Module 3: Real Estate Investment Financing Basics

A Beginner's Guide to Building Wealth Through Property

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Module Overview

Time Required: 90-120 minutes
Difficulty Level: Beginner
Prerequisites: Modules 1-2 completed

Learning Objectives

By the end of this module, you will be able to:

1. Understand how mortgages work and their key components
2. Identify different loan types and their requirements
3. Calculate your maximum borrowing capacity
4. Understand what lenders evaluate when approving loans
5. Improve your financial profile to qualify for better financing
6. Explore alternative financing options beyond traditional mortgages
7. Calculate the true cost of leverage and make informed borrowing decisions
8. Navigate the loan pre-qualification and pre-approval process

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Part 1: Understanding Mortgages - The Fundamentals

A mortgage is a loan secured by real estate. The property serves as collateral—if you don't pay, the lender can foreclose and sell the property to recover their money. This security allows lenders to offer relatively low interest rates compared to unsecured debt.

The Four Components of a Mortgage Payment (PITI)

When you make a mortgage payment, it typically includes four components:

P - Principal The amount that pays down your loan balance. This builds equity.

I - Interest The cost of borrowing money. This is the lender's profit.

T - Taxes Property taxes collected by the lender and held in escrow, then paid to the county/municipality on your behalf.

I - Insurance Homeowner's insurance (and PMI if applicable) collected and paid by the lender.

Example PITI Breakdown:

Loan Amount: $200,000 at 7% for 30 years
Monthly Payment: $1,330

Principal: $164 (builds equity)
Interest: $1,166 (lender's profit)
Property Tax: $250 (held in escrow)
Insurance: $100 (held in escrow)
Total PITI: $1,680

Important Note: In the early years, most of your payment goes to interest. Over time, more goes to principal. This is called amortization.

Amortization: How Loans Get Paid Down

Amortization is the process of gradually paying off a loan through regular payments over time.

Key Characteristics:

• Payments remain constant (for fixed-rate loans)
• Early payments are mostly interest
• Later payments are mostly principal
• The loan balance decreases slowly at first, then accelerates

30-Year Loan Example ($200,000 at 7%):

Year 1:
- Total payments: $15,960
- Principal paid: $2,189
- Interest paid: $13,771
- Remaining balance: $197,811

Year 10:
- Principal paid that year: $3,231
- Interest paid that year: $12,729
- Remaining balance: $175,710

Year 20:
- Principal paid that year: $6,008
- Interest paid that year: $9,952
- Remaining balance: $109,435

Year 30:
- Final payment pays off remaining balance
- Total interest paid over 30 years: $279,017

Critical Insight: On a $200,000 loan, you'll pay nearly $280,000 in interest over 30 years! This is why cash flow matters—rental income must cover this cost.

Fixed-Rate vs. Adjustable-Rate Mortgages (ARM)

Fixed-Rate Mortgage:

• Interest rate never changes
• Payment remains constant for entire loan term
• Predictable and stable
• Higher initial rate than ARMs
• Most common for investment properties

Pros:

• Predictability for cash flow planning
• Protection if rates rise
• Simple to understand
• No surprises

Cons:

• Higher initial rate
• No benefit if rates fall (unless you refinance)
• May pay more interest long-term

Adjustable-Rate Mortgage (ARM):

• Interest rate adjusts periodically based on market indices
• Usually lower initial rate than fixed
• Common structures: 5/1 ARM, 7/1 ARM, 10/1 ARM
  • First number = years at fixed rate
  • Second number = adjustment frequency after that (annually)

Pros:

• Lower initial interest rate
• Lower initial payments
• Can be advantageous if you plan to sell/refinance before adjustment

Cons:

• Payment can increase (sometimes dramatically)
• Uncertainty makes cash flow planning difficult
• Risk if rates rise significantly
• More complex to understand

Beginner Recommendation: Stick with fixed-rate mortgages for predictability and simplicity. ARMs are for experienced investors with specific strategies.

Loan Terms: 15-Year vs. 30-Year

30-Year Mortgage:

• Lower monthly payments
• More cash flow for investors
• More total interest paid
• Slower equity building
• Most common for rentals

15-Year Mortgage:

• Higher monthly payments
• Less cash flow (or negative cash flow)
• Much less total interest paid
• Faster equity building
• Lower interest rate (typically 0.5% less)

Comparison ($200,000 loan at 7% vs. 6.5%):

30-Year Mortgage at 7%:
- Monthly P&I: $1,330
- Total Interest: $279,017
- Equity in 10 years: $24,290

15-Year Mortgage at 6.5%:
- Monthly P&I: $1,743
- Total Interest: $113,798
- Equity in 10 years: $92,945

Difference:
- Higher payment: $413/month
- Interest savings: $165,219
- Additional equity in 10 years: $68,655

For Investors: Most choose 30-year mortgages because:

• Lower payments = better cash flow
• Can invest the payment difference in more properties
• Leverage works better with lower payments
• Flexibility is valuable

However, if cash flow is strong and you prefer lower debt, 15-year loans make sense.

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Part 2: Understanding What Lenders Evaluate

When you apply for a mortgage, lenders assess your ability and willingness to repay. They evaluate five key factors, often called the "Five C's of Credit."

1. Credit (Credit Score and History)

What It Is: A numerical representation (300-850) of your creditworthiness based on your borrowing and repayment history.

