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March 27th, 2018 by Graham Parham
Conventional lending is the most popular source for mortgage lending in today’s 1 to 4 unit properties. Conventional lending can be either conforming or non-conforming. If it’s conforming, it will be for an amount under a specified maximum. In most areas, this is $417,000 for a single family home, but the amount is higher in certain areas, like Hawaii or metropolitan cities. When you are purchasing a multi-family property will graduate up to $625,500. Nonconforming mortgages are for higher amounts usually called a jumbo loan.
The biggest difference between a conventional mortgage and other mortgage programs is the required down payment. Government-backed mortgages have low down payment requirements to help home buyers move into a primary residence.
For example, you could get an FHA mortgage with just 3.5% down and a VA mortgage with no down payment. Banks have different requirements for the down payment on a conventional mortgage ranging from 3% to 20%. For investment property loans FHA or VA does not offer a non-owner occupied programs. Occasionally loan servicers that are reselling a previously funded VA loan that was inherited through foreclosure will offer a qualifying assumable option to investors to purchase that property. These types of transactions are very few and far between.
Most of your 1 – 4 unit property transactions are typically sponsored by Fannie Mae or Freddie Mac.
Before the mortgage crisis of 2008, there were many portfolio lenders in the marketplace offering non-prime loans to investors. The most famous product that many seasoned investors utilize was the “Option Arm.” The Option Arms typically offer a lot of flexibility from the standpoint of payment options as well as qualifying options. Many say that the Option Arm was abused in many ways which allowed loan officers to put families into homes that they really couldn’t afford. This part is true in some cases, but for investors, it made a lot of sense on paper because of the flexible payment options. With the new Dodd-Frank Act in place, portfolio lenders were forced to eliminate these products.
Portfolio lenders act very much the same way as your normal conventional lenders, but with different guidelines. Most all their loans are underwritten manually. They do not rely on Fannie Mae or Freddie Mac’s underwriting engine to approve their loans. Each loan is examined differently to make sure the loan falls within the portfolio guidelines. These lenders do have a niche in the marketplace because sometimes these loans do not fall into the normal conventional guidelines. These are not subprime lenders but make sense lenders. Their down payment and loan terms requirements may vary as well as their credit requirements.
Private Money Loans (Hard Money)
Private mortgages provide investors substantial returns at interest rates that are compounded several times annually. The rates on these types of loans are much higher than that of the traditional conventional loan, not to mention the upfront cost. Private mortgages (also called “Hard Money Loans,” trust notes, private notes, etc.), are in my opinion, much safer than paper investments because they are secured by real property. I have personally seen settlement statements where hard money lenders that charge four & five points upfront at closing with interest rates anywhere from 10% to 20%.
It is completely legitimate for an individual to offer a private mortgage for a home purchase giving a buyer a non-bank option for financing. Many rehabbing companies will take advantage of hard money because of the short-term nature. It allows a rehabber to purchase the property and roll in the closing cost in addition to the rehab cost. Once the rehab is done, the property is sold for a profit, and the hard money loan is paid off. Traditional lending is focused on the long-term loans, where private moneylenders can get a much higher interest rate and higher cost for easily accessible money to conduct their business on a short term basis.
Some of the main reasons why investors use hard money are that underwriting will not be as rigorous as conventional lending. However, in this new era of “The Ability-to-Repay,” banks and mortgage companies are refusing more borrowers than ever before. These home buyers are coming in droves to private lenders to find the private mortgage they need to buy a home. Even though hard money loans are extremely expensive, they do serve a purpose in today’s lending community.
Non-Recourse Loans (IRA Loans)
A non-recourse loan does not allow the lender to pursue anything other than collateral. For example, if you default on your non-recourse home loan, the bank can only foreclose on the home. They generally cannot take further legal actions against you. The bank is out of luck, even if the sale proceeds do not repay the loan. Most investors would prefer using a non-recourse loan over a recourse loan simply because of this fact. With both types of loans, the lender is allowed to seize any assets that were used as collateral to the secure loan.
The most popular type of non-recourse lending for the 1 – 4 family property category is a self-directed IRA. Self-directed IRAs can purchase investment real estate as another form of tax-sheltered retirement investment. The IRS requires non-recourse loans for all real estate purchases that use leverage from within their self-directed IRA. Many investors will use their IRAs to purchase real estate in today’s market. Some use self-directed IRAs to purchase real estate because they can’t qualify in the traditional conventional lending. It could be for the fact that their credit profile does not meet today’s standards or they’ve maxed out on the number of loans that Fannie Mae or Freddie Mac will allow.
Specialty lending companies that support self-directed IRA transactions for real estate will require you to set up a separate entity into an LLC for each of property. These lenders will approve the loan the same way commercial lenders do which means they are underwriting the property more so than the borrower. Non-recourse loans typically require a larger down payment and a much higher interest rate. Even though the rates are higher than what they can get on the conventional side, it is still not as difficult as private money lending. Many real estate investors that utilize self-directed IRA’s typically will have a shorter business plan and earlier exiting strategy, typically 5 to 7 years.
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