding the List of Don’ts, I’m a big fan of Google Docs. This year, one of my goals was to grow partnerships to help us achieve our #HelmsREI goals. As our partnership network grows, the ease of sharing information is paramount and Google Docs has been the answer. For most all the items listed above, they will live in a Google doc folder. When a perspective lender needs something, I share the link with them. Even though I have fraud protection, my paranoid side will not allow me to store anything with my SSN # on Google Docs. A small percentage of the aforementioned documents have that and to me, it’s worth the extra step to avoid the hassle.

We have two closings scheduled for next month. One is a 42-unit apartment building in Mobile, AL. I’m growing the punch list for that one as well and look forward to sharing with you guys. More to come and super excited about putting this 42-unit together!

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AH BANKS! Pardon My French – Part 2

Given that it has been 2+ years since we went through the process of purchasing our primary residence (and the Pensacola real estate market seems to be recovering), I was optimistically hopeful dealing with banks wouldn’t be as painful this time around…boy was I wrong!

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real estate investing Pensacola

In AH BANKS! Pardon My French – Part 1 I discussed our primary residence purchase and the struggles of doing business with our chosen lender. Below is a recap of our conventional loan process to purchase a long-term duplex rental property in Gulf Breeze.

Given that it has been 2+ years since we went through the process of purchasing our primary residence (and the Pensacola real estate market seems to be recovering), I was optimistically hopeful dealing with banks wouldn’t be as painful this time around…boy was I wrong!

Our Gulf Breeze Long-Term Rental Property Purchase:

  •  Down Payment of 20% (check)
  •  Credit Score of high 700s, low 800s (got it)
  •  Pre-approved with a regional Credit Union with a large local presence and really good interest rates (check)
  •  Occupied? Yes, both units of this duplex are under long term agreements with no indications/desires to leave.

A side note: while many Pensacola realtors require you to be pre-approved before showing you a house, you can certainly find realtors who don’t require this proof. Just know, obtaining pre-approval shows the realtor you’re serious about buying and typically is painless (mostly just a credit score check by your lending institution).

 

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Timeline (the boring details):

  • February 24: Pre-approval received from chosen Pensacola credit union
  • February 27: Entered into contract with a 30 day close date. Escrow provided to closing agent and copy of contract sent to our chosen Pensacola credit union.
  • March 7: Loan application process started (YAY!!)
  • March 14: I followed up with the CU to see how things were processing and promptly received “We are all set for now.” Hearing this during AH BANKS! Pardon My French – Part 1, my internal warning sirens start to go off.
  • March 22: paid for property appraisal through the CU
  • March 28: received confirmation that all initial qualifying documents were received and will now go through pre-underwriting process. Unfortunately this was accompanied with a need to extend the closing to May 9th. of which the seller did not want to do. Thanks for a great realtor for making this happen but my internal warning sirens are starting to get louder.
  • April 1: my loan application is transitioned from the Loan Officer to now the Loan Processor
  • April 12:  no communication in weeks, I receive notice that my loan processor is working toward final loan approval.
  • April 21: where the real fun begins…the loan processor comes back to ask me for previous years tax statements (which I’ve already supplied) and to let me know the appraisal has not come back yet. Since we’re 30 days past from when the appraisal was ordered, no sign of it being completed was frustrating. What’s even more frustrating, the Loan Processor didn’t know what to do. C’mon man?! I immediately sprung with questions like: Who ordered the appraisal within your firm? What’s there #? Who’s your boss? Who can we escalate that to? Give that to me and I’ll do it!
  • April 27: ONE WEEK LATER! The appraisal was finally received, but WAIT, there’s more! We still need your most recent tax return!  Ummm….no you don’t. I’ve uploaded to your portal twice now and receive the thumbs by your boss twice now Ms. Pensacola Loan Processor. Here I’ll upload again for you, just so you don’t have to look for it. There, you see the date of today’s date on the document in the portal? That’s it. Click on it and tell me if that’s what you’re looking for! Needless to say I was pissed.
  • May 1: I start daily calls to the Loan Processor and to the Branch LO Manager to receive status updates. If they don’t answer, I leave them voicemails and start emailing them, CC’ing their bosses. Not to mention my Pensacola realtor and his team start dialing their way up the CU’s corporate chain.
  • May 7: after a week of daily phone calls, emails, and borderline harassment for someone to take my business, I finally receive the good news my loan application was approved. However, “due to new regulations…. there is a 3-day seasoning that has to happen, putting your close date on May 10”. Again, here is where having a great realtor on your side helps. They kept this deal together.
  • May 10: Closed. Two and half months after going under contract, begging this credit union to take my business, we finally closed.