Why It Matters:

• Determines if you qualify for a loan
• Affects your interest rate (higher score = lower rate)
• Influences down payment requirements

Credit Score Ranges:

800-850: Exceptional (Best rates, easiest approval)
740-799: Very Good (Excellent rates and terms)
670-739: Good (Favorable rates, standard terms)
620-669: Fair (Higher rates, tougher qualification)
580-619: Poor (Difficult to qualify, very high rates)
Below 580: Very Poor (May not qualify)

Impact on Interest Rates:

$200,000 Loan, 30-Year Fixed:

760+ Credit Score: 6.5% rate = $1,264/month
680-759 Score: 7.0% rate = $1,330/month
620-679 Score: 7.75% rate = $1,433/month

Difference between excellent and fair credit:
$169/month = $2,028/year = $60,840 over 30 years!

What Affects Your Credit Score:

1. Payment History (35%): Most important factor

   • Pay all bills on time, every time
   • Even one 30-day late payment can drop score 60-110 points

2. Credit Utilization (30%): Ratio of balances to credit limits

   • Keep below 30% (under 10% is ideal)
   • $3,000 balance on $10,000 limit = 30% utilization

3. Length of Credit History (15%): Age of accounts

   • Older accounts are better
   • Don't close old credit cards

4. Credit Mix (10%): Variety of credit types

   • Revolving (credit cards) + Installment (auto loans, mortgages)
   • Not critical, but helps

5. New Credit (10%): Recent credit inquiries and accounts

   • Multiple inquiries in short time can lower score
   • Opening many new accounts looks risky

How to Improve Your Credit Score:

Immediate Actions (30-60 days):

• Pay down credit card balances below 30% utilization
• Correct any errors on credit reports (dispute inaccuracies)
• Become an authorized user on someone's old, well-managed account

Short-Term Actions (3-6 months):

• Make all payments on time (set up auto-pay)
• Pay off collections or charge-offs
• Negotiate "pay for delete" with collection agencies

Long-Term Actions (6-12+ months):

• Keep accounts open and in good standing
• Let negative items age (they matter less over time)
• Don't apply for new credit unnecessarily

Checking Your Credit:

• Get free reports annually: AnnualCreditReport.com
• Monitor with Credit Karma, Credit Sesame (free)
• Check all three bureaus: Experian, Equifax, TransUnion

2. Capacity (Income and Debt-to-Income Ratio)

What It Is: Your ability to repay the loan based on income and existing debts.

Debt-to-Income Ratio (DTI): The percentage of your gross monthly income that goes toward debt payments.

DTI Formula:

DTI = (Total Monthly Debt Payments ÷ Gross Monthly Income) × 100

Example:
Gross Monthly Income: $6,000
Credit Card Minimums: $200
Car Payment: $400
Student Loan: $300
New Mortgage Payment (PITI): $1,500
Total Monthly Debts: $2,400

DTI = ($2,400 ÷ $6,000) × 100 = 40%

Lender DTI Requirements:

Conventional Loans: Maximum 43-50% DTI
FHA Loans: Maximum 43-50% DTI (sometimes up to 57% with compensating factors)
Portfolio Loans: Varies by lender
Investment Property: Lenders may be stricter (36-43%)

Two Types of DTI:

Front-End DTI (Housing Ratio): Housing expenses ÷ Gross income

• Includes only PITI
• Ideally below 28%

Back-End DTI (Total Debt Ratio): All debt payments ÷ Gross income

• Includes PITI + all other debts
• This is what lenders primarily use
• Maximum typically 43-50%

How Rental Income Affects DTI:

For investment properties, lenders may count 75% of expected rental income (to account for vacancy and expenses) to offset the new mortgage payment.

Example:

Your Income: $5,000/month
Existing Debts: $800/month
New Investment Property Payment: $1,400/month
Expected Rent: $1,800/month

Without rental income credit:
DTI = ($800 + $1,400) ÷ $5,000 = 44%

With rental income credit (75% of rent):
Rental Income Credit: $1,800 × 0.75 = $1,350
Adjusted Debt: $800 + $1,400 - $1,350 = $850
DTI = $850 ÷ $5,000 = 17%

Rental income dramatically improves your DTI!

How to Improve Your DTI:

Increase Income:

• Ask for a raise or promotion
• Take on side work or freelancing
• Include rental income from existing properties
• Add a co-borrower

Decrease Debt:

• Pay off smaller debts completely
• Pay down credit cards
• Refinance high-interest debt to lower payments
• Avoid taking on new debt before applying

3. Capital (Down Payment and Reserves)

What It Is: The cash you have available for down payment and reserves.

Down Payment Requirements:

Primary Residence (Owner-Occupied):

• Conventional: 3-5% minimum (usually 5-20%)
• FHA: 3.5% minimum
• VA: 0% down (for eligible veterans)
• USDA: 0% down (in eligible rural areas)

Investment Property:

• Conventional: 15-25% typical (often 20-25%)
• Portfolio/Commercial: 20-30%
• Hard Money: 20-35%+

Multi-Family (2-4 units) Owner-Occupied:

• FHA: 3.5% (house hacking opportunity!)
• Conventional: 5-15%

Why Larger Down Payments Matter:

1. Lower monthly payments = better cash flow
2. Lower interest rates = less interest paid
3. No PMI (if 20%+ down)
4. Stronger offers = better negotiating position
5. More equity = protection against market declines

Down Payment Example ($250,000 property at 7%):

10% Down ($25,000):
- Loan: $225,000
- Monthly P&I: $1,496
- PMI: ~$140/month (until 20% equity)
- Total: $1,636

20% Down ($50,000):
- Loan: $200,000
- Monthly P&I: $1,330
- PMI: $0
- Total: $1,330

25% Down ($62,500):
- Loan: $187,500
- Monthly P&I: $1,247
- PMI: $0
- Total: $1,247

Difference between 10% and 25% down:
$389/month = $4,668/year in better cash flow

Reserves: Cash remaining AFTER closing that could cover mortgage payments.

