🏦 Financing
Financing & Loans
Getting Started
Understand loans. Debt is cheap and leverage is how you outperform every other asset class.
Determine your occupancy
The intended use of the property will determine the available rates lender will lend to you. The lowest will be your primary residence, then Second Home, and investment (1-4 units), and then commercial.
Primary Residence
- Must live in the home for the majority of the year
- The lender usually offers the lowest rate for primary residence because you are most likely to repay a loan for the home in which you are actually living.
Second Home
- Must live in the house for some part of the year
- Some lenders do not allow the home to a rental, airbnb, timeshare, or be under a property management agreement. (Please check with your lender prior to finding a house)
- Require to be a certain distance away from your primary (100 miles usually)
- Second home may offer at primary residence rates or a percent above. Sometimes less than investment properties due to lessor risk.
Investment
- A property you are collecting rent from and do not live at
Mixed-Use Property
- The property must be a one-unit dwelling that the borrower occupies as a principal residence.
- The borrower must be both the owner and the operator of the business.
- The property must be primarily residential in nature.
- The dwelling may not be modified in a manner that has an adverse impact on its marketability as a residential property.
Who should I go to for loans?
Developing a relationship with local banks is important, especially once you start to expand.
Loan brokers can help you find the best rates. They can compare different lenders and provide you with the most competitive options. With their expertise, you can be sure to get the best deal possible.
Avoid using large, national banks. Their fees and interest rates tend to be higher than those of smaller, local banks. Additionally, local banks often provide more personalized customer service.
💡 Interest rates on purchases are lower than rate/term refinances (no cash out)
Interest rates on rate/term refinances are lower than cash out refinanced refinances
What if I can’t qualify for loans with my income?
You are eligible for up to 10 conventional loans, depending on your personal income and debt-to-income ratio.
DSCR loans typically come with a higher interest rate, but are based solely on the income generated by the property.
💡 Start paying off your debts 2-3 months prior to applying for a loan to increase your credit score for better rates. Also get rid of that credit card debt
Should I buy down my interest rate by purchasing points?
It's unlikely to be beneficial. Most investors no longer keep the same loan for 30 years and usually refinance before that. If you plan to keep the same interest rate for 5-7 years, buying points is a good idea. Otherwise, it's not worth it.
Types of loans
Fixed-Rate
If you're just starting out, this is the plan for you. No surprises here: for homes with four or fewer units, you'll know exactly how much you'll be paying each month for the next 30 years.
Flexible Payment Plans
If you're a new buyer, this could be of interest. You can make lower payments initially, which gradually increase, similar to a salary.
Floating Rate Loans
Lenders often tie loan rates to buildings that require work. For example, they might offer a rate of 6% plus the London Interbank Offered Rate (Libor). This hedges their risk in case the economy takes a downturn and interest rates drop. However, if interest rates rise, you may be subject to a higher rate than expected.
However, statistically this is the best type of loan to get in a high interest rate environment.
Interest-Only Loans
You only pay interest on the loans for the initial years. Typically, a balloon payment of the full amount is due at the end of the loan.
Commercial Loans
Once your DTI gets too high or you max out conventional loans, did you know you can get a commercial loan for a single family home?
Terms to Know
Net Operating Income (NOI)
Annual income building makes minus operating expenses. Does not include cap ex or financing costs
Debt Service Coverage Ratio (DSCR)
DSCR = NOI / Debt payments
The operating income of a property is typically measured relative to its debt service. Generally, a ratio of at least 1.25x to 1.40x is required, though in rare cases with specialized programs, stabilized properties can go as low as 1.10x.
Stabilized vs Value-Add/Distressed
The state of your property will determine the loan terms. For those with real estate experience, a sub-3% interest rate is achievable. Value-add projects range from 5-12+%, depending on the condition.
For multifamily properties, 85% physical occupancy and 70% economic occupancy over the last 90 days is recommended. To fill vacancies, concessions such as free rent should be used first.
For non-residential commercial, a long lease with a strong corporate guarantee tenant is ideal.
Interest Rate Lock
Only banks and hard money lenders typically agree to keep the interest rate locked in until closing, barring any significant issues. Interest rates can often change over time.
Recourse vs Non Recourse
Recourse debt means that if the LLC or corporation in the company goes bankrupt, the bank is allowed to seize the individual's personal assets to pay back the debts.
This is often required on major rehab/construction projects, when a commercial building is vacant or has a short lease, or if the individual is willing to pay more in interest. Partial recourse is a middle option.
Prepayment Penalty
If you pay off the loan through sale or refinance, you may incur a penalty.
Long-term fixed rate loans often come with a prepayment penalty.
Lenders with competitive rates often have the most severe prepayment penalties.
Yield maintenance and defeasance should never be used to pay off a loan.
💡 Home loans are backed by the government, so most lenders make money by selling them to Fannie Mae/Freddie Mac, rather than collecting interest payments which is why they typically don’t have prepayment penalties
Bridge vs Agency Loans
Stabilized properties are eligible for agency loans. However, when purchasing a value-add property, most investors opt for a bridge loan due to its faster closing time.
Bridge loans are more expensive than agency loans, and can range from 1-5 years, with amortization payments as if it were a 25-30 year loan. Typically, they are interest only which is why they are the popular choice when DSCR is too low.
Amortization and Balloon Payments
Amortization of 30 years is similar to that of residential loans. For example, a 7 year commercial loan usually requires repayment of the remaining lump sum (balloon) before the end of year 7.
However, most investors typically refinance into a new loan before the balloon payment is due. Additionally, bridge loans may offer extensions in case the market is not ideal at the time of refinancing.
Things Lenders Want to See
Real estate experience
The most subjective part of commercial loans is why it is important to know your local lenders. Knowing your local lenders can help you better understand the loan process and make informed decisions. It can also help you find the best loan terms and rates for your business.
Minimum Net Worth to Loan Ratio
Who would have guessed? Those with more money get better loan rates. It stands to reason that your net worth should exceed the loan amount.
Global Cashflow
Lenders require a Real Estate Owned (REO) schedule from borrowers, with a Debt Service Coverage Ratio (DSCR) of 1.25 or higher.
Personal cashflow
The ratio should be greater than 1:1, sufficient to cover debt service.
Cash to revolving debt ratio
Revolving debt vs cash
Liquidity
Total cash / monthly debt service and at least 6 to 9 months of savings
Global Leverage
The preferred debt-to-value ratio for a real estate portfolio is less than 75%.
Credit rating and explanations of 30 day late payments
A credit score of 680 or higher is required to be eligible for certain financial services. Past tax liens, judgments, and litigations may affect one's credit score.
- Tax returns, not just 1040s, and K-1s
- Schedule of real estate
Why do commercial lenders ignore me when I ask what my interest rate will be if I don't have a property yet?
Please look over terms to know. The range varies greatly because the loans are not as cookie cutter as residential loans.
Who does commercial loans?
- Alex Chang
- Sean Pan
- Conventus lending
- Loanbase.com
- Old Capital Lending
- One of the biggest for syndicators
- For 1000$ off financing, create your user with SARE as first name and then it will generate a code with SARE.