The exciting part of investing in real estate is finding a property and running the numbers. If you don’t have financing ready to go, the property will probably be sold to someone else. How do you get financing for your rental properties? Today, Michael Bowman of Anderson Business Advisors and Bowman’s Business Brief talks to Todd Bowman of AmeriFirst Financial about financing options. Todd is a mortgage broker, who handles mortgages for investors with rental properties.
- What’s needed to qualify for an investment property loan? Pre-approved financing, two years of tax returns, and paycheck stubs to verify income
- What type of pre-approval? Full-underwrite approval, instead of credit approval based on your credit score
- How much of a down payment is recommended or required by lenders? 20 percent for investment properties, but some require only 10 percent for hard money loans
- What are down payment qualifications? Your money only; or money gifted to you needs to be in your bank account 60 days prior
- Do seller concessions factor into loans? Reduces out-of-pocket and closing costs; AmeriFirst’s $1,450 processing and underwriting fee includes six months of taxes and hazard insurance
- What if you don’t have enough for a down payment? Use cash reserves from 401(k), IRA, or stocks and bonds portfolio
- What if you buy a property already being leased out? Take 25 percent of rent based on market rolls for instant income stream
- Is it a cash cow, mailbox money, or dog of a property? Numbers don’t lie; make sure it’s profitable
- What’s an acceptable credit score? It isn’t one particular number, but more about your credit profile; better FICO scores mean cheaper rates and likelihood of approval
- How can you improve your credit score? Revolve credit lines/cards, lower balances, and don’t randomly pay off loans/debts
- What’s debt-to-income (DTI)? Based on your total debt, including credit cards, student loans, and child/spousal support
- What should you look at or make sure of before making an offer on a property? Do your research by driving around the neighborhood and interviewing realtors
Full Episode Transcript
Michael: Welcome everybody to Bowman’s Business Brief, a subsection of Anderson Business Advisors Podcast. What the Bowman’s Business Brief with Anderson Podcast focus on, is the current issues in the business world, but also in the real estate world. Lately, a lot of our clients have been calling and asking questions about getting financing for their rental properties. I’ve been answering those questions and I thought it would be really applicable to our clientele to go ahead and get it straight from a mortgage broker, a person who does mortgages for rental properties and for investors.... Read Full Transcript
I started looking around and I realized that I had a resource very close to me. So I asked my brother, Todd Bowman, who works for AmeriFirst. He is my brother and also my fishing buddy, and thought I’d get him on the line and record a podcast just regarding all the ins and outs of getting financing for your rental properties, because a lot of clients again, have had trouble getting financing. I’d like to welcome Todd Bowman to the show, Todd.
Todd: Thank you very much, Mike. I appreciate having the opportunity to visit with your clients.
Michael: What’s cool about this is when I looked at some of the questions and I asked Todd if he’d be able to do it, he wrote out a bunch of questions that he continually gets asked. This is going to be a great resource for our investors regarding getting financing. To get a baseline, the first thing that I want to go over is just the basics. What do you need to go ahead and qualify for an investment property to get a loan?
Todd: First and foremost, when you do an investment property, have your ducks in a row. You’ve got to have your financing already set in place. A lot of mistakes of first-time investors, they go out and they look on Zillow, Trulia and things, they could find a property, then they contact a real estate agent, and the real estate agent asked, “Do you have a preapproval letter or a pre-approved financing?” and they go, “Oh.” That’s number one, get your financing in place before you go out looking. Things that you will need right away for a mortgage specialist, you’ll need two years tax returns. W-2s for those two years.
The reason why they want to see that is they want to see, do you write off a bunch of stuff, do you have other independent businesses that give you tax credit from your bottom line income. They will also need one month’s worth of pay […] the pay check stubs. They want to verify your income, they want to see that you make what you say you’re going to make. Also, they would like to see two months bank statements just to see that you are a player, that you have the money available to have your down payment covered. Those are the important features.