Reserve Requirements:

• Primary Residence: Usually 0-2 months
• Investment Property: 2-6 months typical
• Multiple Properties: More reserves required

Example: Property PITI: $1,500/month Required Reserves: 6 months Reserve Amount Needed: $9,000

Building Your Capital:

Short-Term (6-12 months):

• Increase savings rate aggressively
• Cut unnecessary expenses
• Sell unused items
• Use tax refunds strategically
• Save bonuses and windfalls

Medium-Term (1-3 years):

• Side hustles and freelancing
• Optimize investment returns
• House hack to reduce living costs
• Consider higher-paying job opportunities

Creative Capital Sources:

• Partner with other investors (pool resources)
• Borrow from retirement accounts (carefully, with awareness of risks)
• Gift funds from family (must be documented)
• Seller financing (reduces needed capital)
• Home equity from existing property

4. Collateral (The Property Itself)

What It Is: The property being purchased serves as security for the loan.

Lenders Evaluate:

• Property value (appraisal)
• Property condition (inspection, appraisal notes)
• Property type (SFH easier than unique properties)
• Location (desirable areas preferred)
• Marketability (could they sell it if foreclosing?)

Loan-to-Value Ratio (LTV): The loan amount as a percentage of the property's value.

LTV = (Loan Amount ÷ Property Value) × 100

Example:
Property Value: $200,000
Loan Amount: $160,000
LTV = ($160,000 ÷ $200,000) × 100 = 80%

Down Payment: $40,000 (20%)

LTV Implications:

• Lower LTV = less risk = better rates
• 80% LTV (20% down) is the standard threshold
• Above 80% LTV requires PMI (Private Mortgage Insurance)
• Investment properties often require 75-80% LTV maximum

Appraisal Process: Lender orders an appraisal to confirm property value. If appraised value comes in below purchase price:

Options:

1. Negotiate lower purchase price
2. Increase down payment to maintain LTV
3. Walk away (if you have appraisal contingency)

5. Character (Credit History and Stability)

What It Is: Your track record of financial responsibility and stability.

Lenders Consider:

• Payment history: Pattern of on-time payments
• Bankruptcy or foreclosure history: Major red flags (usually need 2-7 years distance)
• Job stability: Prefer 2+ years with same employer
• Income stability: Consistent or growing income
• Previous mortgage history: Have you successfully managed mortgages?

Red Flags:

• Recent bankruptcies or foreclosures
• Frequent job changes
• Unexplained cash deposits (money laundering concerns)
• Recent large purchases (depleted reserves)
• Inconsistent income

Green Flags:

• Long employment history
• Stable residence history
• Previous successful mortgages
• Strong savings patterns
• Professional career trajectory

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Part 3: Types of Mortgages for Investors

Different loan types suit different situations. Understanding your options helps you choose the best financing.

Conventional Loans

What They Are: Loans that conform to Fannie Mae/Freddie Mac guidelines. Not government-insured.

Characteristics:

• Most common for investment properties
• Typically require 15-25% down for investment properties
• Competitive interest rates (for good credit)
• Maximum 10 financed properties (including primary residence)
• Strict qualification standards

Requirements:

• Credit Score: 620 minimum, 700+ preferred
• DTI: Maximum 43-50%
• Down Payment: 15-25% for investment properties
• Reserves: 2-6 months
• Documentation: Full income/asset verification

Pros:

• Competitive rates
• 30-year fixed terms available
• Standardized process
• Available through most lenders

Cons:

• Stricter qualification than FHA
• Higher down payment required for investment properties
• 10-property limit
• Requires strong credit and income

Best For:

• Investors with good credit (700+)
• Standard investment properties (1-4 units)
• Those building portfolios (under 10 properties)
• Borrowers with stable W-2 income

FHA Loans (Federal Housing Administration)

What They Are: Government-insured loans designed for owner-occupants with limited down payment funds.

Characteristics:

• Minimum 3.5% down payment
• Lower credit score requirements
• Can be used for 1-4 unit properties (if owner-occupied)
• Perfect for house hacking
• Requires mortgage insurance (MIP)

Requirements:

• Credit Score: 580 minimum (500-579 with 10% down)
• DTI: Maximum 43-50% (sometimes higher)
• Down Payment: 3.5% (580+ score) or 10% (500-579 score)
• Occupancy: Must live in property for at least 1 year
• Property Condition: Must meet FHA standards

Pros:

• Very low down payment (3.5%)
• Lower credit score requirements
• Great for house hacking a duplex/triplex/fourplex
• More lenient qualification

Cons:

• Mortgage insurance required for life of loan (if under 10% down)
• Property must be owner-occupied
• Property condition requirements (may not accept fixer-uppers)
• Loan limits vary by county
• Upfront mortgage insurance premium (1.75% of loan)

MIP (Mortgage Insurance Premium) Costs:

$250,000 Property, 3.5% Down:
- Loan Amount: $241,250
- Upfront MIP (1.75%): $4,222 (added to loan)
- Annual MIP (0.85%): $2,051/year = $171/month

Total Loan with Upfront MIP: $245,472

Best For:

• First-time investors with limited capital
• House hackers buying 2-4 unit properties
• Those with credit scores below 700
• Buyers who can only afford 3.5-5% down

House Hacking Strategy: Buy a duplex/triplex/fourplex with 3.5% down, live in one unit, rent the others. After one year, you can move and keep it as a rental. Repeat the strategy with another FHA loan.