If you’re exhausted from reading this, I don’t blame you. I let a couple months go by before typing it up and I’m just as exhausted reliving this horrifying lender experience. At one point during this process, I felt like Mr. Regional Credit Union was enjoying messing with me. They wanted to show me who had the power.

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Now that I can sit back and non-emotionally reflect, part of me still believes that, but part of me really believes the process is just that broken. I feel for the branch managers and loan processors as their lives are more stressed from guys like me because their system is broken.

Bottom line is this: If this is the new norm for lending institutions, then our buy & hold strategy is going to be a gold mine. Even with continued lower rates, banks and lending institutions are continuing to make it more difficult to do business with them.
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AH BANKS! Pardon My French – Part 1

If this is the new norm, then our buy & hold strategy is going to be a gold mine. Even with continued lower rates, banks and lending institutions are continuing to make it it more difficult to do business with them.
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real estate investing pensacola fl

In the past 3 years we’ve used two different lending institutions – one to fund the purchase of our primary residence in Pensacola and one for a conventional loan on an long-term rental investment property in Gulf Breeze. Now that we are well past the closing on each property, the emotional piece has subsided from my not so pleasant experience and I’ve realized that the lending institution process is just a nightmare. It amazes me how little a loan officer actually knows about underwriting and how little they can speak to the process & knowledge of their underwriting counterparts. It’s not their fault, it just the process sucks and their caught up in the mix dealing with guys like me who want answers. Whether purchasing a primary residence or rental investment in Pensacola, this post is to help you understand what we’ve experienced so your expectations can be set. If your experience is better, then I’d love to hear who you used in the comment section below. Let’s dive into the details:

Our Primary Residence Purchase:
— Down Payment of 20% (check)
— Credit Score of high 700s, low 800s (check)
— National Bank with a large local presence and really good interest rates (check)

Why the 20% down? First off, there are lending programs out there that don’t require 20% down. We wanted to avoid what’s called Private Mortgage Insurance or PMI and banks will waive or discontinue PMI once there is an 80% loan-to-value ratio, hence the 20% down. There are numerous sites found via Google Magic that discuss PMI and I encourage you to do some research – it can save you thousands of dollars in the long run. Also, if you don’t have the 20% down payment, there are creative ways to come up with it – and no, I’m not encouraging you to do anything illegal…there are legal creative ways. 🙂

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Is an 800 credit score required? No, but your credit score does help determine your overall loan rate. The higher your credit score the better. If your credit score isn’t ideal right now, just know it will take several years of a consistent watch to improve it. I’m not an expert, but here’s how we did it: How We Increased Our Credit Rating

Where the “fun” begins... we were pre-approved by our chosen lender, found our ideal Pensacola property, went under contract, and moved onto the financing “fun”. Now every lender (credit union, large national bank, small local bank, mortgage broker – I’ve dealt with them all) has their own set of due diligence. I get it. They’re about to loan a significant amount of money to a person they’ve had no record with and they want to grab a better understanding of who they’re doing business with – makes perfect sense. For this purchase, the initial 11 page document detailed out everything we needed to provide them. Not a big deal. It took a few hours for me to grab and submit all the documentation. “That’s it. We should be good, I’ll send this off to underwriting.” News to my ears, but certainly became a little frustrating after the 3rd & 4th time I heard it. By the fifth round of them coming back asking for more info I had had it. I exclaimed, “ABSOLUTELY NOT! Either you have what you need to process this loan or we are moving on!” Well, at the risk of really pissing my wife off and losing the home we were now emotionally committed to, that tactic work. I didn’t provide another single piece of documentation and we closed in the next couple of weeks.

