House #4: Why Not Rent?

November 12, 2008 · 9 comments

I just received a comment on a previous post asking why I wouldn’t consider renting out The Yellow Stain House. This is a question I get often, and also one I’ve asked myself often. While in theory, renting this property makes a lot of sense (the numbers work well), there are a couple practical issues that make it difficult to take this route at this time:

  1. Most lenders have “seasoning” requirements before they will refinance. In other words, they require that the house be owned for some period of time (generally 6-12 months) before they will consider refinancing it. While it is possible to find lenders who will refinance in shorter periods of time, they generally will only finance up to 65-75% of the *purchase* price, as opposed to the appraised value. So, as an example, I bought The Yellow Stain House for $60K, I would have to put $10K of work into it to rent it (plumbing, flood letter, foundation, etc), and if I were to refinance in the next 6 months, I’d only be able to pull out $45K (75% of $60K). While this is certainly an option, it would still leave me with $25K in the property, which hurts my rental ROI numbers (and ties up my cash). The other option is to wait 6 months, and refinance based on the appraised value; but again, it would require tying up a lot of cash for at least 6 months;
  2. Because I don’t have 2-years of verifiable income in this business, I currently can’t qualify for a loan (I don’t meet the income requirement) without a partner or someone else to co-sign. Generally, this means giving up a percentage of the profits to whomever takes the risk of co-signing. Considering I’ve put up all the cash and have done the majority of the work to this point, I’m hesitant to give away any profit simply for someone to co-sign a loan. While I would consider partnering with the person I partnered with on The Bulge House or the person I discussed partnering with previously on this house, the dynamics of partnering at this stage of the project are a little weird.

All of that said, I’m not completely averse to taking this road, if necessary. In fact, if I were a year further into this business, I’d probably be jumping at the opportunity to hold this property as a rental (the numbers work very well).

But, right now, I’d really like to get a couple more resales under my belt, if for no other reason then to keep me motivated. My wife and I have discussed so many potential exit strategies on this property, and we come back to the rental option often; but for now, I think we both agree that it would only be a last resort if we find we can’t resell the property.

9 responses to “House #4: Why Not Rent?”

  1. Jan Watson says:

    Hi, very clear answer.

    The sale will increase your tax hit on the property I suppose?

    Does the two year experience disqualification for a loan (for a new full-time and therefore no income investor) include the case of a cash-flowing rental property with plenty of equity?

    I’m researching the possibility of arriving in US with lots of cash but no income (Japanese investors) and so am looking at exit strategies from precisely your situation.


  2. J Scott says:

    Hi Jan,

    Yes, if the sale is less than 1 year from when I bought the property, I will pay taxes as “ordinary income.” In other words, the tax hit will be the same as if I earned that money working a job. If I earn a good bit of income, this means up to 35% in Federal taxes.

    As for income requirements of lenders, generally, in order for U.S. lenders to consider your income, you have to have two years of tax returns indicating work in the same field. If you change professions, you have to start this two-year period over. Additionally, if you are self-employed, lenders want to see two years of income from your business; if you’re business is less than two years old, generally all your income is disallowed (because there is no evidence that you can sustain it).

    In terms of rental property, that will definitely count towards your income. If your previous year’s tax return indicates income from a rental property, a lender will generally use that income; in other words if your tax return indicates that you made $20,000 in rental income last year, and you still own the properties, they will credit you with $20,000 in income.

    If it’s a new rental property (it doesn’t show up on last year’s tax return), lenders will generally credit you with 75% of the rental income, based on your actual lease agreements. In other words, if you have a new property that you’re renting for $1000/month (and you have a lease agreement to prove it), lenders will generally credit you with $9,000 in income ($1000 x 12 x 75%). Of course, they’ll also subtract out your mortgage costs as an expense.

    Lenders don’t much care about cash in the bank or equity in properties (because you can spend it or refinance it easily). Even if you have a million dollars in the bank, it won’t help you get a loan for $100,000, unfortunately. Basically, what lenders care about is income, credit score, and the fact that you have enough cash to cover your down payment — any additional cash or equity is ignored.

  3. Bilgefisher says:

    I believe there are lenders out there that will do a quick refinance. Although you may have to build a relationship with them first, it certainly could help down the road. I am currently picking up 3 properties in a somewhat similar fashion. I buy them with hard money, refinance two weeks after closing. I already have approval from the lender on all 3. I am getting full loan amount as well. The only stupulation is my purchase price is 80% of current FMV. You more then qualify for that on all your properties. Plus your credit score is at least 80 points higher then mine. (Assuming your over 800). If you wish I can PM you the mortgage company on the fastlane.

  4. J Scott says:

    Bilge –

    This is great info…and great news! Congrats and thanks for letting me know…

    I’d love to get your lenders info! Is it a small, local bank or one of the big boys?

    Feel free to email to my email address (if you have it), or to


  5. Jan Watson says:

    Hi again, exciting information.

    I’d be very grateful to be kept up to date on Bilgefisher’s loan lead on the Yellow Stain house (I’m British and these names make me feel at home, like I’m in a Dicken’s novel).

  6. Bilgefisher says:

    Sent the info. If you don’t get it, please let me know. It looks like they have an office in your area.

  7. Nugget says:

    First off – great blog. You are doing what I wish I had the reserves and risk tolerance to jump out and do myself. Instead I am taking it slower and working with someone to manage my rehabs. One of the big things slowing me down now is exactly this problem of getting the money back out after purchase/rehab. I would be very curious to find out who bilgefisher’s lender is as well if you are willing to share.

  8. J Scott says:

    Hey Nugget –

    I forwarded you the info from Bilge…hope it helps!

    And thanks for the kind words!

  9. nathan says:

    One other thing to think about for aquiring a conventional loan being self employed, is that the lender will require two uears business license to prove your self employment. If you are moving to the US, or already here for that matter, and plan to take that route, it is definately worth noting

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