VA Loans (Veterans Affairs)

What They Are: Government-backed loans for eligible veterans, active duty service members, and surviving spouses.

Characteristics:

• 0% down payment possible
• No mortgage insurance
• Lower interest rates
• Can be used for 1-4 unit properties (if owner-occupied)
• Excellent for veteran house hackers

Requirements:

• Eligibility: Military service requirements
• Certificate of Eligibility (COE) required
• Credit Score: No official minimum (lenders typically want 620+)
• DTI: Flexible, typically up to 41%
• Occupancy: Must be primary residence

Pros:

• Zero down payment
• No PMI ever
• Competitive rates
• Excellent for house hacking
• No prepayment penalties
• More lenient on credit

Cons:

• Only for eligible veterans
• Must be owner-occupied
• VA funding fee (0.5-3.6% of loan, varies by down payment and use)
• Property condition requirements
• Loan limits in some areas

Funding Fee:

• First Use, 0% Down: 2.15% of loan
• First Use, 5% Down: 1.5%
• First Use, 10%+ Down: 1.25%
• Subsequent Use: 3.3%
• (Disabled veterans are exempt)

Best For:

• Eligible veterans and service members
• House hacking with zero down payment
• Those with limited capital but military service
• Multi-family house hacking (2-4 units)

Portfolio Loans

What They Are: Loans kept by the originating bank rather than sold to Fannie/Freddie. Bank sets its own rules.

Characteristics:

• Flexible guidelines (varies by bank)
• Can exceed 10-property limit
• May work for unique properties
• Often higher rates
• Relationship-based lending

Requirements:

• Varies by lender
• Often require substantial relationship with bank
• May require higher down payments
• Typically want strong credit and reserves

Pros:

• Flexibility for unique situations
• Can finance 10+ properties
• May work for self-employed investors with complex income
• May work for unique or non-conforming properties

Cons:

• Higher interest rates (typically 0.5-1.5% more)
• Shorter terms (15-20 years common)
• May have prepayment penalties
• Balloon payments possible
• Harder to find and qualify for

Best For:

• Investors with 10+ financed properties
• Self-employed with complex income
• Unique or non-conforming properties
• Those with strong banking relationships

DSCR Loans (Debt Service Coverage Ratio)

What They Are: Loans qualified based on property's income rather than borrower's personal income.

Characteristics:

• Qualification based on rent-to-payment ratio
• No income verification required
• Higher interest rates
• Popular with self-employed investors
• Becoming more available

Requirements:

• DSCR Ratio: Typically 1.0-1.25+ required
• Credit Score: Usually 660-700+
• Down Payment: 20-25%
• Reserves: 6-12 months common
• No personal income documentation

DSCR Calculation:

DSCR = Monthly Rent ÷ Monthly PITI Payment

Example:
Monthly Rent: $2,000
Monthly PITI: $1,600
DSCR = $2,000 ÷ $1,600 = 1.25

DSCR above 1.0 = Property income covers debt
DSCR of 1.25 = Property income is 25% more than debt (preferred)
DSCR below 1.0 = Property doesn't cover debt (may not qualify)

Pros:

• No personal income verification
• Great for self-employed
• Can scale quickly
• Qualification based on property performance
• No DTI limits

Cons:

• Higher interest rates (1-2% more than conventional)
• Higher down payments required
• Fewer lender options
• May require cash-out seasoning (waiting period after purchase)

Best For:

• Self-employed investors
• High-income earners with complex tax returns
• Those with maxed DTI but cash flow positive properties
• Scaling quickly without income limitations

Hard Money Loans

What They Are: Short-term loans from private lenders based primarily on property value.

Characteristics:

• Short term (6-24 months typical)
• Based on After Repair Value (ARV)
• Quick closing (days, not weeks)
• Minimal qualification requirements
• Very expensive

Requirements:

• Property must support the loan (based on ARV)
• Down Payment: 20-35%+
• Credit: More flexible (sometimes okay with 600+)
• Experience: Varies by lender

Costs:

• Interest Rates: 8-15%
• Points: 2-5 points upfront (1 point = 1% of loan)
• Fees: Higher than conventional loans

Example:

$200,000 Purchase
$50,000 Rehab
ARV: $300,000

Hard Money Loan: 70% of ARV = $210,000
- Less Your Cash: $40,000 down
- Loan Amount: $210,000
- Interest Rate: 12%
- Points: 3 (3% = $6,300)
- Monthly Payment (interest-only): $2,100
- Time to Flip: 6 months
- Total Interest: $12,600
- Total Cost: $18,900

Exit: Sell for $290,000 or refinance to conventional loan

Pros:

• Fast approval and closing
• Based on property, not borrower
• Good credit not required
• Works for flips and heavy rehabs
• Bridge to conventional financing

Cons:

• Very expensive (high rates and fees)
• Short term (must exit quickly)
• Less favorable terms
• Can lose property if can't repay/exit
• Not for buy-and-hold unless temporary

Best For:

• Fix and flip investors
• Bridge financing
• Quick closings needed
• Properties that don't qualify for conventional
• Experienced investors with clear exit strategy

Not Recommended For:

• Beginners without exit strategy
• Buy-and-hold investments
• Tight margins

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Part 4: Calculating Your Maximum Investment Capacity

Let's determine how much you can afford to invest based on your financial situation.

