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Investment Property Loan Financing Tips

Understanding the psychology of lender risk

The reason investment property loans are more expensive, harder to obtain, and more restrictive than loans on personal homes, is that investment property mortgages are inherently riskier than home lending. Fannie Mae and Freddie Mac charge higher rates for investor property loans, much more than for primary home loans because of these higher risk factors. It’s a simple axiom – the greater the risk, the higher the cost. Of course, the opposite axiom is likewise the same – the lower the risk, the smaller the cost. For lenders, real estate investors are inherently more dangerous as a group to make loans to than are homeowners.

Thinking like a bank thinks…

Banks have to look objectively, and ruthlessly so, at their bottom line. What’s their worst case scenario in any lending situation? Naturally, a foreclosure. And in the case of those investing in rental property who are unable to make their monthly loan payments, since they have no emotional stake in the property, they will be more likely to walk away from their loan obligations in any worst-case scenario. Much more so than any homeowner would, since homeowners are emotionally grounded to their home – which is most probably their single greatest asset. This helps explain why total mortgage costs run higher for real estate investments, as well as why investment property mortgage rates are higher than homeowner rates.

Real estate investors understand that buying a rental property is simply a game of numbers. A homebuyer views their purchase decision in much more emotional ways – deciding what emotional benefits will accrue him if he buys a particular home. Conversely, this makes it much more difficult for the homebuyer to give up “his baby” so to speak. And this single reason is what makes lenders value the homebuyer as much less risk than anyone buying rental property.

Mortgage rate differentials

Regardless of the specific area of the U.S. you may look to buy in, real estate investments will have mortgages that will generally run about half a point greater than home loans on average. In addition, many fees tend to be added to loans on investment properties – many more than home mortgages. Thus, the overall cost of any rental property mortgage will be greater as well. Some of the factors involved in the overall costs associated with an investment property loan include the borrower’s current credit score, the loan-to-value ratio for the loan, the property character (ie. – single family, duplex, multi-family, multifamily with owner-occupying one unit) and the specific mortgage program being applied (FHA, Fannie Mae, Freddie Mac or no government-insured program).

LTV’s

In many instances, when in investing in real estate, lenders set up loan-to-value (LTV) ratios at higher overall amounts than home loans. The greater the amount you put down on the rental property you’re trying to finance, the less overall risk to the lender. Most lender these days have maximum loan-to-value ratios of 70% of the purchase price, where you, the buyer, must put down at least 30%. But if you put down 40%, or even 50%, you’ll find your interest rate and overall costs of the mortgage loan will come down substantially. This is also because you are helping to substantially lessen the lenders overall risk. (After all, it’s much harder to walk away from a property you have 50% down in equity than it is if you had only 30% down.)

Using rents as income qualifiers

Traditionally, banks will allow 75% of gross rents currently in place on units in any property you’re thinking of acquiring to help offset the monthly carrying cost of the loan. Keep in mind that this applies only to actual rentals…not hypothetical “market” rents. In addition, the tenants need to already be in place. Typically, the same 75% figure can be used to offset monthly loan costs in any refinance situation for your rental property.

Credit scores

You should also remember that lenders usually require those buying rental property to have better credit scores than their homebuyer counterparts. Lenders like to see scores of at least the low to mid-700’s before extending any rental property mortgage. (That’s not to say that it’s impossible to obtain a loan if your score is in the 600’s – but it will be more difficult, and certainly, it will come with a much higher interest rate. The bank, after all, is always looking to defray their risk.)

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Buying Investment Property For No Money Down

Myth or reality?

Ah, if it were only that simple…the most often-asked question in property investing has to be: can you actually purchase investment real estate for no money down? Well, I certainly have not. Nor have I heard of any other investor I know doing so. That said, in theory, there are ways to limit your own financial exposure in any investment property acquisition. Just don’t expect to find a situation where you can buy property completely for no money down. Investors tend to get pretty scared when they see you have no proverbial skin in the game. And then they either run away, or jump ship.

OPM made simple

Using other people’s money (OPM) is a tried-and-true formula many experienced investors have honed to a fine craft. Some ways of doing so involve seeking out owner-financing for a piece of investment property that’s on the market for sale, asking for greater loan to value ratios from your lender, asking for relatives and friends for unsecured loans for any given project, and partnerships (also known as joint ventures) where your partners take on partial ownership responsibilities with you (though not necessarily project control, or even any hands-on participation in the process).