Michael: I love how you say what we were speaking about that as well as thinking about putting the cart before the horse and getting prepared. The exciting part of investing in real estate is actually finding the property, running the numbers, the analysis, and like you said, a lot of people don’t get their financing in place. In some markets right now, if you don’t have the financing ready to go, the property will be sold from underneath you. That’s awesome advice.
Now, you mentioned something between preapproval and […]. Explain what types of things get a preapproval and learn what that is.
Todd: Excellent question. When you go to a major bank or something, what a lot of times they’re going to do is they’re going to give you what’s called the credit approval based upon your credit score. That’s great and wonderful, there’s too many variables when you do that kind of an approval, because you have such as your tax returns. If you have a business, the big banks aren’t going to see the business until they request those from you, and you could be already under contract, and it shows that you write off too much in your business, and it takes away from your bottom line income. This way, you don’t qualify.
What I recommend that all investors do is they get what’s called a full underwrite approval before shopping for a home. We do this at AmeriFirst Financial because we do not want to see you go under contract and then get denied at the twelfth hour because you didn’t have enough income or you did not have enough cash reserves. Be aware of what’s called a credit approval versus a full underwrite approval.
Michael: That’s huge. What you said falls out of contractor. What you’re doing is breaking the contract and in most cases, you’re going to lose your earnest money which is the money you’re putting down to show your good faith in the contract. Awesome. Get the full approval, full underwrite approval, so that you’re ready to go and able to close, you don’t lose your earnest money.
Speaking about putting money down on the deal, it seems that one of the questions that keeps coming up is, “How much do I have to have down for a loan? How much of a down payment? How much skin in the game do I have to have?” or what are lenders requiring right now?
Todd: In typical investment properties, you’re going to see 20% down on an investment property. Now, there is some private monies out there that will do 10% down, just be aware of those types of terms and conditions because those are typically in the industry called hard money. They’re going to have a short-term note and a higher interest rate. Now, depending upon what you’re buying this property as a fix-and-flip, those are ideal types of loans for that, because you’re going to be putting less down, and you’re only going to be carrying it for a short amount of time.
Your typical long-term investment rental property, you want to put down 20%-25% or more, because if you do, then you’re going to see that your debt-to-income, and your debt service scene, all those things will balance out to be more of a profitable investment versus a high interest rate lowered down, you’re going to see a higher monthly payment which then takes away from your profit.
Michael: Absolutely. It’s funny how everything flows together. The next thing that we run into with questions and concerns, a lot of times, our clients will call us at the last minute saying, “Oh my gosh, I just ran into this problem. How do I jump over this hurdle?” one of the questions that comes up is, “I don’t have enough money for the down payment. Can my parents gift me the money? Can my brother give me the money? What about gifts?” What about the down payment qualifications?
Todd: That happens a lot. That’s why we go back to that whole beginning the phase of that qualification. If we and I had shown our two months bank statements, we would know where we sit financially. That is a common occurrence of people that get the credit approval only. Typically on an investment property, it is your money only. It cannot be a gift. That is very critical.
Now, the seasoning for your money is 60 days. If you have a family member that wants to be a part of the investment and wants to be a part, then obviously, you’re going to have to have that money in your bank account for 60 days so it is seasoned and that is going to be a private entity amongst yourselves, not amongst the bank.
Michael: I just have to ask you for money 61 days in advance before I buy another property.
Todd: There you go.
Michael: I like it. When you get into again, building your down payment, putting your skin in the game, there are times where in some markets, the sellers want to get rid of the property. They’re either go through probate, they’re going through some hard times, they just want to sell it out, and they’re willing to make some concessions. How does that factor into loans?
Todd: Actually, that’s a big key because there’s two factors when it comes to seller concessions. First factor is going to reduce your bottom out-of-pocket cost when you’re buying this house. When people buy a home, they typically think down payment only. That’s great, that’s what you have skin in the game. A lot of times, what beginning investors forget to do is they forget to factor in what are called closing costs. Closing costs are typically your title company, because they don’t do it for free.
