How Can I Use Other People's Money to Buy More Rental Properties?

You can buy more rentals with other people's money through six main routes: conventional investment-property loans, borrowing against equity you already own, DSCR loans that qualify on the property's rent, seller financing, private or hard-money loans, and equity partners. A conventional loan sold to Fannie Mae needs at least 15% down on a one-unit rental (25% on 2 to 4 units), six months of payments in reserve, and Fannie Mae's limit is 10 financed properties. Financing more than 80% of the property's value generally requires mortgage insurance, which adds to your borrowing costs. Each route trades your cash for debt or a share of the profits, and every loan payment is due whether or not the unit is rented.

How the use of leverage magnifies gains and losses shows the math behind that trade. For the other way to earn from mortgages, owning the loans instead of the property, see how to make money from other people's mortgages.

Which financing routes are there?

How many conventional loans can you get?

Fannie Mae's limit for a loan on a second home or rental is 10 financed properties in total, on loans approved through its Desktop Underwriter (DU) system, the automated approval tool lenders use. Its rules for counting:

• What counts: Every one- to four-unit home you are personally obligated on, including your own home if it has a mortgage. A duplex counts as one property.
• What does not count: Properties financed in an LLC's name when you are not personally obligated on the loan, commercial property, and apartment buildings of 5 or more units.

Reserves, savings left over after closing, rise as you add properties. You need six months of the new loan's payment, including taxes, insurance, and dues, plus a share of what you owe on your other financed properties (not counting the new rental and your home): 2% if you will have 1 to 4 financed properties, 4% for 5 to 6, and 6% for 7 to 10. In Fannie Mae's own example, a borrower who will have eight financed properties needs 6% of the $629,530 owed on six other rentals, or $37,772, on top of the six months of payments. What lenders count in your debt-to-income ratio explains the income test. Under Fannie Mae's rules, eligible rental income can offset the new property's payment; any qualifying surplus may also count as income if you have at least 12 months of rental property management experience.

Can you borrow against equity you already have?

Yes, two ways, each of which raises the debt on a property you already own.

Cash-out refinance of a rental. You replace the current loan with a larger one and take the difference in cash for your next down payment. Fannie Mae caps the new loan at 75% of the appraised value on a one-unit rental and 70% on 2 to 4 units. The mortgage you pay off must be at least 12 months old, and at least one borrower must have been on title for six months. Example: a one-unit rental appraised at $300,000 with $120,000 owed can take a new loan of up to $300,000 x 75% = $225,000, freeing $105,000 before closing costs, but the payment now covers $225,000 instead of $120,000. What refinancing involves covers the costs and steps.

A home equity line of credit (HELOC) on your own home. A HELOC is a revolving line secured by your home. The CFPB says you can usually draw during a period that could last 10 years, then repay over 10 to 20 years, often with a much higher payment once repayment begins. Rates are usually variable. If you fall behind, you could lose your home, so using a HELOC for a rental's down payment puts your residence at risk. The HELOC payment also adds to the monthly debts your next lender counts. How a HELOC works has the details.

What are DSCR loans?

A DSCR loan is a rental-property loan approved mainly on the property's debt service coverage ratio (DSCR) rather than your personal income, according to Redwood Trust, which buys and makes them. Ponce Bank, which makes loans on investor-owned 1- to 4-unit homes, defines DSCR as net operating income (rent minus operating costs, before the mortgage) divided by the yearly loan payments, and requires at least 1.20 along with a maximum loan of 70% of value on a purchase. Ponce also requires a global DSCR of at least 1.0, meaning the owner must be able to cover the property loan and all personal obligations.

Example: a rental with $28,800 a year of net operating income and $24,000 a year of loan payments has a DSCR of $28,800 / $24,000 = 1.20. Each lender sets its own minimum ratio, down payment, and rate, so get each one's rate, points, and minimum DSCR in writing before you apply.

How do seller financing and hard-money loans work?

Seller financing. The seller acts as the lender: you pay part of the price up front and pay the rest over time under a promissory note secured by the property. Down payment, rate, and term are whatever you negotiate. If the seller still owes on their own mortgage, check that loan for a due-on-sale clause, which lets the seller's lender demand full repayment when the property is sold. Federal law allows lenders to enforce these clauses even where state law would not, and the short exceptions, such as a transfer into the owner's living trust, do not cover a sale to you. Have a real estate attorney or title company confirm the seller's loans are paid off at closing or that their lender consents.

Private and hard-money loans. These short-term loans from non-bank lenders are approved mostly on the property's value. Sachem Capital, a publicly traded lender, reports typical rates of 10% to 13%, origination fees of 1% to 3% of the loan, terms of one to three years, and loans of up to 70% of the property's value (85% of total project cost on a renovation). Its loans are usually secured by extra collateral as well, which can include the owners' personal guarantees. The full balance comes due at the end, so you need a refinance or sale lined up. The disadvantages of private lenders covers the costs in detail.

What should you know before taking on an equity partner?

An equity partner puts in cash in exchange for a share of ownership and profits, instead of a fixed payment. Put the split, each partner's duties, who covers shortfalls, and how either side can exit in a written partnership or LLC operating agreement before buying.

If your partners hand over money and rely on you to manage the property, their stakes can be securities. The SEC defines an investment contract, one kind of security, as money put into a common enterprise with an expectation of profit from the managerial efforts of others. Offering securities requires registering with the SEC or using an exemption such as Regulation D, which comes with a Form D filing after the first sale. A securities lawyer can confirm which applies before you accept money from passive partners.