Owner-financing

This is where most investors will begin in their efforts to reduce the amount of money they actually invest in any given piece of investment real estate. Finding a “desperate” seller is a good way to locate investment property where you can have the seller take back a large amount of the financing in paper supplied by them. The mortgage may be for a short-term, but if you work out a long-term amortization schedule (say, 30 years), your cash flow will be greatly improved. Most short-term mortgages given by sellers tend to be in the 3 to 5 year range. Afterwards, you can look to convert the mortgage to a standard one with your usual bank/lender that you have a relationship with already.

Also, keep in mind that sellers don’t necessarily have to be desperate to give owner-financing. If you “give” in price a little bit off of your negotiated amount, and pay a little extra, you may find that a seller is willing to offer paper in return for the increased price. Paper they had no intention originally of giving…

Greater LTV’s

Another option to lessen your actual cash outlay is to ask your lender for a slightly greater loan-to-value ratio for any given investment property. Most times a lender’s standards for investment property may be a top LTV of 70%. But if you shop lenders, you may find you can do a little better. In addition, consider buying a property where you become an owner-occupant. So, for example, if you purchase a three-family house, you can live in one unit and rent out the other two. In this scenario, since the property is also your home, you can apply for a mortgage under owner-occupied LTV ratios – which can be much greater than 70%.

Unsecured loans from family and friends

If you’re comfortable with this arrangement, consider borrowing funds for down payments and/or repairs and renovation from your family and/or close friends. You can download any number of promissory note blank forms online, see which makes the most sense for you, then ask your family member or friend to sign with you. The note will usually be for a specified amount of time, with a set rate of interest, with both principal and interest due at the end of the term.

If you give your relative or friend several points above what they could get from a bank, both you and they will be quite happy with the arrangement. Let’s say you offer them an interest rate of 5% on their unsecured loan. They’ll be happy receiving such a high return, and you’ll be ecstatic obtaining an unsecured loan at such a low percentage. A good deal for both parties. Keep in mind that you rather obviously better not default on your payout of the principal and interest – or Thanksgivings could become pretty icky in the future. So make sure you know your relatives and friends well enough to not mess with them in any financial sense. This rather obviously involves the utmost trust on both your parts. So make sure you know yourself and your relatives or friends very well before undertaking this scenario.

Partnerships

Lastly, consider partnerships (or joint ventures) with other investors. Some may not want the headache of being responsible for al the work that’s required once you’ve purchased the property. Some don’t want to be property managers. Others don’t want to do property renovation work. So they let you handle it – in return for a share of the operating and future sale profits, since they will become part-owners with you.

Counting the ways

All these ways of financing investment property are designed to lessen your overall cash outlays in any given project. You can use one or several of these techniques to help you keep you overall exposure down. Will you be able to totally pay for an investment property with no money down? Not very likely. But you can lower your total cash cost – and in so doing, lessen your own risk, as well as substantially increase your return on investment (ROI). Obviously, the smaller your own cash amount invested in a property, the greater your leverage – and the greater your ability to reap larger ROI’s on your minimal cash investment.

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A New Year’s Property Investing Tips

Time for review…

The beginning of a new year makes for a perfect time to go over your property investing strategy. There are several key elements in any good property investing plan that should be reviewed at regular intervals…so why not now? It shouldn’t take very long to do this review, so let’s get started!

Annual rent roll review

A solid property investing strategy is to review your annual rent roll to ensure you are maximizing market rents from all your units. If you don’t already have tenants under leases, consider creating set leases with small yearly bumps included in them. If you have current leases coming due this year at different intervals, make sure you have a good idea of what bump-ups you want to ask for. Market research is critical here. Go out and check your competition. See what the going rate is for similar units as the ones you have coming available, or that will be up for renewal. Never leave rent roll money on the table. Always be maximizing your cash flow in this way.

Maintenance review time

Have you deferred any needed repairs to your units and/or buildings from last year? Make sure you create a schedule for the needed repairs, lest they become even bigger problems that could cost you exponentially the longer you put off the fixes. Budget for the repairs, and include them in your pro forma cash flow expenses for this year to get a more accurate picture of exactly how much you will net from your property investing.

Debt structure review

If you have long term mortgage notes in place from a long time ago, consider refinancing while rate s are still relatively low. This could end up saving you greatly in the long run. If you paid all cash for a property recently, consider whether this would be a good time to increase your leverage by taking out a mortgage on the property now. If you’ve added improvements to it in the past year, this would also help free up your cash. Crunch your numbers first, and see if the extra debt load from the new mortgage will still allow you a positive cash flow. If so, then a new mortgage may be a great way to help free up your cash for more property investing.

