Now that you have learned about the benefits of real estate, how to identify a market, analyze a deal, and applying different strategies, it's time to understanding the financing. As David Greene mentions in his book “Long-Distance Real Estate Investing”, there are a “core four” you need in your real estate team that is comprised of the deal finder, the property manager, the contractor, and the lender. Today we will be discussing the lender and their role in financing your deals.
Before you start looking for properties, it's important that you receive pre-approval from a potential lender to understand your buying power. This will also give you a leg up on the competition because it shows the seller you are a serious buyer who is capable of closing. In a hot market, a pre-approval is a minimum requirement to get your foot in the door and have your offer be reviewed.
When you are looking to build a relationship with a lender, you may come across direct lenders as well as mortgage brokers. In short, direct lenders are actual lenders such as banks and credit unions that will have in-house underwriting and review your documents themselves. On the other hand, mortgage brokers will connect you to different programs that they have build a network around and be an intermediary between you and the final lender from start to finish.
There are pros and cons to using direct vs a broker as a direct bank may have more flexibility in terms of removing some of their own underlays as well as the convenience of dealing with on shop when doing multiple loans across your portfolio. On the other hand, brokers are able to shop around rates with different banks and also become your advocate in terms of trying to get you the best deal possible. In addition, you may come across complex deals that the direct lender you have worked with in the past is unwilling to lend on. This is when the mortgage broker can speak with multiple banks in hopes to find a lender who will loan you the money.
Finding a lender will vary depending on where you want to invest as well as your asset class. For the purposes of this discussion, we will assume that we are seeking residential mortgages for 1-4 unit rental properties in the state of Missouri. As your lender needs to be licensed in the state in which your property is located, it may benefit you to find a national lender who has the license and knowledge to lend in most if not all 50 states. To find a lender, you can ask your investor network, Biggerpockets forums, and local real estate property managers and agents, you may notice names being repeated as lenders who have a high reputation for being investor friendly and closing deals are sought after.
Once you have identified the lender you would like to work with, it's important that you ask them good questions to ensure that you understand one of the core members of your core four. Remember that you do not have to “impress” them as they too are trying to earn your business. Some lenders do not like to work with investors, a quick interview is also a good way to measure how responsive the lender may be and also see if they are investor friendly.
When you are obtaining a Fannie Mae (conventional) mortgage, banks have to adhere to certain rules and regulations set by the government agency, however banks can have their own “overlays” and rules (e.g. maximum 4 properties per person vs 10), so it's important to be able to identify the differences between Fannie Mae’s requirements and the bank’s additional overlays. It may be disadvantageous for an investor to work with a bank with multiple overlays which restrict the investor from scaling their portfolio. Below are some basic questions you may want to ask your potential lender:
How many loans do they close per month (understand the bank’s volume and experience. A bank doing 35 loans a month may know how to navigate complex situations vs a bank doing 3 loans a month as they will have seen more unique cases).
What type of loan programs are available? (e.g. Owner Occupied, Non-Owner Occupied, VA, FHA, Conventional, Portfolio, Delayed-Refinance)
What states are you licensed to operate in?
What are your minimum and maximum loan amounts
What paperwork is required, Debt to Income (DTI), Debt Coverage Ratio requirements?
What are current interest rates for a FICO score of XXX?
What fees are involved (administration, closing costs, etc.)
What is your average time to close?
What is the maximum number of loans per person?
What are the reserve requirements per loan, do you help investors with planning for multiple loans?
The answer to these questions will vary from lender to lender and I would recommend you interview at least 5 lenders to understand the differences and similarities across the market. Once you have selected a lender you would like to work with, you will need to submit the paperwork required to get pre-approved. This will result in a hard inquiry and briefly lower your credit score, so make sure you are ready to purchase a home in the near future. Once you are pre-approved, you are ready to make an offer on a property.
As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.