At AmeriFirst, we have a $1450 processing and underwriting fee, and then you’re going to have your six months worth of taxes, and hazard insurance, everything gets incorporated into the down payment and closing costs. I use the word down payment because that’s going to be your 20% and then you’ve got the closing costs on top of that.
Michael: I chuckled because I remember one of my first real estate deals when I went in there and I had calculated, “I got the down payment. This is great,” and then all of a sudden, there is those fees, and taxes, and I said, ‘Oh, ouch,” we had to do some creative things to get it done.
Todd: Absolutely. That’s where the seller can contribute up to about 2% of the purchase price which is a great thing. If you had a $300,000 house that you’re buying as an investment property, the seller could contribute $6000 towards your closing costs in prepaid and taxes, which doesn’t seem like a lot, but if someone handed you $6000, would you say no to that?
Michael: Absolutely not. I don’t mind sharing my past transgressions or my mistakes in life and I hope other people can learn from them. That’s another thing about when you’re coming up for the down payment and your skin in the game is what I call it. it’s the, what happens if you take all of your money and put it into the deal, are you still going to be able to—when they do the calculations—still qualify for the loan?
Todd: On an investment property, you are going to see what are called, that you’ll need, cash reserves. Cash reserves are money in your bank account after the transaction is closed. Now, these reserves could be 401(k)s, depending upon certain IRAs, investment portfolios, portfolio in stocks and bonds, and different things like that, depending upon how liquid they are, but you are going to see depending upon the number of properties that you own, that you will see up to 2-6 months to 2% of the total loans that have out on investment properties. You really need to visit with your mortgage specialist to make sure he reviews the number of properties that you own, because that will factor into the cash reserves needed for that investment property.
Michael: Those are the things that people don’t tell you when you’re online qualifying with one of the online brokerages. They don’t they don’t run through the stuff with you and then they leave you high and dry for sure. I’ve ran into that with some clients too, they couldn’t get the answers there. What about if I buy a property and it’s already being leased out?
Todd: Excellent question. The nice thing when you’re buying a property that is and already has a lease on it, you’re able to take that lease and you’re able to take about 25% of the market rule, rent rules for that area, and apply it to your income. It’s instant income streaming. It will really give you a great opportunity to look at some of your bottom line numbers saying, “Look, under this, I’m going to have this as instant income,” and you could be able to say if this is going to be a great deal for me or not.
Michael: In addition to prequalify, you need to run your numbers and make sure it’s going to be a profitable deal. A lot of people just assume that you’re going to get into it and it’s just going to be a cash cow. I call it mailbox money, you walk out and grab that check, but you really have to run your numbers. That’s why I love education when it comes to real estate investing. They point it out. They teach you how to go ahead and calculate the investment, and make sure that you’re not getting into a dog of a property .
Todd: I’m sorry to interrupt you there Michael, but I do have to stress that numbers don’t lie. I’ve used this saying for many years, because there are so many investment properties, you run the numbers, take the time, they don’t pan out. I’ve had a couple investors that ran the numbers right away and then were like, “This is great,” and then they got a little cocky in their investments, and they just bought properties without running the numbers, and then all the sudden realized, “This was a bad deal.” I use the saying, “The numbers don’t lie,” because it will save you a lot of headache and heartache in the future.
Michael: Real estate investing is so much fun. I can see how people get caught up into that. All right, so the other part of getting a loan has to be your credit score. Back in 2005 or 2004, you just had to have a pulse to get a loan. I think dogs were getting loans back then.
