Agent Update –Best Financing Strategy for Residential Investors?
On a recent trip I met a couple while in line on the skybridge. Not yet married but both investment property owners. He had 3 multi (1-4 unit) and she 1, SFR. They were optimistic in their home State of Michigan as well as their Florida destination. Due to Scarcity in these markets, I tend to agree. With the goal of building a rental retirement portfolio, what is the best path if utilizing financing? There are two primary lending options; QM or Non-QM.
First, let’s break down the difference(s) between QM (Qualified Mortgage) and Non-QM (Not a Qualified Mortgage). The first mistake, and I can’t blame someone not in the industry, is to assume a ‘non-Quality’ mortgage is an inferior choice. Most often confused with pre 2008 ‘Subprime’ loans that in large part, led to the mortgage crisis – not the case. Due to significantly higher down payment percentages and larger and longer reserve (net liquid asset) requirements, I would estimate 85%+ of borrowers who qualify for a QM mortgage would not qualify for a non-QM mortgage for an investment property.
Every individual is unique. So too are their individual qualifying factors or IPAC (Income, Property, Assets, Credit) profiles. It is almost a certainty identical twins past the age of 25 will have differences between their IPAC’s. This fact makes my profession both challenging and rewarding. I once read an article by the National Association of Realtors (NAR) and according to their survey, only slightly more than 60% of accepted offers reach closing. Mortgage56 has a 99%+ closing ratio – well above industry Average - a direct result of qualifying clients correctly.
In simplistic terms, QM Mortgage policy is set by the Consumer Financial Protection Bureau (CFPB). The enterprises (Fannie, Freddie) and Agencies (FHA, VA, USDA) then create guidelines to meet the IPAC requirement policies set by the CFPB and the ATR rule. These loans work well for salaried, W2 or passive (pension, social security) incomes with less required assets for down payment and reserves. Non-QM Mortgage guidelines are set by the investor (MBS) market. Risk is reduced with larger down payment and reserve requirements. This allows investors to take advantage of passive loses yet maintain consistent cash flow. For property investors, self-employed, 1099, union laborers tipped employees, and even farmers in some cases can use business cash flow or subject rental income to calculate income without regard to 1040 reported income.
What is the best investment property purchase strategy? What does the borrowers IPAC tell us? Step one is to select a Broker/Lender skilled in both QM and non-QM loan products and has established wholesale relationships for each. Mortgage56 fits the bill! Step two would be to answer the question of your long-term strategy and how /when do you want to get there? Are you willing to move every few years? Mind living in one unit of a 4-unit property? Do you want to take advantage of passive losses to pay less taxes or are you OK with breaking even? Are you on the first, fifth, 10th or 30th home? Do you focused on SFR on 1–4-unit buildings only or more flexibility from 5 to 30 unit properties? This is tip of the iceberg but you get the point. What a good broker/lender will do is match the financing type (QM vs. non-QM) to your investment goal with buyer IPAC in mind.
QM Investment Strategy
For Fannie and Freddie Conventional investment loans I have seen clients have great success on the First 3-4 properties. Starting with Single Family (SFR) as a primary (5% down payment) and 18 -24 months+ later converting it to an investment property. Then taking the next step moving into another SFR (primary) or into one unit of a 1–4-unit property – still as a primary (multi-unit conventional primaries require larger down payments than SFR). This works for the first 4 properties even if you stay put in one property or up until income runs into passive losses on a schedule E. Or, go the pure investment property type and pay Down payments starting at 15%.
Purchasing as a pure investment property type, the down payment and reserve requirements increase as the number of financed properties increases. Once you get to the 5th property, fewer brokers/lenders will process these loans (no worries, Mortgage56 does). Guidelines increase as do asset and income requirements and simply put…a lot more time and work on the broker/lender to get to closing. Max of 10 financed properties with QM loan products. However, if the ‘day job’ income can support debt ratios you will enjoy lower interest rates with QM. As the passive losses on Schedule E start adding up against salary or W2 income meeting debt ratio (DTI) requirements gets harder. FHA & VA? Yes, you can buy one, 1-4 unit as a primary as long as you live in one unit.
Non-QM Investment Strategy
Non-QM loans will have interest rates roughly 1.5-3% higher relative to an equal QM loan product. Non-QM loans generally have higher down payment requirements as well as reserve asset requirements. The term of reserves can range from 6 to 24 months depending on the number of financed properties. Their advantage is for borrowers not showing significant net income from self-employment or passive losses. Net taxable income is not used in the debt ratio calculation. For most lenders the borrower can close under the protection of an LLC as well. The two most popular products are DSCR and Fix and Flip. These are exclusively investment and sometimes second homes.
DSCR (Debt Service Coverage Ratio)
The DSCR product uses a form 1007 (comparable market rental income) rent schedule to determine the numerator of the ratio. The 1007 is to the ratio as an appraisal is to value. The ratio is [total rental income]/ [PITI + expenses]. In today’s market low LTV’s (60% or <) might be able to obtain financing with a ratio as low as .08 - .09. Currently 1.25+ is preferred. Benefits are taking advantage of passive losses on tax returns, a much easier process, especially if 5 or more financed properties, and no income calculations requiring high taxable income on the 1040. Having the needed liquid assets and reserves isn’t for everyone. For self-employed, 1099, tipped income, commission, bonus, union etc. etc.....DSCR deserves a look. Or DSCR may be the answer to “NO” from a bank or other QM only broker/lenders.
Fix and Flip
This product allows renovation investors an easier path to purchasing a second home or investment property in disrepair at a below market or ‘stabilized’ value. Fix and Flip lenders normally require the borrower to close as an LLC. Purchase principal plus 50 - 100% of the principal amount can be obtained for the purchase and renovation. The loan amount is an Interest Only (IO) product until the renovation is completed and all draws exhausted. This initial total loan amount is based on ‘As is and After Repair Value’ and other compensating factors. Compensating factors are experience (previous number of fix and flips completed), General Contractor involvement, renovation plans, Real Estate Agent involvement and LTV. The more compensating factors, the lower the interest rate and higher the renovation loan amount allowed. Upon completion the balance is converted to a DSCR product or sold. This is an excellent product for the long term residential real estate investor consistently acquiring properties over time.
Other Non-QM Products
Bank Statement (cash flow)
Interest Only
40 yr. Term
Jumbo
Foreign National
ITIN
No Established Credit + More
In Summary, there is no cookie cutter approach. Every client IPAC is different. As a good in – general, Start with QM on your first 2 – 4 investment properties then move to the Non-QM model to continue to grow your portfolio. If this is the goal. Fix and Flip? Non-QM out of the gate. QM renovation loans are so cumbersome most lenders have dropped these products. So, find a good Broker/Lender for a long-term relationship, work with them to develop a strategy relative to your personal IPAC and…. get shopping! Yes, inventory is thin for the SFR market but there may be more opportunities than you would think for investment properties. And, as with any type of investing…the sooner you get started, the farther along you will be at retirement!
I hope this is informative and relevant for both the new and experienced investors. Have more questions? – 7 x 24 availability. Currently licensed for residential zoned properties in Michigan, Minnesota, Ohio, and Florida.
* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.