Conventional loans are typically the hardest to obtain for real estate investors. Some lenders do not allow income from investment properties to be counted toward total income, which can make global underwriting a problem for certain investors, especially those who already have several existing conventional, conforming real estate loans reporting on their credit. In these cases, the investor must look outside conventional funding for their investments. Two of the more popular choices for alternative financing are portfolio loans and hard money loans.
These loans are loans made by banks which 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 comes to term. Banks which make these kinds of loans are called portfolio lenders, and are usually smaller, more community focused operations.
Advantages of Portfolio Loans
Because these banks do not deal in volume or answer to huge boards like commercial banks, portfolio lenders can do loans that commercial banks would not touch, like the following:
- smaller multifamily properties
- properties in dis-repair
- properties with an unrealized after-completed value
- pre-stabilized commercial buildings
- single tenant operations
- special use buildings like churches, self-storage, or manufacturing spaces
- construction and rehab projects
Another advantage of portfolio lenders is that they get involved with their community. Portfolio lenders like to lend on property they can go out and visit. They rarely lend outside of their region. This too gives the portfolio lender the ability to push guidelines when the numbers of a deal may not be stellar, but the lender can make a visit to the property and clearly see the value in the transaction. Rarely, if ever, will a banker at a commercial bank ever visit your property, or see more of it than what she can gather from the appraisal report.
Disadvantages of Portfolio Loans
There are only three downsides to portfolio loans, and in my opinion, they are worth the trade off to receive the services mentioned above:
- shorter loan terms
- higher interest rates
- conventional underwriting
A portfolio loan typically has a shorter loan term than conventional, conforming loans. The loan will feature a standard 30 year amortization, but will have a balloon payment in 10 years or less, at which time you'll need to payoff the loan in cash or refinance it.
Portfolio loans usually carry a slightly higher than market interest rate as well, usually around one half to one full percentage point higher than what you'd see from your large mortgage banker or retail commercial chain.
While portfolio lenders will sometimes go outside of guidelines for a great property, chances are you'll have to qualify using conventional guidelines. That means acceptable income ratios, global underwriting, high debt service coverage ratios, better than average credit, and a good personal financial statement. Failing to meet any one of those criteria will knock your loan out of consideration with most conventional lenders. Two or more will likely knock you out of running for a portfolio loan.
If you find yourself in a situation where your qualifying criteria are suffering and can not be approved for a conventional loan or a portfolio loan you'll likely need to visit a local hard money lender.
Hard Money and Private Money Loans
Hard money loans are asset based loans, which means they are underwritten by considering primarily the value of the asset being pledged as collateral for the loan.
Advantages of Hard Money Loans
Rarely do hard money lenders consider credit score a factor in underwriting. If these lenders do run your credit report it's most likely to make sure the borrower is not currently in bankruptcy, and does not have open judgments or foreclosures. Most times, those things may not even knock a hard money loan out of underwriting, but they may force the lender to take a closer look at the documents.
If you are purchasing property at a steep discount you may be able to finance 100% of your cost using hard money. For example, if you are purchasing a $ 100,000 property owned by the bank for only $ 45,000 you could potentially obtain that entire amount from a hard money lender making a loan at a 50% loan-to-value ratio (LTV). That is something both conventional and portfolio lenders can not do.
While private lenders do check the income producing ability of the property, they are more concerned with the as-is value of the property, defined as the value of the subject property as the property exists at the time of loan origination. Vacant properties with no rental income are rarely approved by conventional lenders but are favorite targets for private lenders.
The speed at which a hard money loan transaction can be completed is perhaps its most attractive quality. Speed of the loan is a huge advantage for many real estate investors, especially those buying property at auction, or as short sales or bank foreclosures which have short contract fuses.Hard money loans can close in as few as 24 hours. Most take between two weeks and 30 days, and even the longer hard money time lines are still less than most conventional underwriting periods.
Disadvantages of Hard Money and Private Money Loans
Typically, a private lender will make a loan of between 50 to 70 percent of the as-is value. Some private lenders use a more conservative as-is value called the "quick sale" value or the "30 day" value, both of which could be considerably less than a standard appraised value. Using a quick sale value is a way for the private lender to make a more conservative loan, or to protect their investment with a lower effective LTV ratio. For instance, you might be in contract on a property comparable to other single family homes that sold recently for $ 150,000 with an average marketing time of three to four months. Some hard money lenders m lend you 50% of that purchase price, citing it as value, and giving you $ 75,000 toward the purchase. Other private lenders may do a BPO and ask for a quick sale value with a marketing exposure time of only 30 days. That value might be as low as $ 80,000 to facilitate a quick sale to an all-cash buyer. Those lenders would therefore make a loan of only $ 40,000 (50% of $ 80,000 quick sale value) for an effective LTV of only 26%. This is most often a point of contention on deals that fall out in underwriting with hard money lenders. Since a hard money loan is being made at a much lower percentage of value, there is little room for error in estimating your property's real worth.
The other obvious disadvantage to a hard money loans is the cost. Hard money loans will almost always carry a much higher than market interest rate, origination fees, equity 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 overall loan cost, it still means you net 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 present in alternative lending. If you exhibit poor credit and have no money for down payment you can be sure the lender will charge higher interest rates and reduce terms to make up for the added risk.
When dealing with private lenders make sure to inquire about their valuation method.
Also, with hard money lenders, you should be careful in your research and background checking. While hard money loans are one of the more popular alternative financing options, they are often targets for unscrupulous third parties. Before signing any loan paperwork make sure to run all documentation by a qualified real estate attorney and / or tax professional. If you suspect fraud or predatory lending contact the state attorney general office.