I currently own over 160 units of residential real estate and two storage unit complexes. I have more than 20 units of rental real estate under contract. I am more than $15 million in debt. One of the biggest questions people always ask me is how I got approval for that much debt so quickly, especially in my 20s. So in this article, we’ll go over all my tips and tricks to help you get approved for any type of loan.
I’ll explain everything you need to get approved for all of the debt that you want. Usually when people are unable to get approval it's because you're not doing things correctly or not understanding the bank’s criteria. The secret is in knowing what you are doing and knowing the exact criteria the banks look for so you can be someone the banks want to give a loan to.
First we need to understand that debt is a tool. Just like any other tool, it can be used for good or for evil. If you use debt incorrectly it can end you up in a horrible place. If you're already in a terrible place with debt, it might be worth it to go follow Dave Ramsey. He’ll teach you rules that aren't going to help you create wealth but will just help you get out of debt.
Now if you don't have debt you should not be listening to advice from Dave Ramsey because his advice essentially is to not get into, not use debt ever. This is foolish! Compare it to a car. Cars can kill people but they are also very useful. If used correctly, tools like cars and debt can be advantageous to you. If it's not used correctly it can land you in a big mess. So first thing make sure you understand debt is a tool. It's a very dangerous tool if used incorrectly but if you use it correctly it can help you amass a ton of real estate control and wealth.
A good credit score is the first step to getting approved for debt. You can't get a good credit score unless you have credit. You can't get credit if you have a bad credit score. I know that is counterintuitive, that's why I suggest starting with easy debt that you can actually get when you have no debt. Let me explain. If you have no credit score and you have no debt and that's why you have no credit score, you won’t get a loan for a house. You have to start small.
You won’t get approved because you have no credit history and no score or a very low score. The bank doesn’t have evidence that you’re trustworthy to pay back the loan. This means you need to create your own credit score by getting debt with credit cards or potentially car loans. You need to build up a good reputation with these credit companies.
What they're looking for is first that you actually have debt. Second, that you're making payments on time. Third, that you're not using all of the utilization on your credit cards. So for example, if you get a credit card and get approved for a limit of $5,000. You don't want to use all $5,000. Use no more than 10% of your credit limit. Pay it off every month or if you can't pay it off, pay it down to under 10% every month.
If you are using your credit card to its limit because you’re in trouble, you probably shouldn’t have a credit card. Some people should not have debt because they use it to make mistakes that cost them in the future. So, please don't use over 10% of your credit. Always kept it under 10%.
Credit cards are something that you use because you're trying to build credit. If you can't use it wisely, simply don't get a credit card. The same goes for a car loan. You're making your payments every single month, never miss a payment, always pay on time. These things should help you build a good enough score to where you can get approved for a loan with a mortgage. That first mortgage will further build your credit score.
Every time you get new debt or new credit it's going to affect your credit score. This is why I suggest that everyone gets three to four credit cards and consistently follow all of these rules. There are other credit score tactics and ways to increase your credit score that we won’t go into here. See my other articles about building your credit score for more info.
Banks want to know that you're a responsible person with your finances and with debt. These are the things that all banks look at to determine whether you're someone that they want to lend to.
Next is how much cash on hand you have or how much in reserves. They’ll ask for bank statements to see that you've got enough in reserves so if you lose your job or things go south you've got enough money in the bank. They’ll look for the down payment on whatever you're getting debt on plus additional reserves that can support your lifestyle. If possible get a year worth of reserves so that after you've got your down payment you could cover all of your expenses, and any payments for a year.
Many banks will approve you for a loan if you've got six months of reserves for all of your expenses and enough for the down payment. Some might even do it for less but you should have more than that and understand this is something the banks look at. So if you've just got enough for your down payment plus a couple hundred bucks in the bank, that’s not enough to get approved. Nor should you want to get a loan with that little reserves anyway. Make sure you've got plenty of cash in the bank.
We’ll cover number three and number four together because they're kind of the same thing: good income. This is often the reason that people don't get approved for a loan. They assume that money in the bank and good income last year is enough. The bank will look at your taxes and they want to see that you’re paying them (not writing everything off).
You need taxable income to show that you actually made income. I call this pay to play. If you want to get approved for loans you've got to pay taxes. This changes as you buy more real estate. If you become a real estate professional you can use something called cost segregation. You can accelerate the depreciation from the rental properties that you've bought and use that depreciation against your taxable income so you don't have to pay taxes.
