Chapter 9
Securing the Best Mortgage Terms
IN THIS CHAPTER
Understanding the best ways to shop for mortgages
Solving common borrowing problems
In Chapter 8, we discuss how to choose among the many loan options available so that you can select the one that best suits your personal and financial situation. In the process of delving into the different types of real estate investment financing, you may have already begun the process of speaking with different lenders and surfing websites.
In this chapter, we provide our top tips and advice for shopping for and ultimately securing the best financing that you can for your real estate investment purchases and refinances. We also cover common loan problems that may derail your plans.
Shopping for Mortgages
Financing costs of your real estate investment purchases are generally the single biggest expense by far, so it pays to shop around and know how to unearth the best deals. You may have thought you were buying an income property, but you are really buying a loan in order to buy an income property. You may find that many lenders would love to have your business, especially if you have a strong credit rating. Although having numerous lenders competing for your business can save you money, it can also make mortgage shopping and selection difficult. This section should help you simplify matters.
Relying on referrals
Many sources of real estate advice simply tell you to get referrals in your quest to find the best mortgage lenders. Sounds simple and straightforward — but it’s not. For instance, loans for commercial investment properties and residential rental properties with five or more units have different lender underwriting requirements and terms compared with residential one- to four-unit loans (see Chapter 2 for explanations of these types of investments).
Good referrals can be a useful tool for locating the best lenders. Here are a few sources we recommend:
- Start with a bank or credit union that you have a relationship with currently and then seek referrals from it if it’s not interested in making the specific loan you have in mind.
- Collect referrals from people who you know and trust and who have demonstrated some ability to select good service providers. Start with the best professional service providers (tax advisors, lawyers, financial planners, real estate agents, and so on) you know and respect, and ask them for their recommendations.
- Contact associations of real estate investors, especially those in your state. (You can find a comprehensive list organized by state at the website
www.realestateassociations.com.) Networking with local investors is a great way to find out more about the local real estate market and to benefit from other people’s experiences.
Don’t take anyone’s advertisement or referrals as gospel. Once you become known as a real estate investor, you will begin receiving solicitations from lenders you never knew existed. Just like anything online these days, a large dose of extreme caution is in order. And, while you would think traditional word of mouth should be safe, always be wary of business people who refer you to folks who have referred business to them over the years. You want to make sure that the referral is not just a payback or reciprocal arrangement with no justification, but actually someone that warrants consideration. Whenever you get a recommendation, ask the people doing the referring why they’re making the referral and what they like and don’t like about the suggested service provider. You may be surprised to discover that they have actually never used them but are just reciprocating a referral they received. You don’t want to be the guinea pig.
Mulling over mortgage brokers
You don’t need to use a mortgage broker unless you’re trying to get a loan for a property that has some challenges or you as the buyer have less than stellar credit or want to put the minimum down. Mortgage brokers also may not be justified when the market conditions are favorable and many lenders are aggressively seeking to make loans. Thus, in these instances, we recommend going directly to lenders for simple deals (a relatively small price tag, a property that’s in good condition and enjoys a good location, and so on) and using mortgage brokers for bigger, more complicated, or more difficult deals, especially if the capital markets are tight and lenders aren’t motivated to make deals. Mortgage brokers also can be helpful when you’re purchasing five or more units or commercial property, but they become essential for all types of properties when you are looking to finance large real estate deals over $5–10 million.
Many property buyers get a headache trying to shop among the enormous universe of mortgages and lenders. Check out the following sections when deciding whether you want to use a broker.
Counting a broker’s contributions
A good mortgage broker can help with the following tasks in your real estate investing team:
- Advice: If you’re like most people, you may have a difficult time deciding which type of mortgage is best for your situation. A good mortgage broker can take the time to listen to your financial and personal situation and goals and offer suggestions for specific loans that match your circumstances. Brokers do work on commission, which unfortunately can temper the objectivity of their advice, so tread carefully. Don’t blindly accept a mortgage broker’s advice, which may be nothing more than a commission-driven sales pitch masquerading as counsel.
Shopping: Even after you figure out the specific type of mortgage that you want, dozens (if not hundreds) of lenders may offer that type of loan. (You’ll find fewer lender options for five-plus-unit residential properties and commercial properties.)