Pre-tax time review

Prior to April 15^th, the beginning of the year gets you to focus early on whether you are maximizing your depreciation on your buildings. It’s also an excellent time to get in to see your accountant to go over these matters – before they are snowed under with work come tax time in April. Maybe they will have some new suggestions about how best to maximize your day to day expenses, as well as your capital expenses to help offset your cash flow income, realizing a smaller tax bite come tax time.

Insurance review time

Consider the beginning of the year as the perfect time to review your current building insurance policies. Yu should already be working with one dedicated insurance agent for all your property investing needs. Go over with him any adjustments he would recommend to make sure you are adequately covered in the event disaster strikes – or you have a negligent tenant. Also remember to review your current liability insurance policy on each of your buildings. This may the most critical insurance item to review. Make sure your insurance agent feels you are properly covered in the event of a tenant accidentally hurting themselves on your property, and suing you.

To sum up…

Utilizing this time of year as a great time to review all these key elements of any good property investor will help you substantially. You’ll end up maximizing your cash flows, as well as reducing taxes, and making sure you’re adequately covered in the case of emergencies or disasters.

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Financing Investment Property

Some basic tips

When looking to finance investment property acquisitions, here are a few of the most basic tips you’ll want to consider before you begin your property search. Figuring the best way to finance your investment will be one of the first steps you’ll need to take prior to spending a great deal of time and energy in locating a real estate investment.

Get to know your local lenders

There will be greater latitude with smaller, local banks. Each local bank will have their own set of lending guidelines. Get to know each lender’s guidelines, and their individual strengths and weaknesses. Get local real estate agents to refer you to their “preferred” lenders. These real estate pros should each give you three names. See whose name pops up the most out of all local lenders, then work directly with them.

Make sure your credit is excellent before starting your search

Always know your credit score at any point in time. Your score will have the greatest impact on your ability to secure a mortgage when financing investment property, as well as having a tremendous impact upon the interest rate you will be granted. A score of 740 should be a bare minimum. Preferably, you’ll need a score in the upper 700’s to low 800’s these days to ensure getting the best interest rates on real estate investment loans.

Be prepared to put up a large down payment

Unlike homeowner loans, banks assign greater risk to investment properties. They therefore help lower that risk by asking for larger down payments. Most lenders will require 25 to 30 percent down on most investment properties. Some lenders require 40% or more, depending on your credit score. The lower the score, the higher the down payment required.

Ask for some owner financing

Never be embarrassed to at least ask if the owner will consider SOME amount of owner participation when financing investment property – EVEN if they do not say they will on their property information listing sheet. Always ask! You never know just how desperate a seller’s situation may be, and you don’t want to pass up the opportunity to utilize other people’s money (OPM) when possible.

Think outside the box (creative financing options)

Use home equity lines of credit. It’s an extremely cost-effective use of borrowed funds – as long as you’re aware of the potential dangers. You need to set a conservative time horizon for the sale of the investment property to ensure a quick payback of borrowed home equity funds. Otherwise, you’re asking for trouble – placing your own home in jeopardy. In addition, consider short-term borrowing from credit cards – especially discounted credit card offers with zero percent or one or two percent charges on borrowed funds. Of course, shop around for the lowest surcharge cards. Most cards require some upfront surcharge – ranging from two to four percent on average. Again, know your time horizon for holding your investment property acquisition – then choose the credit card offer that best fits your needs, and offers the most leeway in payback period.

Another oft-used method of alternative financing is a shot-term loan from a relative. This can work – but be sure to absolutely create a signed promissory note to your relative/friend/”angel.” That way, everyone is on the same page, knows the repayment period, interest rate, and what will happen if you default. At the end of the repayment period, you certainly want to retain your relative/friend/”angel” as someone who continues to hold you in high esteem. Of course, you should always discuss these creative ways of financing investment property with your financial advisor prior to making any moves. It just makes good business sense to get another outside professional opinion first.

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President Obama’s Latest Proposal and It’s Effect On Investment Property Loans

Some potentially good news for those looking to refinance existing investment property loans

In his State of the Union speech last night, President Obama offered up a new proposal for helping the current housing crisis. While designed specifically for home owners, property investors who rent out part of their homes could take advantage of the new legislation if it were to get Congressional approval.

The hallmark of the new law would be to help out those whose mortgage debts are greater than the value of their properties. The program would benefit those who have continued to make payments on their existing mortgages, whose properties are not already in foreclosure proceedings, and who currently do not have loans backed by the government.