You show it to banks and that’s an acceptable display of income. If you pay to play at the front, spend your money properly and then use depreciation, you can still continue to get approved for loans. If you're on the front end and you're being dishonest or truly are spending all of your money, that shows in your taxes. You're not going to get approved for a loan.
The next consideration is your debt to income ratio. Your income is based on your taxable income in your taxes. Your debt to income is the same. They're going to look at your income from taxes and compare that to your debt. Your income vs. debt on a monthly basis is the debt to income ratio. They will look at whether you have enough income to take on this new debt.
You can talk to your loan officer about their criteria. Every year I meet with my accountant and with my loan officer. I ask them what my taxes need to look like to buy however much real estate. This does not mean I’m dishonest on my taxes. Let’s say I have a goal of purchasing a certain amount of real estate. I'm not going to be able to meet that goal because I have expensed too much on my taxes. It might mean me saying I bought all this equipment for my business, I’m not going to include that in my taxes. I can choose not to expense it as a business expense. I can choose to take it as a personal expense so my taxes show enough income so that I'm good to go.
Finally, it comes down to your relationship with the bank and how much business you've done with them. People ask me how this massive amount of debt and payments has not ruined my debt to income ratio. Once you get to the point where you have rental history, the banks allow you to count 100% of your rental income. In your first year they'll have certain things that may exclude you from being able to do this. For example, if you're new to investing in real estate they might say they can't count the rental income until you have a year track record with this property.
A helpful hint so that you can get an idea of what they're looking for: Fannie Mae Selling Guide Rental Income. This will show you general requirements for documenting rental income so you can look at your particular situation, whether you bought the rental mid-year, already had taxes on the property, or are buying a second property. If you can prove your rental income from this they'll dive into all of these different scenarios and show you what you can count.
I have such a good track record with my bank that I just tell them what the rental income will be. Often I don't even need to do that because whatever the current rental income is it's enough to at least break even so it doesn't affect my debt to income ratio. Then I file my taxes and they see that I crushed it on the property and have this new additional income. Yes, every purchase does affect my debt to income ratio but it actually makes my debt to income ratio better because with the payment I am getting cash flow. I can count all of that cash flow up above and beyond what the new debt is.
So for those of you that are worried about a property hurting your debt to income and not getting approved for more loans, it should do the opposite. The whole point of investing in real estate is putting you in a place where you're creating more income and opportunities for yourself. The more rental properties you buy the more income you should have and the better your debt to income ratio. It's just getting those first couple loans that might be difficult and that's why you need to pay to play with your taxes.
These are all things that you can tweak or change to look better to a bank. However, the majority of the time if you're not getting approved it's because of one of these reasons. Figure out which one it is, what you need to do to look better. That could be paying more taxes, making more income, or increasing your credit score.
Credit scores can be difficult because as you ask for more debt that can temporarily bump down your credit score. That's why it's important to start building up your credit score at a young age or a year or two before you purchase a rental property or first house. When it's time to get approved for that loan you look good and you're not realizing right then that you don’t have enough credit to get approved.
With my kids they’ll get a credit card in high school. They're not going to use it but I’ll teach them the principles behind credit and debt and all of that. If you're thinking about investing and you don't currently have credit, you need to start building a credit score as soon as possible.
The last point that I will make is: once you get into commercial lending they want to know that you personally are a good borrower. It's still important but your credit score and your personal track record become a little less important. The numbers for the actual property and what they think it can produce is more important. It still helps if you've got a ton of money in the bank, incredible debt to income ratio, all those things make you look better to the bank.
If you're buying a property where the numbers are absolutely atrocious it's going to be harder to get approved. I ran into this with commercial lending on a bigger property where they were really hesitant to lend to me because they didn't believe that I could increase the value of these properties and the rents. Luckily I had a bunch of other rental properties that I could bring to them.
There were four units and I could say “Look, I've done this before on a smaller scale but I promise I can do it.” They worked with me and approved me even though the terms weren't necessarily incredible. Then I proved myself with this bigger commercial deal and now they don't question me at all.
If you do get them to lend you and you crap down your leg they're going to be following up on those properties. You need to make sure you're doing what's required on your due diligence to make sure properties go well. That way the lenders continue to have a good relationship with you because you've got a good reputation when it comes to the way that you've handled things.