Step 1: Calculate Your Available Capital

Down Payment Sources:

Savings Available: $_________
Retirement Funds (if using, carefully): $_________
Gift Funds from Family: $_________
Equity from Current Property: $_________
Investment Account Liquidation: $_________
Total Available for Down Payment: $_________

Reserves Needed:

Emergency Fund (personal): $_________
Investment Property Reserves (6 months PITI): $_________
Closing Costs (2-5% of purchase price): $_________
Repair/Maintenance Buffer: $_________
Total Reserves Needed: $_________

Net Available Capital:

Total Available: $_________
Minus Reserves Needed: $_________
Available for Down Payment: $_________

Step 2: Determine Your Maximum Purchase Price

Based on down payment percentage:

If investing 20% down:
Maximum Purchase Price = Available Down Payment ÷ 0.20

Example:
$50,000 available ÷ 0.20 = $250,000 maximum purchase price

If investing 25% down:
$50,000 ÷ 0.25 = $200,000 maximum purchase price

More Down Payment = Lower Price But Better Cash Flow

Step 3: Calculate Your DTI and Borrowing Capacity

Current DTI Calculation:

Gross Monthly Income: $_________

Current Monthly Debts:
- Credit Card Minimums: $_________
- Auto Loans: $_________
- Student Loans: $_________
- Personal Loans: $_________
- Other Mortgage Payments: $_________
- Child Support/Alimony: $_________
Total Current Debt: $_________

Current DTI: (Total Debt ÷ Gross Income) × 100 = _________%

Maximum Allowable Debt:

If maximum DTI is 43%:
Maximum Total Debt = Gross Income × 0.43

Example:
$6,000/month income × 0.43 = $2,580 maximum total debt

Currently Using: $1,200
Available for New Mortgage: $2,580 - $1,200 = $1,380/month

Maximum Loan Amount: Based on available payment capacity, calculate maximum loan:

Available Monthly Payment: $1,380
Interest Rate: 7%
Loan Term: 30 years

Using mortgage calculator:
Maximum Loan Amount: ~$207,000

Add Down Payment: $50,000
Maximum Purchase Price: $257,000

Important: This is PITI (principal, interest, taxes, insurance). Don't forget to account for all four components.

Step 4: Factor in Rental Income

Lenders typically credit 75% of expected rent against the mortgage payment:

Expected Monthly Rent: $2,000
Lender Credit (75%): $1,500

New Property PITI: $1,800
Net Cost After Rental Credit: $1,800 - $1,500 = $300

Your DTI improves dramatically!

Comprehensive Example: The Johnsons

Financial Situation:

• Gross Monthly Income: $8,000
• Current Debts: $1,400/month
• Current DTI: 17.5%
• Available Capital: $60,000
• Emergency Reserves: $15,000
• Net Available for Investment: $45,000

Maximum Purchase Price Analysis:

Option 1: 20% Down

• Down Payment: $45,000
• Purchase Price: $225,000
• Loan Amount: $180,000 at 7%
• Monthly P&I: $1,197
• Property Tax: $225
• Insurance: $100
• Total PITI: $1,522

DTI Calculation:

• New Total Debt: $1,400 + $1,522 = $2,922
• DTI: $2,922 ÷ $8,000 = 36.5% ✓ (Under 43% limit)

With Rental Income:

• Expected Rent: $1,900
• Lender Credit (75%): $1,425
• Net Payment: $1,522 - $1,425 = $97
• Adjusted Total Debt: $1,400 + $97 = $1,497
• Adjusted DTI: 18.7% ✓ (Excellent)

Cash Flow Projection:

• Rent: $1,900
• PITI: $1,522
• Maintenance: $150
• Vacancy: $95
• Property Management: $152
• Total Expenses: $1,919
• Cash Flow: -$19/month (essentially break-even)

Verdict: The Johnsons can afford this property, will qualify for the loan, and while cash flow is tight, appreciation and tax benefits make it worthwhile.

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Part 5: Alternative Financing Strategies

Beyond traditional mortgages, creative financing can help you invest with less capital or work around qualification challenges.

Seller Financing

What It Is: The property seller acts as the lender, allowing you to make payments directly to them instead of a bank.

How It Works:

1. Negotiate terms with seller (interest rate, down payment, term)
2. Sign promissory note outlining terms
3. Property deed recorded with mortgage/deed of trust
4. You make payments to seller
5. When paid off (or refinanced), you get clear title

Typical Terms:

• Down Payment: 10-30%
• Interest Rate: 6-9% (negotiable)
• Term: 5-10 years with balloon payment
• Amortization: 20-30 years (with shorter term = balloon)

Example:

Purchase Price: $200,000
Down Payment: $30,000 (15%)
Seller Financed: $170,000
Interest Rate: 7%
Term: 5 years, amortized over 30 years

Monthly Payment: $1,131
After 5 years: Balloon payment of ~$158,000 due
Strategy: Refinance to conventional loan or sell property

Advantages:

• Flexible qualification (no bank requirements)
• Lower closing costs
• Faster closing
• Negotiable terms
• May work when banks won't lend

Disadvantages:

• Higher interest rates usually
• Shorter terms (balloon payment risk)
• Fewer properties available with seller financing
• Must refinance or pay balloon (exit strategy crucial)

Best For:

• Properties that don't qualify for conventional financing
• Buyers with credit challenges
• Sellers who want income stream
• Situations where quick closing matters

How to Find:

• Ask every seller if they'd consider it
• Target free-and-clear properties (no existing mortgage)
• Older sellers may want income stream
• Motivated sellers in slow markets

Subject-To Financing

What It Is: You take over the seller's existing mortgage payments without formally assuming the loan. Title transfers to you, but the loan remains in seller's name.