Thoroughly shopping among the options to find the best mortgage takes time and knowledge you may well lack. A good mortgage broker can probably save you time and money by shopping for your best deal. Brokers can be especially helpful if you have a less than pristine credit report or you want to buy property with a low down payment — like 10 percent of the value of a property. Purchasing a multifamily residential property with five or more units or a commercial, industrial, or retail property is difficult with less than a 20- to 30-percent down payment.
Be careful when selecting a broker, because the worst among them get in the habit of repeatedly using the same lenders — perhaps because of the lofty commissions those lenders pay out. (More on understanding mortgage broker’s commissions in the “Keeping up with commissions and other contingencies” section.)Paperwork and presentation: An organized and detail-oriented mortgage broker can assist you with completing the morass of forms most lenders demand. The paperwork (even if it consists of online forms) can be truly overwhelming and tedious if you haven’t been through the process before and your records aren’t in order. Mortgage brokers and escrow officers can assist you with preparing your loan package so that you put your best foot forward with lenders. The mortgage broker only gets paid if the loan is funded, so she can also be an advocate and lobby the lender to do some more difficult deals that take some trust and creativity to complete.
Savvy real estate investors know that they need to act quickly if they see a great deal, so have your personal financial statement prepared in advance so that it can be easily updated. A personal financial statement lists all of your monthly income and expenses, as well as all of your cash flow from real estate and non–real estate assets. Also included is a balance sheet section that shows the current value of all your assets, minus the liabilities owed, with the difference being your net worth. Each time you seek a loan for an investment property, you have to provide a current financial statement to the broker (and, actually, all potential loan sources).- Closing the deal: After you sign a purchase agreement to buy a real estate investment property, you still have a lot to do before you’re the proud new property owner (see Chapter 14 for all the details). A competent mortgage broker makes sure that you meet the important deadlines for closing the deal.
Keeping up with commissions and other contingencies
A mortgage broker typically gets paid a percentage, usually between 0.5 and 1 percent, of the loan amount. This commission is completely negotiable, especially on larger loans that are more lucrative. (In case you’re interested, the commission on larger deals — say, on a loan of $25 million or more — is 0.25 to 0.5 percent.) Don’t confuse the mortgage broker commission with the lender-required points. When lenders have a lot of money to place, you may find that using a mortgage broker doesn’t cost you the full amount of their quoted commission because lenders will reduce their points by enough to cover a portion or even all of the mortgage broker fees.
The mortgage broker may also be receiving compensation (or other financial incentives based on the volume of placed loans) from certain lenders, which further complicates your analysis. It also means that you need to explore fully the fee structure with each proposed loan. Be sure to ask what the commission is on every alternative loan that a broker pitches. Some brokers may be indignant that you ask — that’s their problem. You have every right to ask; after all, it’s your money.
Even if you plan to shop on your own, talking to a mortgage broker may be worthwhile. At the very least, you can compare what you find with what brokers say they can get for you. Again, be careful. Some brokers tell you what you want to hear — that is, that they can beat your best find — and then aren’t able to deliver when the time comes. Some mortgage brokers promise fantastic terms to get you in the door; then, when you’re just about ready to close on your loan, they come up with a last-minute problem with your credit report, appraisal, or some other issue that prevents them from delivering on the loan as quoted. This bait-and-switch tactic often works because most borrowers have some blemish or negative on their loan application or credit report. So make sure you find a mortgage broker who doesn’t overpromise and underdeliver. Of course, if you follow our advice, you will have carefully vetted all potential mortgage brokers by checking references from their current and prior loan-closing clients, and you will minimize your chance of experiencing any last-minute surprises.
If your loan broker quotes you a really good deal, ask who the lender is. Most brokers refuse to reveal this information until you pay the necessary fee to cover the appraisal, credit report, and required environmental reports. But after taking care of those fees, you can check with the lender to verify the interest rate, the points, the amortization term, and the prepayment penalties (if any) that the broker quotes you, and make sure that you’re eligible for the loan.
Web surfing for mortgages
You can shop for just about anything and everything online, so why should mortgages be any different? Mortgage websites often claim that they save you lots of time and money.
