The debt to income ratio, also known as DTI, is an important metric that lenders consider when evaluating loan applications for investment properties. It measures the percentage of a borrower’s gross monthly income that goes toward debt obligations like mortgage payments, credit cards, student loans, car loans, etc. A higher debt ratio indicates greater risk for the lender, as the borrower has less disposable income available to make payments if they encounter financial difficulties. Generally, lenders prefer to see DTIs of 43% or less for rental property loans. However, debt ratios exceeding this threshold don’t automatically disqualify borrowers. Those with higher DTIs can still qualify by meeting other loan criteria like having a larger down payment, stellar credit score, and ample cash reserves. When evaluating an investor’s DTI, lenders will examine both the overall ratio incorporating all debts, and also the ‘rental’ DTI specifically covering the new investment property’s projected expenses. Keeping rental DTIs lower through larger down payments and positive property cash flows can help investors qualify and manage risk.
How lenders calculate DTI for rental properties
Lenders have two main methods of calculating DTI when underwriting loans for investment properties. The first examines total DTI across all an applicant’s debts – their mortgages, credit cards, student loans, auto loans, etc. The typical maximum allowed is 43%. So for example, an investor earning $10,000 a month with total debts of $4,000 would have a 40% total DTI ($4,000/$10,000). The second DTI calculation focuses specifically on the new rental property’s expenses. Known as the ‘rental’ or ‘subject property’ DTI, this ratio divides the property’s PITI (principal, interest, taxes and insurance) by its monthly gross or net rental income. So if the PITI is $2,000 and gross rent is $3,000, the rental DTI is 67% ($2,000/$3,000). Many lenders cap this at a lower ratio like 30-40%. A lower rental DTI indicates the property will generate positive monthly cash flow even after paying the mortgage. When approving loans, lenders review both total and rental DTI to gauge investors’ overall payment burdens and the viability of the rental income stream.
Tips for investors to manage their debt ratios
Here are some tips for real estate investors to keep their DTIs within lender limits when financing rental properties:
– Make larger down payments to reduce mortgage amounts and PITI expenses
– Limit use of leverage and borrowed funds
– Pay down existing debts to lower total DTI
– Focus on properties projected to have positive cash flow
– Offset passive rental losses by increasing W2 income
– Build up cash reserves to demonstrate ability to withstand vacancies
– Obtain cosigners when first starting out to supplement qualifications
– Purchase multi-unit properties to increase rental income
– Partner with other investors using joint ventures or LLCs
– Improve personal finances and credit score over time
Other factors lenders consider besides DTI
While DTI is important, lenders also weigh several additional factors when evaluating rental property loans:
– Down payment amount – More equity reduces risk
– Credit score and history – Higher scores preferred
– Income sources – Multiple streams ideal
– Cash reserves – Reserves help withstand vacancies
– Property type – Residential better than commercial
– Experience as landlord – Seasoned investors preferred
So even with high DTIs, investors can potentially qualify by offsetting with other strengths like a sizable down payment, excellent credits cores, or a long history of property management experience.
Strategies for real estate investors with high DTIs
For investors who exceed lender DTI requirements, here are some strategies to still finance rental properties:
– Explore alternative lenders with less stringent requirements
– Offer a larger down payment to offset higher DTI
– Add a cosigner or partner to supplement qualifications
– Purchase via LLC and use company underwriting
– Look to private/hard money lenders as a higher cost option
– Build up your credit profile and cash reserves over time
While potentially more expensive, these options allow investors to get started while working to improve their personal finances and reduce DTIs over time.
The debt to income ratio is a key factor lenders examine when underwriting loans for investment properties. By making larger down payments, improving personal finances, and partnering with other investors, real estate investors can meet DTI requirements and manage the risks of higher leverage.