They didn’t know if you needed a social security number or even be alive, but now I imagine that they’re going to look at your credit score and people’s credit scores range all the time. I do suggest, especially with all the credit breaches out there, that people do get credit monitoring just to make sure that your credit isn’t being tainted, especially if you’re going in for a loan and all of a sudden you find out that your credit score is not up to par because of maybe your identity stolen. The other thing that people have found out is that it takes a while to remove any discrepancies on your credit report. Make sure you’re monitoring your credit before even attempt to get in a loan. What is an accurate credit score that people looking for, for investment loans?
Todd: The bottom line is there isn’t one particular number. It’s your credit profile. Now, obviously if you’re down in the 600s and so forth, then we’ll need to take the time to work with you to get your FICO scores up and get you in a better position. Your rates and everything and your approvals are based upon your credit worthiness as far as how strong are you, what are your repayment history like and so forth. There isn’t really a particular threshold that you have to be at, but you’re going to see that the better the FICO scores and the better credit that you have, the cheaper your rates are going to be and your credit approval.
Now, one thing going back to your credit monitoring systems, before you go and apply for a loan and have them run your credit, please notify your credit monitoring systems because they will sometimes block the credit from being run and so you don’t want to have a credit enquiry but without a result of that credit being pulled.
Michael: You want a ding.
Todd: Yes, you want to be able to have that be processed through, especially because the time that you’re going to be investing to go see your mortgage specialist and to try to run your credit and they can’t, now you’ve just wasted your time and you’re going to have it done at a later time and that does take time away from your investments.
Michael: The rule of thumb I’ve used for is maybe a 740 and above and maybe the 20% down payment, is that a good rule to go by?
Todd: It is, but I would not pigeon hole yourself into having a 740 because you do have some investment banks that will go lower than that.
Michael: Oh really? Cool.
Todd: Yes absolutely. Do not get caught up into, “I have a 660 and I guess I can’t get a loan.” That is not the case. It’s your whole total credit profile that we base it upon. There’s some people that just get it.
Michael: If you have a credit score below, you’re not getting the right one you want, maybe you get turned down, what are some things you can do improve your credit score? What do you run into with your clients and you say, “All right, do this, this, and that, and then let’s try to run through it again.”
Todd: The biggest thing that I see as a score improvement is your revolving credit lines. These are your credit cards. When you look on your credit card and you say, “Oh look, I’ve got a $5000 credit limit on my credit card,” and it’s a brand new card, people go and they transfer money from an old credit card into the new credit card because it might have a lower interest rate. Now, they take $2500 from this card, and $2500 from this card and they put it on the zero interest credit card. It happens, and what happens with that zero interest credit card, all of a sudden it’s brand new, you put $5000 on a $5000 credit limit and it shows the card is maxed out. Brand new card maxed out, they’re going to lower your FICO scores.
The biggest thing that I see with people is to improve their FICO course, is get their balances down and there’s not a rule of thumb, but I’m going to use from my experience, I’d like to see anything less than 50% on the card balance, $2500 or less, good payment history obviously will help. If you need to increase your FICO scores look at the balances on the cards, contact me. We’ll go through it, do a credit analysis, and figure out what we need to do to be able to increase our FICO scores.
Do not just randomly pay off things because it might not affect it. That’s why you need to have a specialist look at it and figure out what’s going to give you the best bang for the buck to increase your FICO scores to be able to get you into buying an investment property.
Michael: That’s awesome advice. It is weird how they weigh them in different credit agencies and I’ve been seeing my own personal score. I paid something off and I thought, “It’s going to jack my score way up and it barely budged, so that’s good advice. Another thing I’m sure they’re going to look at is what your debt-to-income ratio is.
Todd: Right, this is what’s called your debt-to-income or DTI, you’ll hear that in the industry. Here again, DTI is based upon what your total debts are and this could include all your credit cards, student loans, it could also include child support, spousal support, all these things that get drawn into what’s called your debt-to-income. There’s two numbers in your debt-to-income that you’re going to maybe hear when you’re doing a purchase of a home.