In our experience, the internet is better used for mortgage research than for securing a specific mortgage. That’s not to say that some sites can’t provide competitive loans in a timely fashion. However, we’ve seen some property purchases fall apart because the buyers relied upon a website that failed to deliver a loan in time. While the purchase of an owner-occupied, single-family home or condo has become routine and can often be done successfully online, income property loans can be a much different matter. You may see a lot of online lender ads that claim they are experts in making investment property loans, but our advice is to be wary and remember the old adage that if it’s too good to be true, it’s too good to be true.
Here’s a short list of some of our favorite mortgage-related websites that you may find helpful:
- Mortgage information sites: The folks at HSH Associates (
www.hsh.com/) collect mortgage information and data. Bankrate operates a site (www.bankrate.com/) that is broader in scope but has lots of useful information on mortgages. However, be advised that both of these sites collect fees from mortgage lenders who advertise on their websites. Government-related sites: The websites of the U.S. Department of Housing and Urban Development (
www.hud.gov) and the U.S. Department of Veterans Affairs (www.va.gov) provide information on government loan programs and feature foreclosed homes for sale.Fannie Mae, which stands for the Federal National Mortgage Association (
www.fanniemae.com), and Freddie Mac, which is the Federal Home Loan Mortgage Corporation (www.freddiemac.com), have worked over the years with the federal government to support the mortgage marketplace.Mortgage Bankers Association (MBA): The trade association for mortgage lenders, the Mortgage Bankers Association (
www.mba.org), has articles and data on the mortgage marketplace. Its web resources page also includes links to state and local mortgage banker associations. It also has consumer tools and information on purchasing real estate, including a link to your free annual credit report. This group is an excellent source of information on loans for residential properties with five or more units and commercial, industrial, and retail properties.- Legal research sites: Legal issues certainly raise their ugly heads on many a real estate deal. The website of self-help legal publisher Nolo Press (
www.nolo.com) offers some free resources as well as details on all the company’s legal books.
Solving Potential Loan Predicaments
The best defense against loan rejection is avoiding it in the first place. To head off potential denial, disclose anything that may cause a problem before you apply for the loan. For example, if you already know that your credit report indicates some late payments from when you were out of the country for an extended period or your family was in turmoil over a medical problem, write a short note to your lender that explains this situation. Or perhaps you’re self-employed and your income from two years ago on your tax return was artificially much lower due to a special tax write-off. If that’s the case, explain that in writing to the lender. Also, loan approvals have a human element, and loan officers don’t like surprises. They would prefer to have from you an upfront, full-disclosure of anything that may be less than ideal rather than find it themselves on your credit report or loan package submittal.
With the non-cash deduction of depreciation taken by most real estate investors, working with a lender that routinely makes real estate investment property loans is particularly important because she’ll understand your tax return and how to calculate your actual net cash flow. These lenders will add back in the non-cash deduction, whereas an inexperienced lender’s underwriters will use only the taxable income line on your IRS Form 1040. (This is a perfect example of how online lenders are not ideal for investment property loans as their algorithms aren’t able to handle anything other than basic “vanilla” loan applications.)
Even if you’re the ideal mortgage borrower in the eyes of every lender, you may encounter financing problems with some properties. And of course, not all real estate buyers have a perfect credit history, lots of spare cash, and no debt. If you’re one of those borrowers who must jump through more hoops than others to get a loan, don’t give up hope. Few borrowers are perfect from a lender’s perspective, and many problems aren’t that difficult to fix.
Polishing your credit report
Late payments, missed payments, or debts that you never bothered to pay can tarnish your credit report and squelch a lender’s desire to offer you a mortgage loan. If you’ve been turned down for a loan because of your less-than-stellar credit history, request a free copy of your credit report from the lender that turned you down.
Getting a report before you even apply for a loan is advisable. Once a year, you’re entitled to obtain a free copy of your credit report from each of the three credit bureaus. The contact information for the credit bureaus is
- Equifax: 800-685-1111;
www.equifax.com/ - Experian: 888-397-3742;
www.experian.com/ - Transunion: 800-916-8800;
www.transunion.com/
Or, you can get all three from the website authorized by federal law — Annual Credit Report.com; www.annualcreditreport.com/
If you are in the middle of a loan application when you learn of concerns that are accurately documented on your credit report, immediately contact the lender and try to explain them. Getting the bum’s rush? Call other lenders and tell them your credit problems upfront to see whether you can find one willing to offer you a loan with decent terms. Mortgage brokers may also be able to help you shop for lenders in these cases. Each lender has its own criteria, so it is possible that your specific situation is a deal-breaker for one lender but not a problem at all for another lender.
