There are varying opinions and schools of thought when it comes to funding any project. I am going to discuss the approach I am taking for the first one…Conventional Funding. As of now, I have gathered information on various financing options, whether it is conventional, hard money, portfolio, it doesn’t matter. My goal is to identify my level of affordability before placing offers. Based on cash on hand, I know I have the 25% down required for a $125K-150K purchase. This information along lets me know exactly what market I should look into before finding a property. I know my target range and it sits well in my business plan for marketing areas. If this criteria wasn’t met then I would continue to save funds to reach this goal.
For lenders that serve conformed loans, which are in line with industry guidelines set by Fannie Mae and Freddie Mac, it’s important to understand friction points in the loan application process. These rules are strict due to the issues that arose during the sub-prime mortgage issues in 2008. This situation gets complicated when the property targeted is no longer a single-family house. So if you are like me and choose a duplex, 3-unit, or 4-unit property, the simplicity of a conventional loan for investment property comes with additional interest and inquiries from the bank. They are likely to tack on penalties, restrictions, and insure you have more liquid assets.
At the minimum most lenders want assured that you have proof of funds for the following:
- 25% down payment
- Closing costs (not covered by seller)
- 3-6 month cash reserves
- Debt-to-income ratio below 43% for qualified buyer
Note: I don’t bring up credit score, because you should focus to be in the mid to high 700’s. I highly recommend focusing on building your own personal credit before going any further. Higher credit scores bring instant credibility with any lender and will make them work harder for you. Just like someday your hard money will work harder for you.
Debit to Income Ratio
“Don’t live beyond your means. Don’t buy more than you can pay for. Don’t expect to get rich quick. And don’t confuse salesmen for friends or advisers.”
-Charley Reese
Your debt-to-income ratio should be affected predominantly by current mortgages and be mindful banks are required to adjust the ratio based on number of family members in the house. At the end of the day, the bank wants to make sure you can make the payments of the investment property and your critical bills without starving. It is good to know that the new mortgage is added in this valuation. If the income from current tenants in the new property is required, it will require additional paperwork provided by the seller to substantiate steady occupancy in order for underwriters to approve based on the new debt-to-income ratio. This valuation is much easier in larger multi-family houses because there are typically extensive income/expense statements associated with those properties.
Without throwing shade at specific lenders, I will say that I reached out to a couple big name mortgage lenders in hopes of receiving an investment loan. I received pre-approvals, but then I found a 3-unit which was no longer supported by the same investment property. After working with my good friend and Real Estate Broker, he and his wife (Real Estate Team) provided contact information for local mortgage lenders. I immediately reached out to one and noticed a significant shift in the personal approach to the conversation. The local lender explained the minutia that halted the big company, but found a way to get the pre-approval letter I needed to move forward with my offer.
The Offer
The offer is for a 3-unit property. Two tenants occupied and one vacancy with some tenant roll information to understand current net income and possible income with full occupancy. After walking the property, I have identified three key areas to raise appraisal value (equity) in the property. At least one area is a maintenance concern which justifies a reduced offer price of $10,000 below asking. Additionally, the property has sat on the market for nearly a year which for most is concerning, but for me isn’t based on potential improvements and increased cash flow. So the current offer is focused on the Seller knowing these items:
- conventional loan
- 25% down
- Seller provides max 2% closing costs
- $1,000 Escrow
The offer requires working with the seller/seller agent to insure the purchase agreement has the appropriate information and the right format. For instance, this property the seller “prefers” a commercial agreement over residential due to the level of detail in the document. However, due to the lender and loan type being used a residential agreement with additional provisions is the only way the offer can be submitted. Now let the negotiations begin!