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I hate dealing with middle men or gate keepers, and in this case, the Loan Originator or Loan Officer. They provide no value to me and appear to do nothing but protect the underwriters. You can’t have underwriters talking to clients!? What was an emotional event at the time, I now see as a broken process. It was a broken process during this purchase in 2013 and is still a broken process on our most recent Gulf Breeze rental property purchase in 2016. That horror story is coming in Part 2 which I’ll link back here later.
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Purchasing Our First Duplex

Up until this point we’ve only invested in single family homes, but as we keep doing our research, small multi-family (MFRs) are the way to go.
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purchasing first duplex real estate investing pensacola fl

We looked in the Pensacola area for 12+ months and made offers on 3 other MFRs before we found one that fits our investing criteria. I was so anxious to get in a MFR at times I found myself compromising on our #s – trying to convince myself the #s were ok, they’ll improve later.  They were not ok and we’re not doing this to be just ok. Compromising on the #s is a no-no and this has been a great discipline exercise for me and great display of patience (which I rarely have – I must be getting older/wiser). As we stuck to our investing criteria, we finally found one. And I’m not just talking about a good deal, I’m talking about a great deal; at least it looks like that on paper :).

Excitement. What makes this such a great deal?

  1. Cash Flow. This Gulf Breeze duplex is expected to cash flow way better than our investment criteria require. I couldn’t wait to close on it and have the revenue coming in.
  2. Expanding: Our portfolio was expanding and so was our net worth.
  3. Subdivide Lot = Extra Cash Flow. This duplex is on a lot big enough to be sub-divided (which we will eventually do). This area of Gulf Breeze is zoned for many uses, so very little investment on the sub-divided property should yield a few extra hundred dollars more in monthly cash-flow. Another option is to sell off the subdivided lot, lowering our cost point on the duplex.

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Struggles. As-in, things that made me question what we’re doing.

  1. Patient to find a good great deal.  Now that we’ve found a great deal, this will be easier for me to repeat the next time.
  2. Banks/Mortgage Brokers. This probably goes without saying but I’d rather someone dig sand out from underneath my toe nails with a spoon vs. working with Banks/Mortgage Lenders . We have a great credit score, we have the down payment, W2s, etc, but I just felt like I was chasing them  –take my business please!!! Can’t quiet understand why they weren’t chasing me.
  3. Postponed Closing. Even though I finally caught a lender by the tail and started the process of ensuring financing with them a few days after we went under contract, it took 3+ months for them to pull everything together. The Gulf Breeze seller wanted to pull out, but thanks to my realtor for calming the seller down and bringing him back in. This was a new relationship with this bank and I’m hoping this doesn’t happen with our next acquisition. If it does, at least I’ll be used to it – they have REALLY good rates.
  4. Choosing a property management company. Gulf Breeze is a bit of a drive and with our portfolio expanding, I thought its best to bring on some extra help. I called 4 different property management companies (top hits from Googling ‘Pensacola Property Management’) and went with the only one that called me back. Luckily, they have impressed us thus far with their availability and response times.
Verification Process. There are a few things we wanted to verify about the duplex and made our contract contingent upon. The previous owner provided all of this. They are:
  1. Verified Rent Roll. We wanted to make sure the tenants were paying at least the amount of rent we used in our calculations to underwrite the deal. They were actually paying a little more.
  2. Current Tenant Rental Agreements. We also wanted to ensure what the current rental agreements look like as we would inherit those (at least until they expire) with the purchase. We also wanted to be aware of any security deposits the tenants paid that will need to be transferred to us at closing.
  3. Maintenance History of Each Unit. Just another verification step we took to ensure we weren’t acquiring a property that had a bunch of deferred maintenance.

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As the months roll on and this property produces like expected, I’m certain our Excitements will make me easily forget our Struggles. Like a new parent who struggles to get through the first 6 months, I’m hoping we quickly forget the stress and zombie feeling of being new parents.
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