Sometimes you may feel that you’re not in control when you apply for a loan. In reality, you can fix a number of credit problems yourself. And you can often explain those that you can’t fix. Some lenders are more lenient and flexible than others. Just because one mortgage lender rejects your loan application doesn’t mean that all the others will.
As for erroneous information listed on your credit report, contact the credit bureaus. You may be surprised to find that the information about you is quite a bit different from one credit bureau to another. However, you can’t control which of the credit bureaus your lender chooses to review. Many lenders actually get a composite report that pulls information from all three credit bureaus into a single credit report customized to that lender’s underwriting criteria. So, in order to be the best credit risk and benefit from the lowest rates, you need to make sure that all three credit bureaus have accurate information and that you have an explanation on file for any blemishes.
If specific creditors are the culprits, contact them too. They’re required to submit any new information or correct any errors at once. You can open a dispute on their websites. If you call them, keep notes from your conversations and make sure that you put your case in writing and add your comments to your credit report. If the customer service representatives you talk with are no help, send a letter to the president of each company. Getting mistakes cleaned up on your credit report can sometimes take the tenacity of a bulldog — be persistent.
Another common credit problem is having too much consumer debt at the time you apply for a mortgage. The more credit card, auto loan, and other consumer debt you rack up, the less mortgage you qualify for. If you’re turned down for the mortgage, consider it a wake-up call to get rid of this high-cost debt. Hang on to the dream of buying real estate and work at paying off your debts before you make another foray into real estate. (See Chapter 8 for more information.)
Conquering insufficient income
If you’re self-employed or have changed jobs, your income may not resemble your past income, or more importantly, your income may not be what a mortgage lender needs to see relative to the amount that you want to borrow. This is also true for individuals who receive widely varying commission compensation or performance bonuses as a significant part of their income. A simple (although not always feasible) way around this problem is to make a larger down payment.
If you can’t make a large down payment, another option is to get a cosigner for the loan — your relatives may be willing. As long as they aren’t overextended themselves, they may be able to help you qualify for a larger loan than you can get on your own. But, there is a real risk to them if you default on the loan, so make sure they really understand the potential consequences should circumstances go wrong. As with partnerships, make sure that you put your agreement in writing so that no misunderstandings occur.
Dealing with low property appraisals
Even if you have sufficient income, a clean credit report, and an adequate down payment, the lender may turn down your loan if the appraisal of the property that you want to buy comes in too low. This is a relatively rare situation that happens more in rapidly appreciating markets; it’s unusual for a property not to appraise for what a buyer agrees to pay.
Many sellers have a distorted view and are unrealistic about the true value of their real estate and need a reality check. This is especially true during a period like the late 2000s/early 2010s when real estate values generally fell. Assuming that you still like the property, use the low appraisal to renegotiate a lower price from the seller. Or if you still really want the property, and because you won’t likely be able to get the full amount of the loan you planned as part of your acquisition deal structure, you may be able to get the seller to carry back part of the purchase price as seller financing at favorable terms. The seller gets the price that she wants, but you need to get below-market financing to still make the deal work from your perspective.
You may be the owner of a property in need of refinancing because the loan is coming due or the terms are unfavorable and the appraisal is too low. In this case you obviously need to follow a different path. If you have the cash available, you can simply put more money down to get the loan balance to a level for which you qualify. If you don’t have the cash, you may need to forgo the refinance until you save more money or until the property value rises. Robert and his partners bought down a large loan that came due in 2013, when the local real estate market where this property was located had still not fully recovered. However, they knew the terms of the expiring loan and had anticipated that paying down the loan would be beneficial, so they had been saving extra cash for this specific reason. Not only did they get a new loan, the smaller loan represented lower risk for the lender and the loan rate was much more competitive than if they had attempted to get a loan to fully replace the principal balance due on the expiring loan.