How It Works:

1. Seller deeds property to you
2. Existing mortgage stays in place (in seller's name)
3. You make the mortgage payments
4. You control the property

Example:

Seller owns property worth $250,000
Remaining mortgage: $180,000 at 4% interest
Seller needs to move, can't afford two payments

You offer:
- Cash to seller: $20,000
- Take over payments: $859/month
- Total acquisition cost: $20,000 + existing loan

Your effective purchase: $200,000
Built-in equity: $50,000
Low interest rate: 4% (vs. current 7%+)

Advantages:

• Very low cash needed
• Inherit existing (potentially low) interest rate
• Fast closing
• May work when you can't qualify for new loan

Disadvantages:

• Due-on-sale clause risk (lender can call loan due)
• Seller's credit at risk if you don't pay
• Requires trusting relationship with seller
• Complex legal structure
• May violate mortgage terms

Critical Risks:

• Due-on-Sale Clause: Most mortgages allow lender to demand full payment if property transfers. Lenders rarely enforce if payments continue, but it's a risk.
• Seller's Credit: If you miss payments, seller's credit suffers
• Insurance Issues: Property insurance must be properly structured

Best For:

• Experienced investors
• Motivated sellers who must move
• Properties with low-interest existing loans
• Situations where you have exit strategy

Not Recommended For Beginners: Legal complexity and risks make this an advanced strategy.

Partnerships

What It Is: Pooling resources with other investors to purchase properties together.

Common Partnership Structures:

50/50 Partners:

• Equal capital contribution
• Equal ownership
• Equal decision-making
• Equal profit/loss split

Money Partner + Operator:

• Money partner: Provides capital (75-90%)
• Operator: Finds deals, manages property (10-25%)
• Profit split: Often 50/50 or 60/40 to operator (despite capital imbalance)
• Operator compensated for time/expertise

Syndication:

• Multiple passive investors pool money
• One operator manages investment
• Investors get preferred return (e.g., 8%)
• Operator gets fees + remaining profits

Advantages:

• Access deals you couldn't afford alone
• Share risk
• Combine complementary skills
• Learn from experienced partners
• Scale faster

Disadvantages:

• Shared control (slower decisions)
• Potential conflicts
• Profit sharing reduces returns
• Legal complexity
• Difficult to exit if partnership fails

Keys to Successful Partnerships:

1. Clear Written Agreement:

   • Ownership percentages
   • Decision-making process
   • Capital contribution requirements
   • Profit/loss distribution
   • Exit strategy
   • Dispute resolution

2. Complementary Skills:

   • One has capital, other has time
   • One finds deals, other manages
   • One has experience, other is learning

3. Aligned Goals:

   • Same investment timeline
   • Similar risk tolerance
   • Agreement on strategy

4. Regular Communication:

   • Scheduled meetings
   • Transparent financials
   • Open discussion of issues

Sample Partnership Structure:

Property: $300,000 fourplex
Down Payment Needed: $75,000 (25%)

Partner A (Money Partner):
- Contributes: $75,000 (100% of down payment)
- Ownership: 50%
- Role: Passive investor

Partner B (Operator):
- Contributes: $0 cash, all time and expertise
- Ownership: 50%
- Role: Find deal, manage acquisition, manage property

Agreement:
- Partner B gets $200/month management fee
- Remaining cash flow split 50/50
- Major decisions require both partners' agreement
- Exit: Must offer to buy out partner before selling to third party

Home Equity Line of Credit (HELOC)

What It Is: A revolving credit line secured by equity in your primary residence.

How It Works:

1. Get HELOC on your primary residence (up to 80-90% LTV)
2. Use funds for down payment on investment property
3. Pay interest only on amount borrowed
4. Replenish as you pay down

Example:

Your Home Value: $400,000
Existing Mortgage: $250,000
Available Equity: $150,000

HELOC Amount (80% LTV): $320,000 - $250,000 = $70,000

Use $50,000 for investment property down payment
Interest Rate: 8%
Monthly Interest: $333

Investment property cash flow: $400/month
Net after HELOC interest: $67/month

Advantages:

• Access equity without selling/refinancing
• Only pay interest on what you use
• Revolving credit (pay down, use again)
• Lower rates than credit cards or hard money

Disadvantages:

• Uses your home as collateral (risky!)
• Variable interest rates (can increase)
• Must qualify based on income/credit
• Can hurt cash flow if investment property doesn't perform

Best For:

• Investors with substantial home equity
• Those with strong cash flow
• Bridge financing until property refinance
• Experienced investors comfortable with leverage

Critical Warning: Using your home equity to invest is risky. If the investment fails, you could lose your home. Only use this strategy if you understand and accept the risk.

Cash-Out Refinance

What It Is: Refinancing an existing mortgage for more than you owe and taking the difference in cash.

