August 6, 2010, Newsletter Issue #230: Information Needed to Apply for an Investment Property Mortgage

Tip of the Week

Investment property mortgage loans require a bit more complicated documentation, particularly if you are purchasing the real estate. This occurs because you have the same debt-to-income considerations and documentation requirements as with the purchase of an owner-occupied property PLUS the addition of a more complex appraisal, the need for lease agreements or tenant-at-will letters from your prospective tenants, and the often additional time it takes to complete these and other tasks (home inspection, pest inspection, etc.) because people need to gain access to the rental units, which often results in multiple visits because of the schedules of both the inspectors and the tenants.

The debt-to-income calculations are also a bit different than you might think. The logical approach is to add the net income you should receive each month to your income thereby improving your debt-to-income ratio immediately. However, this approach is seldom used as the secondary market, to which most mortgage loans are sold, does not like this calculation. Normally, the projection of your net monthly income (gross rents less vacancy [often 5%], mortgage loan payment, real estate taxes, insurance, and any other operating expenses (utilities, trash removal, snow plowing, etc.) for which you will be responsible) is included with your current debt profile (it should obviously reduce your monthly outflow for debts) to calculate your debt-to-income ratio. Confused? Here is a simple example:

Gross Monthly Income before purchase: $5,000

Monthly Debt BEFORE purchase: $1,700

Debt-to-income Ratio: 34%

Investment Property: Gross Rents $1,200

PITI & Expenses $ 900

Net Income $ 300

Method 1: Gross Monthly Income ($5000) plus Net Income ($300) $5,300

Monthly Debt AFTER purchase: $1,700

Debt-to-income Ratio: 32%

Method 2: Gross Monthly Income ($5000) plus Gross Income ($1,200) $6,500

Monthly Debt BEFORE purchase $1,700

(include new mortgage pmt. & expenses) $ 900

Monthly Debt AFTER purchase $2,600

Debt-to-income Ratio: 40%

You can see the difference as your debt-to-income ratio INCREASES to 40% instead of decreasing to 32%. This is a very conservative approach to the calculation but it is what the market wants. Take this into consideration if you are considering an investment property purchase and want to calculate your own debt-to-income ratio.

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