Wednesday, July 2, 2014
First, A Word About Loans
The most common forms of investment financing in today's mortgage market are "conventional" loans underwritten to guidelines issued by Fannie Mae and Freddie Mac. Lenders use the same set of guidelines to approve these loans, which can be used to buy any type of residential property from one to four units. In contrast, government-backed loans, such as VA and FHA programs, can only be used to finance a primary residence. You can't use them to buy rental property.
The abundance and uniformity of conventional loans creates a very competitive mortgage market for rental properties because more lenders are competing with the same mortgage product. Mortgage rates from one conventional loan to another will always be very close, if not the same.
You may not end up here, but your own bank is a good place to start your search to finance an investment property. Commercial banks issue more mortgage loans than any other source. But don't assume your bank is going to give you a special deal simply because you have a debit card from them. Its rates might in fact be higher.
However, a bank does have the ability to issue a portfolio loan, so called because the bank intends to keep the loan in its "portfolio" rather than selling it later on the secondary market. With a portfolio loan, the bank doesn't have to conform to the guidelines for most conventional loans, so it can make exceptions and approve a loan for someone who might not otherwise qualify. For example, conventional guidelines require a borrower to be self-employed for at least two years, whereas a portfolio loan may not have that requirement.
Mortgage banks only do one thing — originate mortgage loans, using their own funds or funds borrowed from a warehouse lender. A mortgage banker handles the entire mortgage transaction, including accepting the initial application, approving the loan and providing the funds for the mortgage. This can be advantageous for the investor because the loan doesn't have to be sent to a third-party for review.
A loan application sent to a mortgage banker will almost always be sold to another lender, or even to Fannie or Freddie directly, on the secondary market. In fact, while your mortgage application is being processed and approved, the mortgage banker may have already committed to sell your loan to other investors. Each secondary investor may offer a different rate, allowing the mortgage bank to choose the most competitive one.
Mortgage brokers usually offer the same programs as a mortgage banker or a commercial bank. They originate mortgage loans, and then send the application to a wholesale lender for approval. Brokers don't approve the loan, nor do they use their own funds to provide financing. A broker can be approved with multiple wholesale lenders, so he or she can shop around for the best rate or send the loan to a lender who can approve a loan that another can't.
Brokers keep lists of lenders with whom they do business; each lender may have unique loan guidelines when it comes to credit scores or other requirements. Brokers can also send loans to lenders who are offering better rates or lower closing costs. However, the broker loses control of the loan application once it's forwarded to a lender for approval. That's something to consider if your loan needs some sort of special attention or waiver.
Often referred to as "hard money" lenders, private lenders are useful if you can't get approved for a conventional loan to buy a specific property. This can happen if the subject property is in such disrepair that the lender won't make a loan until the property is rehabilitated.
Private loans typically have higher rates and fees and larger down-payment requirements than other mortgage choices. The loan will only be good for the time it takes to acquire, rehabilitate and sell the investment, and it will balloon at the end of the loan term, which can be as short as three months or extend up to three years. Once you've renovated the home to where it meets the conventional loan guidelines, you can refinance the private loan into any type of traditional mortgage.
The best way to find a private lender is by getting referrals from real estate agents or mortgage brokers. Active real estate investors often have several private lenders in their database and use them when an unconventional property comes to market.
What Financing Source Should You Choose?
Each financing source has its advantages, but other than a private lender, they offer the same range of financing options. Here are the basic benefits of each:
Retail Bank Trusted relationship, portfolio lending
Mortgage Banker Decision maker, one-stop shop
Mortgage Broker Additional choices, rate shoppers
Take your individual circumstances into account. If you have a competitive rate, the most important thing is that you feel comfortable with your loan officer, get your questions answered promptly and thoroughly and maintain open lines of communication throughout the process.
This information was originally published on Auction.com, LLC, the nation's leading online real estate marketplace. Founded in 2008, the company has sold nearly $20 billion in assets since 2010. Auction.com has more than 900 employees and offices in Irvine and Silicon Valley, California as well as offices in Atlanta, Austin, Denver, Miami and Newport Beach. Visit us at www.auction.com, or on Twitter, Facebook and LinkedIn.