How It Works:

Current Property Value: $300,000
Current Loan Balance: $180,000
Available Equity: $120,000

Cash-Out Refinance at 80% LTV:
New Loan: $240,000
Pays Off Old Loan: $180,000
Cash to You: $60,000

Use for down payment on next property

Advantages:

• Access equity without selling
• Fixed-rate, long-term financing
• Lower rates than HELOCs or hard money
• Extract equity from appreciated properties

Disadvantages:

• Increases mortgage payment
• Resets loan term (if going 30-year)
• Closing costs (2-5%)
• Must qualify based on new loan amount
• May get worse rate than original loan

Best For:

• Properties with significant equity
• When rates are favorable
• Scaling to multiple properties
• Need fixed-rate, long-term capital

Private Money

What It Is: Loans from individuals (friends, family, acquaintances) rather than institutions.

How It Works:

1. Identify person with capital to invest
2. Negotiate terms (rate, term, security)
3. Create promissory note
4. Secure loan with mortgage on property
5. Make agreed-upon payments

Typical Terms:

• Interest Rate: 6-10%
• Term: 5-10 years
• Collateral: First position mortgage on property
• Payments: Monthly or interest-only with balloon

Advantages:

• Flexible qualification
• Negotiable terms
• Faster than banks
• Can structure creatively
• Builds investor relationships

Disadvantages:

• Must have network with capital
• May strain relationships if problems arise
• Usually shorter terms than conventional
• Legal documentation crucial
• Higher rates than conventional loans

Best For:

• Investors with high-net-worth networks
• Properties that don't qualify conventionally
• Bridge financing
• Quick closings

Critical Best Practices:

• Always use proper legal documentation
• Secure loan properly with recorded mortgage
• Make payments reliably
• Keep investors informed
• Never mix friendship and poor business practices

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Part 6: The Pre-Qualification and Pre-Approval Process

Before shopping for properties, get pre-qualified or pre-approved. This shows sellers you're serious and capable.

Pre-Qualification vs. Pre-Approval

Pre-Qualification (Informal):

• Initial estimate of borrowing capacity
• Based on self-reported information
• No verification of income/assets
• No credit check
• Quick process (minutes to hours)
• Less weight with sellers

Pre-Approval (Formal):

• Formal commitment (subject to appraisal and clear title)
• Lender verifies income, assets, employment
• Hard credit pull
• Underwriter reviews application
• Takes 2-5 days
• Strong with sellers (shows you're serious and qualified)

Recommendation: Get pre-approved before making offers. It strengthens your position and prevents wasted time on properties you can't afford.

The Pre-Approval Process

Step 1: Choose a Lender

• Shop multiple lenders (rates and terms vary)
• Ask for referrals from other investors
• Interview lenders about investment property experience
• Compare not just rates but also responsiveness and expertise

Step 2: Complete Application

• Provide personal information
• List employment history
• Detail income sources
• List assets (savings, investments, retirement)
• List debts and obligations

Step 3: Provide Documentation

Income Verification:

• W-2 forms (past 2 years)
• Pay stubs (most recent 30 days)
• Tax returns (past 2 years) if self-employed
• Profit & loss statements if self-employed
• Existing rental property income (leases, tax returns)

Asset Verification:

• Bank statements (past 2-3 months)
• Investment account statements
• Retirement account statements
• Gift letter if using gift funds

Other Documentation:

• Photo ID (driver's license)
• Social Security card
• Proof of residence
• Divorce decree if applicable
• Bankruptcy discharge if applicable

Step 4: Credit Check Lender pulls credit from all three bureaus

Step 5: Underwriter Review Underwriter analyzes your file and determines:

• Maximum loan amount
• Interest rate
• Required down payment
• Conditions for approval

Step 6: Pre-Approval Letter Lender issues letter stating:

• Amount you're approved to borrow
• Loan type
• Expiration date (usually 60-90 days)
• Conditions (subject to appraisal, clear title, no material changes)

Shopping for Lenders

Don't just go with the first lender. Compare multiple options:

Factors to Compare:

• Interest rates
• Points and fees
• Closing costs
• Loan terms
• Responsiveness and communication
• Investment property experience
• Online reviews and reputation

Rate Shopping Window: Credit bureaus treat multiple mortgage inquiries within 14-45 days as a single inquiry, so shop aggressively without hurting your credit.

Questions to Ask Lenders:

1. What interest rate do you offer for investment properties?
2. What are your points and origination fees?
3. What's your estimated total closing costs?
4. How much down payment do you require?
5. What are your DTI requirements?
6. How much rental income credit will you give?
7. Do you have experience with investment properties?
8. What's your typical timeline from application to closing?
9. Are there prepayment penalties?
10. What documentation will I need?

Improving Your Loan Terms

Negotiate Points and Fees:

• Shop multiple lenders for leverage
• Ask about discount options
• Consider paying points to lower rate if planning to hold long-term

Improve Your Credit Score: Even small improvements can save thousands:

Example: $200,000 loan, 30-year fixed

720 credit score: 6.5% rate = $1,264/month
760 credit score: 6.0% rate = $1,199/month

Difference: $65/month = $780/year = $23,400 over 30 years

Increase Down Payment:

• 25% down often gets better rates than 20%
• More down = lower risk = better terms

Reduce DTI:

• Pay off small debts completely
• Avoid new debt before applying

Show Strong Reserves:

• More reserves = less risk = better terms
• 12 months reserves better than 6 months

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Part 7: Key Takeaways from Module 3

Core Principles

1. Mortgages are powerful wealth-building tools:

   • Leverage amplifies returns
   • Principal paydown builds equity automatically
   • Tax-deductible interest reduces costs
   • Fixed-rate loans provide predictability

