Most lenders will only extend Qualified Mortgages. A Qualified Mortgage (“QM”) is a kind of loan having more stringent pre-qualification requirements. QM lenders must show the regulators that they have determined, prior to closing, that you, as a borrower, have the ability to repay your mortgage. This is logical, and will continue to be the norm for conservative lenders. Since these conservative lenders in turn have conservative investors who ultimately purchase your mortgage, their investors also want nothing to do with non-QM loans.
But if I lend you money at 6% (say 2% higher than conventional rates because of some additional risk) – there is no doubt that I already have an investor for the loan I just gave you who is willing to pay me, say, 6.5% for the same loan. Why would an investor do that? Because in a large financial market, he too has someone else on the line willing to pay him something more – and so on, and the business is profitable all around.
The old 12-13% “hard money” loans were being advanced to people having unfavorable credit when standard mortgage interest rates were at 5-6%. Now these non-QM lenders have lowered their rates to 6-8%, when today’s 30-year conventional rates have only dropped to about 4%. It’s not a bad deal to pay slightly higher non-QM rates for a brief period until you have satisfied your lender’s seasoning period requirement – and then you can refinance with a conventional mortgage without a prepayment penalty.
Lenders will discover that you had a foreclosure – that you had student loan late fees – that you defaulted on your car loan – that you already sold the asset claimed on your loan application – that you were arrested several years ago – that you neglected to meet your child support obligations, etc.
It either comes out on your credit report or through the lender’s use of fraudguard security checks – or even when they just Google your name. Lenders have these and several other extensive background checks and “Know Your Customer (KYC)” procedures that they carefully follow.
If you don’t immediately disclose your Deed-in-Lieu of Foreclosure, do you really think they will believe you are providing them with all details on everything else for which they ask?
You will generally always need to write a Letter of Explanation (“LOX”) to address collection accounts and disputes/inquiries on your credit report. And what if your explanation is solely factual and not remorseful?
As useless as sentimentality might appear in the finance world, lenders want to look into your consciousness – otherwise they have nothing to support the notion that you will do everything you can to prevent another late mortgage payment or foreclosure. The parties recommending your loan need your cooperation in order to support you – because they only have their reputations if something goes wrong with your loan. If they have to work hard for someone who has been concealing the facts (intentionally or unintentionally), they are likely to move on to the next file.
Does the Seller truly have the authority to sell the property to me?
One of the biggest red flags is having a Seller who is a trustee. Not only should you quickly confirm that the declaration of trust, or trust agreement, exists and is fully executed (by all appropriate parties), but that the agreement hasn’t expired or been revoked. Without such confirmation, a whole host of issues could arise that might cast a shadow on whether you or your lender will receive clean title. And, by the way, the Seller’s name on the title report needs to match the owner of record on both the chain of title and appraisal.
Worst Case? Your lender will decline the loan based on an unacceptable title report, and you will have wasted untold amounts of time and money on a property that was just never going to close.
Best Case? Your closing will be delayed until the title company, escrow agent, attorneys, and lender can sort things out.
Finally, you might be surprised to find out later that your Seller would have been happy to provide you with certain documents you needed to satisfy yourself or your lender. All you needed to do was ask for a:
If you own title to a residential rental property via an LLC (“limited liability company”), then you better have owned this asset for at least 24 months and reported it on Schedule E of your 1040 tax return – otherwise you will have a tough time utilizing the income from this property to qualify for a loan. Without the 24-month seasoning period, there is a good chance the net rental income cannot be used in calculating your Debt-to-Income ratio (DTI) unless you elect to transfer title from the LLC to your individual name.
Now don’t rush out and transfer the ownership from the LLC to yourself personally without first consulting with your accountant and lawyer – especially because of the potential tax ramifications and liability risks. But you won’t get conventional residential financing for your LLC rental property, because the lender will treat it as if it were a commercial property (which means lower LTV requirements and higher pricing – even if you personally guarantee the loan).
On the other hand, if title is in your name, then typically 100% of the income and expenses on Schedule E can be used to calculate your DTI – without having to comply with the 24-month rule. In addition, if the property is so new that it has not yet been reported on your previous tax return, then some lenders will allow you to use 75% of the revenue (confirmed via the lease) less PITI, with only 75% used to account for other standard expenses you will incur.