That’s your front-end ratio and your back-end ratio. The front-end ratio is your total housing debt and that sometimes you’re going to see like a 16% or 21% or 31% and then the back-end is going to be your total debts of housing, student loans, your credit cards, installment loans for your car payments and so forth. We want to see somewhere around the 36% would be ideal obviously, but we can take you up to about a 45%–46% just depending upon your credit history.
This really what draw us back to your credit history, cash reserves in the bank, everything. It’s your total credit profile, but you need to make sure that that debt-to-income is all in that checks and balance. This is where doing the full credit approval and income approval is so important when you’re in—
Michael: I love that you’re recommending that. Again, just from my own past and thinking I had all my ducks in a row without the full credit approval or underwrite approval, and that just makes sense investing somewhat emotional at times and you find out that perfect property you’re excited about only to be turned down by a loan, so I love your recommend it doing that, that’s for sure.
Todd: Yeah and it’s very important, especially if you’re married. You don’t ever want to tell your wife that she’s not going to get that investment property that she fell in love with.
Michael: Nor do you want to tell her that she’s in charge of the demoing of the property and all of the rehab, too. Not a good idea. What other things you run into that you would take a look at or make sure that things are in line before even making the offer on the property?
Todd: One of the important things is drive the neighborhood. You want to look at what your rent rolls are going to be. Are you going to maximize your profit by buying this house? You’re limited sometimes on the number of properties that you’re able to buy because your debt-to-income. You want to be able to look and say, “This is the most bang for my buck property,” and is it going to appreciate, too.
Michael: It’s funny when I’m speaking at my conferences, especially ones here in Vegas, you run into people who have seen too many of the flip this and flip that on the TV shows and I just open the blinds to the biggest value and I show the biggest value. It’s so interesting because some areas you’re still able to make a profit quick turn in and some other areas you’d be stuck with the property, and you want to build a quick turn in, and you’re paying those hard money loans and everything else like that. It can really sink you or some of them just won’t run out. I love research, research, and research, get educated and that’s the—
Todd: The important part is that research. If you don’t take the time to do your research, first of all, it’s going to probably cost. It’s going to cost a lot of money. Number two, if you don’t kick the tires at the house, go through it. See the last time the AC is replaced. There’s maintenance records on the house that you can get a hold of from the sellers. All these things make a difference in your total investment experience. I’ve had an investor lose his shorts on his first deal because he didn’t take time to find out the maintenance records and the AC had not been replaced in 15 years.
Michael: Well they’re cheap, are they?
Todd: Yes, they’re pretty cheap. A couple of bucks here and there. Part of that is kicking those tires and making sure what’s out there known. I also recommend highly that you interview your real estate agent. Do you want to have an agent that has experience in rental properties, buying investment properties. They’re going to know. They’re going to see things that normal real estate agents are just doing, first time home buyers or repeat clients are not going to know. That is very important. They have some knowledge and experience in the rent and investment property field.
The other recommendation is also if you’re not using Todd Bowman at AmeriFirst Financial, ask your loan officer questions about investment properties. He should know those answers. One of the biggest problems a lot of times happen on appraisals. The loan officer will order an appraisal for the property, but he does not order the rent rolls for the area. Every investor that’s going to be buying a property needs to know what the area rent rolls are because when they go to sell that loan, they’re going to have to have that for the portfolio.
Michael: Well, this is awesome. Those are the questions that I had. Those are the pressing ones that my clients have been asking that I compiled and with the top one we did cover. I appreciate you taking your time on your busy day. If people want to get a hold of you, I know you only do loans in certain states, like 26 may be up there, the last time I talked to you?
Todd: That’s correct.
Michael: As my brother and to my clients, I’m sure you answer some questions firstname.lastname@example.org is his mail, I’ll just put him on the spot, but anyway, thank you again for being here and sharing some of your wisdom with them in our podcast here at Anderson Business Advisors and Bowman’s Business Brief. Thanks, Todd.
Todd: All right. Thank you, bye-bye.