A potential windfall for some property investors

On the surface, Obama’s latest proposal appears to be a boon for property investors already living in their own multi-family homes that are currently under water, whose mortgages are held by private companies. Eligibility for refinancing existing loans that are held by either Freddie Mac or Fannie Mae was increased last October to help those property owners whose homes were already under water. And those changes did not require any Congressional approval. However, this proposal does, since the loans will be backed by the Federal Housing Administration (FHA).

Many owner-occupied property investors have taken advantage of historically low mortgage rates by refinancing their investment property loans in the past year. But others are still unable to do so because they don’t qualify for refinanced mortgages, due to their mortgages exceeding the value on their properties.

Requiring legislation

The new proposal by Obama will require legislation since the FHA is currently prohibited from making refinanced loans on properties that exceed the value of the owner-occupied property investor’s house. These types of loans are inherently of greater risk, mainly because the property owner has no further equity remaining in his house. So if the FHA were to not be paid back on any new loan due to this proposed legislation, taxpayers would have to bail out the FHA.

As part of the new law, and since the FHA currently has so few reserves, Obama is proposing that any potential default costs due strictly because of this program be covered through new fees to be levied on the banking industry. The Republican-controlled Congress will be a large obstacle in getting this legislation passed given the current antagonistic political climate in Washington. For now, it’s wait and see…

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Investment Property Finance Update: Easy Credit Score Tune-Ups

Keeping score of the game – the FICO score

With the average 30-year fixed rate mortgage hovering around a 3.65 percent interest rate right now for investors with the highest FICO (Fair Isaac Corp.) scores, it’s a good time to review how to tune up your credit score to help qualify for the best rates.

As a reminder, FICO scores were created to measure an individual’s financial fitness. The score ranges between 300 and 850, and is used by the vast majority of lenders in the U.S. While there are other scores used by banks, FICO is the lending industry standard for assessing overall credit risk. The main use of this scoring tool is to simply show the risk of possible default by any individual borrower.

Who qualifies for the best mortgage rates

Before the financial meltdown of the last several years, FICO scores of 720 and above were considered uniformly as the scores that would qualify borrowers for a bank’s best mortgage rate. But more recently, that number has been pushed upwards, and now 750 and above tends to be the new standard for qualifying excellence. About a third of U.S. consumers fall into this top-ranked category, while the median FICO score was 711 last year.

So naturally, as part of your overall investment property finance plan, you’ll want to check your credit score to see where you’re positioned before applying for any new mortgage. You can find yours through sites like freecreditscore.com or freescore.com. If you’re already at 750 or above, trying to improve your score will be a pretty fruitless endeavor, since lenders don’t really create a pecking order of default riskiness once you’re in the top echelon, and you’re showing the least borrowing risk. However, the goal for most will be to try to take some easy steps to help improve your overall FICO number.

Try these simple, easy credit score tune-ups:

Pay your credit card bill early

That is, pay your bill several days before your statement closing date each month. (This is not the statement due date!) Paying early will ensure you show a zero balance going into your next statement period.

Try to get any late payments removed

First, make sure there are no errors, and second, if you did unfortunately make a late payment, simply ask to have it removed as a “one-time-only” courtesy. If your credit card company says no, well, at least you tried…

See if your credit card company will increase your credit line

Remember, you’re seeking an increase to ultimately boost your FICO score – not to actually use the increased credit line! This is accomplished by helping your “utilization” ratio, which weighs the amount of actual debt you have outstanding with the total amount of credit you can actually use on any given card.

Apply for new credit cards sparingly

Each time you apply for new credit, your FICO score will drop a little bit. So avoid applying for a credit card for every store you walk into that’s offering a “10% off” promotion if you sign up for one of their store cards on the spot.

Don’t close old, unused accounts

Even if you haven’t used a credit card in some time, do not close the account. By remaining open, the available credit line helps to effectively lower your utilization ratio (mentioned above), and your FICO score won’t be adjusted downward.

Set up automatic bill payments

Good, on-time payments can help bump up your FICO score, by as much as 50 points if done regularly on all your cards for at least six months. If you don’t like the concept of automatic deductions, you can arrange for your credit card company to send you timely email alerts as payment reminders.

Pay down some debt

If you receive a windfall, tax refund, bonus or the like, consider making a sizeable dent in your debt load. Any outstanding debt over 35% of your existing credit line on any one credit card will drag your score down. However, paying the debt down to get the ratio under 35% will yield a nice boost to your FICO score.

The key to your bottom line

Try utilizing some or all of these credit score tune-up tips, and get your FICO score up over that 750 mark. That way, when you next apply for investment property financing, your score will help qualify you for the bank’s best mortgage rates, ultimately either saving you money on a monthly basis, or allowing you to purchase more house for the money.

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