Let’s say you buy a residential investment property for $150,000 using cash. You fully expect to get a renter, but first need to make some improvements to the property. So, being as smart as you are, you postpone financing the property because you should undoubtedly be able to get higher loan proceeds after you enhance value to $200,000 – right? Most lenders will not advance more than 75% of the original purchase price for the “Cash-Out Refinancing” of investment properties – until at least 12 months after the purchase. This means that you cannot get a loan based on value during that time frame, unless you obtain the loan from a “portfolio” lender (a lender who can maintain the loan on their own books without either selling it to FNMA or having it guaranteed by FHA). Nothing wrong with getting a portfolio loan, but they are oftentimes more expensive.
The government enforced this idea in order to prevent the flipping of homes. Before the housing crisis, investors were bidding up the price of homes via quick cash closings, only to turn around and either quickly selling for a higher price or financing virtually 100% of the price right after closing (there were several lending programs that made it easy for them to do so). Thus, the government wanted to prevent NON-owner occupant borrowers from continuing the same flipping practices – mainly in order to avoid purchasing or guaranteeing a loan secured by properties with inflated values.
Art Espinoza recently asked me to return to his radio show entitled “The Art of Investing”. Art is a respected financial advisor and wealth manager with offices in Vero Beach, Florida and Brookfield, Wisconsin, and his show airs every Saturday at 9:30 am on WAXE 107.9FM and 1370AM, or on iHeart Radio.
Commercial Real Estate (CRE) represents an attractive asset class.
Here are a few of the obvious reasons for some reinforcement:
– Inflation Protection (with contractual rent increases, CRE can offer the perfect inflationary hedge
– Long-Term Capital Appreciation (according to the National Council of Real Estate Investment Fiduciaries or NCREIF, CRE returns have outperformed the S&P 500 since the late 1970’s – ignoring the correction of property values in 2008-09)
– Low Return Volatility (CRE can lead to more predictable, recurring cash flows – especially well-located properties having a stable roll-over schedule of creditworthy tenants on longer-term leases)
– Diversification (CRE returns generally have a low correlation to stock and bond returns)
And for those of you who just can’t stay out of the stock market… Although 2013 was an exceptional year for the S&P 500 (32.7% return), equity REIT’s in 2014 are likely to outperform last year’s abysmal 2.7% return. The threat of interest rate increases weighed heavily on the REIT sector in 2013, but these returns should improve with the focus now leaning on company earnings – which should lead to additional demand for space in markets with limited supply.
I recently had the pleasure of appearing on a radio show entitled “The Art of Investing”, hosted by Art Espinoza. Having known Art for quite some time in the Vero Beach community along the Treasure Coast of Florida, he asked me to discuss what’s happening in the real estate market, who the primary borrowers of real estate capital are, where I see interest rates going, and a variety of other related topics.
Art has been a respected financial advisor and wealth manager for 28 years, and has offices in Vero Beach, Florida and Brookfield, Wisconsin. His show, “The Art of Investing”, is broadcast every Saturday morning at 9:30 am on WAXE 107.9FM and 1370AM, or on iHeart Radio: http://www.iheart.com/live/WAXE-1079-FM-1370-AM-4788/
Art kindly asked me to make regular appearances on his program, and I look forward to sharing real estate industry dialogue and exchanging topical ideas with listeners in the future.
A bit extreme to settle differences with your real estate partner through the use of a “shotgun buy/sell” provision? You‘ll be relieved you negotiated this in your joint venture agreement: It gives you the option to either purchase your partner’s interest for a set price, or sell your interest to your partner at that same price. So, if you decide to exercise this right, you better be prudent in coming up with a neutral price – because you will either be buying or selling at a price that you’ll need to live with.
(i) Price control (you’ll know what the proceeds will be or how much capital you’ll need to raise)
(ii) Timing certainty (you’ll know upfront in the agreement how long this process will take – generally 30 to 90 days)
(iii) Closing efficiency (there is little to negotiate, and less chance the market will move against you to introduce significant market or competitive pricing risk)
(iv) Ability to exit the relationship (or introduce a new like-minded partner)
(i) Outcome uncertainty (you have no control over whether you will be the buyer or seller)
(ii) Reputation risk (some partners don’t appreciate surprises – you may be viewed as unnecessarily forcing your partner’s hand)
(iii) Lack of Cooperation (from the “shot-gunned” partner)
I am extremely grateful for the support and guidance I have received from the Small Business Development Center (“SBDC”) at Indian River State College, in Vero Beach, Florida.
Below is an interview that I did with Mr. Dick Cantner of the SBDC: