It Qualified. Then the Water Heater Went.
A three bedroom rental. The rent covers the full monthly payment almost exactly: principal, interest, taxes, and insurance. The lender reviews it and approves the loan. On paper, the property carries itself.
Month four, the water heater goes. Month seven, a tenant moves out and the unit sits empty for five weeks. By year end, the property has cost its owner money, and it never once failed the lender's test.
Nothing went wrong with the loan. The loan did exactly what it was built to do.
What the lender actually measured
Many investment property loans qualify on the property instead of your income. Lenders call it the debt service coverage ratio, and it asks one question: does the rent cover the payment?
That's a genuinely useful tool. A conventional loan qualifies you on personal income, so every rental you add counts against you, and eventually your income becomes the ceiling on how many properties you can own. A rent based loan sets that ceiling aside.
But look at what the question leaves out.
Vacancy. Repairs. Property management. The roof, the HVAC, the water heater that always picks the worst month. None of it is in the ratio. A property where rent equals the payment is not cash flowing. It's at breakeven before any of that, and many programs will lend right at that level. Some will lend below it.
The ratio tells you whether the lender is covered. Whether you make money is a separate question, and nobody in the approval process is asking it for you.
Two things the approval doesn't tell you
The rent in the ratio usually isn't your number. It typically comes from the appraiser's estimate, and on a leased property, often the lower of the lease and the market figure. Your spreadsheet assumes what you plan to charge. The lender uses what the appraiser supports.
And qualifying on the property doesn't mean the lender ignores you. Credit and reserves still count, and both affect pricing.
The second number
Before an offer, run two numbers.
The first is the lender's: does the rent cover the payment. That tells you whether the loan is possible.
The second is yours: what's left after a realistic allowance for vacancy, maintenance, management, and a reserve for the big items. If the deal only works on the lender's number, the margin isn't there, and the first water heater will say so.
What realistic means
Every rental turns over, and the weeks between tenants produce no rent. Repairs arrive on their own schedule, not yours. Management costs something, whether you pay a company or pay with your weekends. And the big items, the roof, the HVAC, the water heater, don't come due every year, which is exactly why they need money set aside every month.
--- *Author: Chad Villacorta, mortgage broker at West Capital Lending (NMLS #2636410). Licensed in 34 states. Estimate only, not a loan commitment. Subject to credit approval and underwriting.*
Subject to credit approval and property qualification.
West Capital Lending | NMLS #2636410 | Subject to credit approval and property qualification.