2. Lenders evaluate the Five C's:

   • Credit (score and history)
   • Capacity (income and DTI)
   • Capital (down payment and reserves)
   • Collateral (the property)
   • Character (stability and track record)

3. Different loan types serve different needs:

   • Conventional: Standard for investment properties
   • FHA: Great for house hacking with minimal down payment
   • VA: Excellent for eligible veterans
   • Portfolio/DSCR: Alternative when conventional doesn't work
   • Hard Money: Short-term, expensive bridge financing

4. Calculate your capacity before shopping:

   • Know your available capital
   • Understand your maximum loan amount
   • Factor in rental income credits
   • Maintain adequate reserves

5. Creative financing expands possibilities:

   • Seller financing
   • Partnerships
   • HELOCs and cash-out refinances
   • Private money
   • Subject-to (advanced)

6. Pre-approval is essential:

   • Shows sellers you're serious
   • Reveals your true budget
   • Identifies issues to resolve
   • Speeds up closing

Your Action Steps

Before proceeding to Module 4, complete these tasks:

1. ✅ Check Your Credit

   • Get free reports from all three bureaus
   • Review for errors and dispute any inaccuracies
   • Note your current score
   • Create plan to improve if needed

2. ✅ Calculate Your Financial Capacity

   • Complete the Available Capital worksheet
   • Calculate your current DTI
   • Determine maximum purchase price
   • Identify any obstacles to financing

3. ✅ Improve Your Financial Profile (if needed)

   • Pay down credit card balances
   • Correct credit report errors
   • Increase savings for down payment
   • Stabilize income if inconsistent

4. ✅ Research Lenders

   • Identify 3-5 potential lenders
   • Compare rates, fees, and terms
   • Read reviews and check reputation
   • Note questions to ask

5. ✅ Get Pre-Approved

   • Choose your best lender option
   • Complete application
   • Gather required documentation
   • Obtain pre-approval letter

6. ✅ Understand Financing Options

   • Review which loan types you qualify for
   • Consider creative financing if applicable
   • Understand trade-offs of different options

7. ✅ Take the Module 3 Quiz

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Module 3 Self-Assessment Quiz

Test your understanding. Answers provided at the end.

1. What does PITI stand for? a) Price, Income, Tax, Interest b) Principal, Interest, Taxes, Insurance c) Property, Investment, Tax, Insurance d) Purchase, Interest, Time, Income

2. What credit score typically gets the best mortgage rates? a) 620+ b) 680+ c) 720+ d) 760+

3. What is the typical maximum DTI ratio for conventional loans? a) 28% b) 36% c) 43-50% d) 60%

4. What percentage of rental income do lenders typically credit toward DTI? a) 50% b) 75% c) 100% d) It varies

5. What down payment is typical for investment properties with conventional loans? a) 3.5% b) 10% c) 15-25% d) 40%

6. What is the minimum FHA down payment for credit scores 580+? a) 0% b) 3.5% c) 5% d) 10%

7. True or False: FHA loans can be used for investment properties.

8. What type of loan is qualified based on property income rather than borrower income? a) FHA b) VA c) DSCR d) Conventional

9. What is a HELOC? a) High Equity Loan Cooperative b) Home Equity Line of Credit c) Housing Expense Loan Contract d) Hard Equity Lending Option Corporation

10. What's the difference between pre-qualification and pre-approval? a) They're the same thing b) Pre-approval is informal; pre-qualification is formal c) Pre-qualification is informal; pre-approval is formal with verification d) Pre-qualification is only for FHA loans

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Quiz Answers

1. b) Principal, Interest, Taxes, Insurance
2. d) 760+ (though 720+ gets very good rates)
3. c) 43-50% (43% is most common maximum)
4. b) 75% (to account for vacancy and expenses)
5. c) 15-25% (most commonly 20-25%)
6. b) 3.5%
7. False - FHA loans require owner-occupancy (but great for house hacking)
8. c) DSCR (Debt Service Coverage Ratio) loans
9. b) Home Equity Line of Credit
10. c) Pre-qualification is informal; pre-approval is formal with verification

Scoring:

• 9-10 correct: Excellent! You understand financing thoroughly.
• 7-8 correct: Good work! Review missed concepts.
• 5-6 correct: Fair. Re-read challenging sections.
• Below 5: Review the entire module before proceeding.

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Conclusion: You're Financially Prepared

Congratulations on completing Module 3! You now understand how mortgages work, what lenders require, how to calculate your investment capacity, and the various financing options available.

You've learned:

• How mortgages are structured and amortized
• The Five C's lenders evaluate
• Different loan types and their requirements
• How to calculate your maximum investment capacity
• Creative financing strategies
• The pre-approval process

Most importantly: You understand that financing is a tool, not an obstacle. With knowledge, preparation, and good credit, you can access the capital needed to build wealth through real estate.

The next step is learning how to analyze specific properties to determine if they're good investments. You know how much you can invest and how to finance it. Now you need to know how to evaluate whether a property is worth buying.

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You're ready for Module 4: Analyzing Investment Properties.

In the next module, you'll learn the critical financial metrics every investor must understand, how to calculate expected returns, how to analyze cash flow, and how to determine if a property is a good deal or a money pit.

You're building real capability. Each module adds essential skills. Let's continue.

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"Leverage is the reason some people become rich and others do not become rich." — Robert Kiyosaki