Conventional loans are often the most difficult for real estate investors to obtain. Some lenders do not allow income from investment properties to be counted as total income, which can make blanket underwriting a problem for certain investors, especially those who already have several existing conventional home loans reporting their credit. In these cases, the investor must look outside of conventional financing for their investments. Two of the most popular alternative financing options are portfolio loans and hard money loans.
Portfolio loans
These loans are loans made by banks that do not sell the mortgage to other investors or mortgage companies. Portfolio loans are made with the intention of keeping them on the books until the loan is paid off or matured. The banks that make these types of loans are called portfolio lenders and are generally smaller and more community-focused operations.
Advantages of portfolio loans
Because these banks do not operate in volume or respond to large boards like commercial banks, portfolio lenders can make loans that commercial banks would not touch, such as the following:
- smaller multi-family properties
- properties in poor condition
- properties with an unrealized finalized value
- pre-stabilized commercial buildings
- single tenant operations
- Special use buildings such as churches, warehouses or manufacturing spaces.
- construction and rehabilitation projects
Another advantage of portfolio lenders is that they engage with their community. Portfolio lenders like to lend on properties they can visit. They rarely lend outside of their region. This also gives the portfolio lender the ability to push through the guidelines when the numbers on a deal may not be stellar, but the lender can visit the property and clearly see the value of the transaction. Rarely, if ever, will a commercial bank banker visit your property or see more than he can get from the appraisal report.
Disadvantages of portfolio loans
There are only three downsides to portfolio loans and in my opinion they are worth sacrificing to receive the services mentioned above:
- shorter loan terms
- higher interest rates
- conventional subscription
A portfolio loan generally has a shorter loan term than conventional conforming loans. The loan will have a standard repayment of 30 years, but will have a balloon payment in 10 years or less, at which point you will need to pay off the loan in cash or refinance it.
Portfolio loans also typically carry a slightly higher-than-market rate of interest, typically one-half to one full percentage point higher than what you would see at your large mortgage bank or retail chain.
While portfolio lenders will sometimes stray from the guidelines for a large property, you will likely have to qualify using the conventional guidelines. That means acceptable income ratios, global underwriting, high debt service coverage ratios, better than average credit, and good personal financial health. If you don’t meet any of those criteria, your loan will be out of the question by most conventional lenders. Two or more are likely to put you out of the race for a portfolio loan.
If you are in a situation where your qualification criteria are suffering and you cannot be approved for a conventional loan or portfolio loan, you will likely need to visit a local hard money lender.
Hard money and private money loans
Hard money loans are asset-based loans, which means that they are written primarily with the value of the pledged asset as collateral for the loan.
Advantages of hard money loans
Hard money lenders rarely consider credit scores as a factor in underwriting. If these lenders foreclose on your credit report, they will most likely make sure that the borrower is not currently bankrupt and does not have open judgments or foreclosures. Most of the time, those things might not even remove a hard money loan from underwriting, but they can force the lender to take a closer look at the documents.
If you are buying a property at a deep discount, you may be able to finance 100% of its cost with hard money. For example, if you’re buying a $ 100,000 bank-owned property for just $ 45,000, you could potentially get that full amount from a hard money lender that makes a loan with a loan-to-value (LTV) of 50%. That’s something both conventional and portfolio lenders can’t do.
While private lenders verify the income-producing capacity of the property, they are more concerned with the as-is value of the property, defined as the value of the property in question as it exists at the time of loan origination. Vacant properties with no rental income are rarely approved by conventional lenders, but are a favorite of private lenders.
The speed at which a hard money loan transaction can be completed is perhaps its most attractive quality. The speed of the loan is a great advantage for many real estate investors, especially those who buy a property at auction, or as short sales or bank foreclosures that have short contractual fuses. Most take between two weeks and 30 days, and even the longest timelines are still shorter than most conventional subscription periods.
Disadvantages of hard money and private money loans
Typically, a private lender will make a loan of 50 to 70 percent of the present value. Some private lenders use a more conservative as-is value called a “quick sale” or “30-day” value, which could be considerably less than a standard appraised value. Using a quick sale value is one way the private lender can make a more conservative loan or protect your investment with a lower effective LTV ratio. For example, you may have a lease on a property comparable to other single-family homes that recently sold for $ 150,000 with an average time to market of three to four months. Some hard money lenders lend you 50% of that purchase price, quote it as value, and give you $ 75,000 toward the purchase. Other private lenders can do a BPO and request a quick sale value with a marketing exposure time of only 30 days. That value could be as low as $ 80,000 to facilitate a quick sale to a cash buyer. So those lenders would make a loan of just $ 40,000 (50% of the $ 80,000 quick sale value) for an effective LTV of just 26%. This is often a point of contention in unsigned deals with hard money lenders. Since a hard money loan is made at a much lower percentage of value, there is little room for error in estimating the true value of your property.
The other obvious downside to hard money loans is cost. Hard money loans will almost always have much higher-than-market interest rates, origination fees, principal fees, exit fees, and sometimes even higher attorney, insurance, and title fees. While some hard money lenders allow you to finance these fees and include them in the total cost of the loan, it still means you’ll get less when the loan closes.
Weighing the good and the bad
As with any loan, you have to weigh the good and the bad, including loan terms, interest rate, points, fees, and access to customer support. There is always a trade-off in alternative loans. If you have poor credit and don’t have money for a down payment, you can be sure that the lender will charge you higher interest rates and reduce terms to offset the additional risk.
When dealing with private lenders, be sure to ask about their valuation method.
Also, with hard money lenders, you need to be careful in your research and background check. While hard money loans are one of the most popular alternative financing options, they are often the target of unscrupulous third parties. Before signing any loan paperwork, be sure to have all the paperwork done by a qualified real estate attorney and / or tax professional. If you suspect fraud or predatory loans, contact your state attorney general’s office.