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%

Screen Shot 2018-02-05 at 4.00.05 PM

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.

JOIN OUR PRIVATE FACEBOOK GROUP: REI FOR THE W2 EMPLOYEE

 

  • 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%

Like this article? SIGN UP! No spam. Scout’s honor. 

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.

Related Articles:

Should I Buy This Duplex?

I recently found myself in an advisory roll for a couple individuals, Eric & Jolene. Complete strangers to me but Eric & Jolene reached out for some advice on purchasing their first duplex, happy to provide.  To my knowledge these newbs at real estate investing don’t know one another as one lives in North Carolina, the other in Minnesota, but had very similar, scary similar, scenarios.

Eric (NC) & Jolene (MN) were analyzing their own duplex with the idea of living in one side while renting out the other side. They both wanted to cash flow $100-200 per unit but neither could calculate their numbers to work and fit their investment criteria, but why?

Screen Shot 2018-02-05 at 4.00.05 PM

Each presented their case. “Are my expenses, utilities or taxes too high? Have I over estimated my vacancy expense?” Typically I find utilities and taxes as two expense categories that really drive down cash flow, so they both were on the right track. They have done some homework. Property taxes, not much anyone can do about them. Possibly something you can do about utilities via bill back to the tenants but you have to be sure your competition does this as well and/or how that will affect your rental income.

Pro Tip: If a property is master metered, the most economical way to bill back utilities to tenants is through RUBS – ratio utility billing system. Be sure your state statutes support RUBS and it will save you thousands on sub-metering a master metered property. 

Next case point, both Eric & Jolene presented, “Rent is not up to market rates on Unit B. There is a long term tenant of 10+ yrs that I know I can go up on but even when I do that, I still don’t hit my $100-200/unit criteria.”

My Advice: Your goals are wrong.

Both Eric and Jolene were analyzing their properties as if they were living in them, meaning they were missing out on revenue from one unit, meaning 50% economical vacancy…all the time. This wouldn’t allow them to hit their investing criteria but if they wanted to live in one side of a duplex and rent out the other, they have to look at it a different way.

Here’s what I told them:

You have to make a decision on whether this property is the right property for you. You have to decide if you want to use it as your way of starting to invest in real estate, not that it will hit your investing criteria initially but you know it will once you move out. You have to decide if your goal for this particular property is not to initially cash flow to your criteria, but allow you to dive into real estate investing and eventually steam roll you into additional units.

Both Eric & Jolene currently owned homes, paying $1200-$800/month respectively in mortgage payments. To gain perspective, through our conversation they realized that their goal, as least for this property, was to cut their housing expenses down to $200/month. A reduced mortgage payment plus the second unit’s rental income brought their housing expense down by $1000-$600, respectively. The delta difference, that $1000-$600, they would then start saving for a down payment on their next rental property. By doing this, in less than 24-36 months, both will have enough money saved for a down payment on their next rental property.

Setting goals is highly important but setting the right goals is important-er!! I did that one for my 9th grade english teacher 🙂

In my 10 Step Guide to Buying and Holding a Small Multi-Family Rental Property we discuss this very thing. Step 1 is completely dedicated to defining your goals and more importantly, your purpose for real estate investing. Once you’ve truly discovered what those two are all about, real estate investing becomes clearer. In Step 2 we’ll create your investing criteria that’ll act as your guard rails when analyzing opportunities.

Have a question? I’m happy to help. Reach out on this form.

Related Articles: