What we learned about lending for real estate

2022/05/12

Earlier versions are published as a series of articles on www.svinvestorsclub.com. This article has a series of edits made after that publication.

Summary

This is a quick overview of lending options that we use to finance our real estate purchases. I often get asked what loans are available for financing real estate buys, so I thought to write it up for posterity. But also as a reminder for myself, since there is plenty of detail that is easy to gloss over.

The text is relevant for the lending landscape in the USA only. Other countries have their own rules and unique opportunities, but I know nothing about those. I am therefore sticking to the USA and the loans available to you for real estate dealings in the States. I also intend to describe the landscape in broad strokes, and give plenty of links that you can use for your own research. It is hard to make a complete overview of all financial products available out there in what is intended to be a relatively easy to read blog post, so I am focusing on loan programs that are most popular with real estate investors.

The exposition mostly follows the sequence of loan programs that we were exposed to. As a result, I am writing in more detail about the loans I know well, and in less detail about those that I am not familiar with. I also specifically do not talk about any revolving credit lines, such as the home equity line of credit (a.k.a. HELOC) or other forms of equity lines of credit secured by real estate.

This means, even though this text gives you ideas of what questions to ask of your lender, the onus is still on you to figure out a loan that best fits your needs as a borrower and an investor. Being nimble in your plans and creative in your approach can open financing doors.

Conforming loans

For most homeowners in the USA, the only loan product for real estate they encounter will be the conforming loan. A conforming loan is a government-backed loan program designed to offer as many working people as possible an opportunity to finance their home - their primary residence. This loan program has a tormented history, and a scrutinized present, that are both out of scope of this article: we will discuss the loan program as it is now from the perspective of a real estate investor who sees real estate financing as a tool that enables creating value through real estate. I will leave untangling its problematic corners to someone with more political savvy.

While conforming loans are usually discussed in terms of personal residence purchases, they are also interesting for real estate investors since conforming loan programs support purchases of 2nd homes–which could then be also rented out part of the year–as well as investment properties.

The conforming loans conform to the limits set out by the Federal Housing Finance Agency (FHFA), hence the name. For us it is of practical importance to know that there is an upper limit to the loan amount that can be made under this program. The limits vary over time, so the best way to know what the limits are is to look them up online. While the ideal would have been to have uniform loan limits for all localities in the USA, the local market variations have forced the existence of several different limits:

The rules for obtaining such loans are set forth by the Federal National Mortgage Agency (FNMA, colloquially known as “Fannie Mae”) and Federal Home Loan Mortgage Corporation (FHLMC, colloquially known as “Freddie Mac”). FNMA publishes the Selling Guide which lists all rules that a conforming loan must fulfill. This includes rules for lenders, borrowers, property and services related to the property. So, for example, to understand what property can qualify as a 2nd home, you could look it up there.

Despite the fact that conforming loans are usually used to finance single-family homes (and primary residences), there are other property types that can be financed this way too. Under similar conditions, it is allowed to finance a property between 1 and 4 units with a conforming loan. It is also possible to finance a primary residence (personal home), a 2nd home as well as an investment property. However, it is not possible to finance a non-residential property, or a property with 5 or more residential units. It is also not possible to finance property which does not have residential use as its primary use. For example, it is not possible to finance farmland.

The lenders who originate (write) conforming loans rarely do so to keep the loan note themselves. They write a conforming loan with the intention to re-sell the loan to a government agency such as FNMA. This is why they must ensure (sometimes at great tedium to the borrower) that all terms in the Selling Guide are upheld.

Because conforming loans are guaranteed by the US government institutions, they present lower risk to the lender compared to other loan products. Therefore such loans usually command the lowest rates out of the full spectrum of loan products. Up to very recently, loan rates as low as 2.5% were possible on 30 year fixed loans. Those times are now gone, maybe forever. Time will tell.

Whatever the loan rates do in the short run, another remarkable feature of conforming loans is that their interest rate is typically fixed for the entire lifetime of the loan once the rate is locked in the loan process. This means, once the loan rate is “locked” (which happens once the underwriting of the loan is complete), a borrower will enjoy a known and predictable–in this case fixed–loan payment for as long as 15 or 30 years. The fact that the loan payments are fixed, and that the US dollar is typically losing value as time goes on makes such a loan a very easy inflation hedge for any homeowner, and is one of the major wealth creation vehicles in recent US history. This is a unique property of the loans in the USA, and the government set lending guidelines are the de facto benchmark for all other lenders. In other parts of the world, adjustable rate mortgage loans are the norm: with such loans, the interest rates are adjusted on a periodic basis as some percentage point above a certain well known index, such as the “London Interbank Borrowing Rate”, or LIBOR, in Europe.

Another important feature of conforming loans is that they are written on the merits of the borrower, not on the merits of the property that is being bought. As long as your credit score and financial situation can support a home purchase, you should be able to qualify for a loan, even if the property itself is not economically viable. FNMA publishes a set of underwriting criteria, which define the loan terms that can be offered to people of various means and various credit scores.

After the credit crunch of 2008 and the ensuing crash of the securities market, the lenders have become increasingly wary of writing loans for properties where the borrower has little “skin in the game” - i.e. downpayment. Downpayment is the cash the borrower needs to contribute towards the closing of the property, and a set minimum for conforming loans is 20%. This means, you will need the ability to put down $20,000 of seasoned funds for a $100,000 purchase. Funds are “seasoned” if they spent some time on your account, typically two months, which gives enough time for it to become obvious that these funds are something you own, but have not gone into debt to get.. Some funds are by default considered seasoned too, such as proceeds from stock sales, regardless of when they were made.

Conventional loans must come without a prepayment penalty. This means, if you decide to pay the loan off early, the lenders must allow you to do so, and must not charge you any additional fees or penalties for the option to do so. The more we go into the realm of commercial lending, the less this useful loan feature comes about.

Conventional loans are usually fully amortized. This means that the loan term and maturity match: once the loan matures, the borrower is expected to have paid the loan off in full.

Some limitations apply, however. The FNMA regulation prescribes that an individual may have a maximum of 10 loans in their own name. So, after you have taken out 10 loans, this borrowing avenue becomes closed to you. It is also not possible to take out a conforming loan in the name of a company. Conforming loans may have multiple borrowers, but they must always be natural persons, which is something that is not always compatible with an investor’s business plan. This is something to keep in mind when dealing with conventional loans. Also, conventional loans rely on strict underwriting rules and protracted appraisal process, making their timelines at odds with the quick close requirements of the investing world. The interest rates will also differ depending on the purpose of the property that is being bought. A loan for a 2nd home would typically be at a rate 0.5% higher than a loan for a primary home. A loan for an investment property would be at a rate 0.5% higher than a loan for a 2nd home.

FHA, VA and other residential lending programs

This, however, is not the full spectrum of residential lending available to every person. For those unable to afford the 20% down payment, the Fair Housing Administration has a loan program that allows one to buy a house for as low as 3% of down payment. This is commonly known as the “FHA loan”. While it was originally intended for first-time home buyers, it is actually available to anyone. The low down payment will require taking out a private mortgage insurance, which would be an additional out-of-pocket cost for the borrower. Some additional conditions apply for the properties seen for a FHA loan. For example some types of deferred maintenance are not financeable. There is a limit of one active FHA loan per person; but people have been known to take out multiple FHA loans one after the other–not concurrently–over their investment career, using them as powerful levers in wealth building. One strategy that commonly goes hand-in-hand with a FHA loan is “house hacking”. As it is allowed to buy up to 4-unit property with a FHA loan just as with the conforming loan, some borrowers would decide to buy multi unit buildings, living in one of the units and renting the others. This sometimes allows them to even come out ahead of the loan repayment game, as the rents collected on other units either considerably help loan repayment, or even exceed the required monthly payment amounts.

There is a range of other more specialized loan programs that I have had less experience with and am unable to write in reasonable detail. The US administration of Veterans Affairs (VA) offers specialized loans for veterans and immediate family members, allowing even 0% downpayment. This option is open to US military veterans who have spent a certain minimum number of days in deployment. Individual states have comparable programs for military personnel. California has the CalVet program, which while technically different from a regular loan, from the borrower’s perspective behaves very similarly to a regular loan. CalVET is also open to current and former military personnel who have seen deployment for a certain minimum time, is aware of degrees of disability, but is constrained that it only may be applied to properties that are physically located in California.

Loan parameters

I’m making a quick detour here to discuss the loan parameters that come to mind, since it is important to be aware of them to be able to handle portfolio loan negotiation. You will see that there are plenty of criteria, and all of them are crucial for the success of your loan shopping adventure and ultimately to your real estate purchase. They also make loan comparisons nontrivial.

Although people usually focus on the loan’s stated interest rate, there are quite a few loan parameters that should be taken into account when comparing loan products. When discussing lending options with lenders, you will do good for yourself if you ask about all of the parameters below.

What I have experienced way too many times is, the lender sales representative will try to sell you on their loan product by touting only the loan parameters that present their product in the favorable light. For example they will show you a low interest rate relative to competition, but not tell you their upfront fees are sometimes much higher. They are banking on hooking you in with the favorable loan parameters. And once you start your loan process, you will be less likely to back out even if you find out that other terms are less than ideal. So they are incentivized to lie to you by omission to get you on the hook. If you make sure that you clarify all the points below, you will be in a much better position to decide between loan products, compared to if you don’t do this.

Determine the following loan parameters:

Whether the lender has open membership or not. This might be the most important first question to ask if talking to lenders that are credit unions. Some credit unions require you to be a member to obtain a loan from them. But they may also limit who may become a member. For example, some credit unions are only open to active or former military personnel and their families. When talking to a credit union, ask this question first to avoid going through a lengthy application process only to learn, late in the process, that you are not eligible to be financed because you are not a member, and are not eligible to become a member because you are not the target demographic.

Whether the lender finances your type of project. Not all lenders will finance every type of project. Some lenders will only finance single family homes. Or residentials. Some will not write long term debt. Some will not fund rehabs. Some can not close in the name of an LLC. Some (paradoxically) will not close in personal names. The criteria vary based on the lender’s business goals. Save yourself time by asking your lender early if your project is compatible with their lending criteria.

If you are an out-of-state investor, whether the lender will finance you. Some lenders will only finance local borrowers. If you are an investor from across the country, you may be out of luck.

Whether the lender operates in the state your property is in. If the lender is not in the state where your property is located, you must ensure that they are licensed to finance you where your property is.

If refinancing, how soon after the purchase may the refinance process start. Some lenders require the property to be “seasoned”, and will not consider it for a refinance until 6 to 12 months pass since the property was bought.

Time to close. This is worth asking early, too. Some banks may offer very favorable interest rates (below) or very cheap origination fees (below). But if their origination process is too long for your intended closing timeline, none of those other favorable terms matter: this lender is simply not compatible with your acquisition timeline. If, for example, your contract promises to close in 30 days, but your lender is only able to close in 60 days, you would be jeopardizing your purchase contract by going with this lender. They may take more time than the seller is willing to wait for you to line up your financing. Too bad. More often than not the time to close is one of the more important parameters you want to ask about, which is why it also appears very early in the list. And sadly, while big banks often offer the best loan rates, they have an abysmal record in the ability to close quickly. This becomes an important trade-off for an investor deal, where time is often of the essence.

Interest rate, or the annual percentage yield (APY). This is the amount, expressed in annualized percentage of the total amount of debt, paid to the lender. What this figure means depends on whether the loan is straight or not.

Whether rate buy-down is possible or not. Most lenders have this option. Lenders will allow you to bring the interest rate down by paying more in fees upfront. Usually you can pay a fraction of a loan point to bring the loan down by a certain fraction of a percentage point. This makes a trade off between up-front loan cost and the amount paid during the lifetime of the loan. Depending on your business plan, either the original or the bought-down interest rate may make sense to you. This depends on the “break even” point: honest lenders will let you know after how long does it pay more to use the “original” interest rate, vs. the bought-down interest rate.

Whether cash flow reserves or liquidity is required. Some lenders will lend to you only if you show that you have enough liquidity to cover debt payments for a certain length of time (typically 6 to 12 months). They may require you to have a certain minimum net worth, relative to the size of your loan.

What the required maximum debt-to-income (DTI) ratio is. This check ensures that you are not too much in debt so as to be a high risk for default. Conventional loans typically have DTI limits on a monthly basis. Your monthly gross income needs to be a certain amount larger than your debt service. Lenders will compute both the front-end (before the loan) and the back-end (after the loan) DTIs to qualify you. Lenders will differ in their method of calculating the DTI. Some will, for example, disregard your passive income. Others will weigh it with a less-than-100% weight, depending on the source. Others will count it at its 100% face amount.

Whether there is a debt service coverage ratio (DSCR) limit. Some lenders typically require that the property brings in more in net operating income than the amount of yearly debt service.

Loan cost. Expressed in “points'', i.e. percent of the total loan amount paid as a fee to the loan originator, upfront. This is what you pay your lender for the convenience of getting a lump sum of money from them.

3rd party fees. These are fees paid to third parties involved in making the loan happen, such as appraisers and surveyors. These fees are usually fixed dollar amounts.

Annual percentage rate, APR. This is the cost of the loan to you, expressed as a percentage of the full loan amount during the first year of the loan. This is a convenient figure to compare two loans against each other. For example, let us suppose that you are quoted a $100,000 loan at a 5% APY, with 1 point and $1000 in fixed 3rd party fees. In the first year of the lifetime of the loan you will be paying 10% x $100,000, or $10,000 in interest. You will also have paid 1% of $100,000, which is $1000 in loan origination. You will also be paying $1000 in fixed fees. The total amount paid over the first year of the loan is $10,000+$1000+$1000=$12,000. As this equals to 12% of the original loan amount, we say that the APR of this loan is 12%. This figure allows you to compare two loan offerings quickly, taking into account all the money that will leave your pocket for repaying that loan over the 1st year of the loan’s lifetime. Of course, the APR is just a quick comparison, and sometimes it will be more favorable to you to front-load the loan cost, and sometimes it is more favorable to you to spread the cost around.

Whether the loan has an interest-only period. Some lenders will allow you to pay only the interest on the loan. Other loans will require you to pay the interest, plus some amount of the principal, with the intention that over time your debt goes down.

Whether property taxes and insurance amounts are escrowed. This means, whether you are required to pay a 1/12th of each year’s amount of property taxes and insurance to an escrow account from where it is then paid out to the tax authorities and insurers.

What the loan term and maturity are. These are usually expressed in months. The term is a period of time over which payments of the loan are calculated. Conventional loans are usually fully amortized, with the loan term and maturity matching.

You would take out a 30 year loan, with a 30 year maturity for example - this means that your payments are divided into 30 x 12 monthly payments, all equal. There exist other loan products for example, a 30 year loan with a 10 year maturity - this means that while there are 10 x 12 monthly payments to be made to the lender, the amount of those monthly payments are computed as if there would be 30 x 12 such payments. This in turn means that after 10 years, the full loan amount is not repaid. A lump sum or a balloon payment is due to the lender for the remaining amount of the loan.

Whether the loan is fully amortized, or has a balloon payment. A fully amortized loan is expected to be fully repaid once its term and maturity expire. If a loan has a balloon payment, it means that once the loan reaches maturity, a certain lump sum of money is expected to be paid to the lender.

Whether the loan has a prepayment penalty or not. Some lenders will charge you an additional fee if you decide to pay the loan off early. This is a way for the lenders to ensure that they achieve a set amount of profit on lending the money to you. Some loan programs are not allowed to have prepayment penalties, such as FHA loans. Other loans have a prepayment penalty based on the net present value of the amount of interest that was projected to be received from you over the remainder of the lifetime of the loan. Others have fixed percentages of prepayment penalty depending on the timeline of loan repayment. For example, “3-2-1” prepayment penalty requires 3% of prepayment penalty if repaid during year 1, 2% if repaid in year 2, 1% if repaid in year 3, and 0% thereafter.

The main goal for the lender here is to ensure that the projected profit on the loan is collected from you. As the loan math works out, most of the interest on a loan, even a very long term one, is collected in the first years of the lifetime of the loan. This is why repaying the loan in the early years is usually seen as a big deal from the lender’s end, since that reduces the profit that the lender expected to get.

Whether you can close the loan in the name of an LLC or not. Some loans, such as conventional loans, must be closed in the names of natural persons. Other loans require the borrower to be a company. This is important for example in case of 1031 exchanges, where you may be required to close in a very particular name or set of names to uphold 1031 exchange rules.

For example, if your company is doing the 1031 exchange, it is of paramount importance that the loan you take out be in the name of the company. Conventional loans are therefore not an option for financing your 1031 replacement property purchase. While the FNMA selling guide only allows natural persons to be on the property title, 1031 rules require your company to be on the title, making the conventional loan incompatible with 1031 company-bound exchanges.

Whether the loan requires personal guarantees or not. Most loans for real estate require some form of a personal guarantee. This is a promise, from the borrower, to the lender, that if the borrower is unable to repay the loan, they will liquidate their personal property to repay the loan. It is of course required that the guarantor pledges some of their personal assets to this end. States usually regulate to what extent the lender can go after the guarantor’s personal possessions, so while personal guarantees seem like a big deal, they aren’t as much as it initially seems.

Whether the loan is recourse or non-recourse. Non-recourse loans allow the lender to repossess the property collateral in case the borrower is unable to repay the loan, but may not go after the guarantor’s personal assets if the liquidation of the property ends up not yielding enough money to cover the entire debt amount. Recourse loans allow the lenders to go after other assets in case of a deficiency (shortfall) after foreclosure, but the extent to which this is possible is regulated by each state. Some states are recourse states, allowing the lenders to go after personal assets. Others, like California are single recourse states, which means the lender needs to choose a single asset to go after in case of a deficiency. California also affords some protection for primary residences, sheltering up to $150,000 of primary residence from foreclosure. Finally there are non-recourse states, where this sort of recourse is not allowed at all.

Whether the loan is assumable or not. I.e. whether the loan can be transferred to a different person or entity, other than the one that originally borrowed the money. Some loans, such as conventional loans are not assumable by definition. Other loans may be assumable, with or without defeasance, which is the amount payable to the lender for the privilege of assuming the loan.

Maximum loan-to-value, which is the percent of the purchase amount that the lender is willing to finance. For example, LTV of 60% means that the lender is willing to finance 60% of the purchase price.

Whether renovation cost can be financed, i.e. added on top of the purchase price. Such loans are usually about loan-to-cost or LTC (rather than loan-to-value or LTV), which is the percentage of the total project cost (purchase plus renovation) that will be financed with a loan. These loan products are geared towards rehabbers, allowing them to renovate the property mostly on lender’s dime. This sort of a loan assumes that the total project cost is a relatively small fraction (up to say 70%) of the property’s after repair value (ARV), so it isn’t suitable for a turnkey property or one that is very nearly so. The lender will use past experience to evaluate the borrower’s ability to pull the renovation off. As you may expect, this means that more experienced rehabbers get better loan terms. Don’t forget that rehab loans are usually completely separate loan products - this is not typically an add-on to a different loan program.

What are borrower credit score limits. Lenders will most of the time set credit score limits for borrowers or guarantors. Better credit scores get better loan terms. This is done on the assumption that credit scores are good predictors of the likelihood of loan default for a given borrower. While that assumption–sadly–has not received enough scrutiny to be regarded as scientific, it is the reality of the USA lending landscape today, and we as borrowers must wrestle with it.

Reserve requirements. Some loans will require that you have a certain liquid reserve (cash or cash equivalents) before, and after taking out a loan. Typically larger loan amounts will require liquidity in the amount of 6 to 12 months of the amount of debt service, and a net worth of about the full amount of the loan.

Is the loan compatible with your entity structure? Some lenders will not lend to LLCs, or LLCs owned by other companies, or LLCs ultimately owned by trusts, and other common asset-protection arrangements. Make sure to know the lender’s position on this early of time to avoid closing delays or fall-throughs. Where this comes back to bite you if you don’t check for it, is when the lender starts inquiring about the ownership structure of the entity that will hold the title to property. This is a normal part of the lender’s loan underwriting process and can’t be skipped. However, since the underwriting can take a long time, you can save yourself a lot of work upfront and save a lot of precious closing time if you ensure that your deal structure is compatible with the intended loan.

Other limits. My colleague Bo notes that lenders limit the amount of credit that a seller may give to the buyer in a transaction, say to 2% of the loan amount. We speculated that this is to prevent a situation where a loan becomes effectively a cash gift to the buyer, at lender’s expense. While this is an interesting limitation to ponder, it was never a factor in any of our transactions.

Portfolio loans

With the FHA and VA loans described, we are leaving the area of conforming loans, which forms a significant percentage of total mortgage lending in the USA, and are entering the realm of custom, or “portfolio loans”.

These loans are not written to be sold to any of the government agencies. They are kept on the lender’s books (hence: portfolio loan), which means that the lender remains the owner and the servicer of the loan.

It is of course always possible that the loan gets sold for various reasons to a different owner and/or servicer, but when that happens the loan terms will not change. I do not see that the servicer address makes a difference to the borrower for the lifetime of the loan.

The loan terms that you will see in portfolio loans are starting to become more varied. The government lending programs still set the benchmark for other loan programs, so you will tend to see a menu of options for fixed rates loans–as a reminder, still a very US American thing.

Seller financing

Before we go into the territory of “esoteric” loan programs, we’d do well to mention the humble seller financing. This is exactly what it says on the tin: the buyer makes an agreement with the seller to finance part of the real estate purchase. In a way, the lender becomes the bank. For elaborate, and especially unusual properties, it is worth inquiring about this option. Some sellers are open to it, and are willing and able to write up a promissory agreement that allows them to collect money with interest from the buyer-borrower.

There are a few reasons why sellers may be open to seller financing. One is that the property has unusual qualities, making it ineligible for regular financing. In this case, the seller tries to sweeten the deal for the buyer by offering a way to finance the deal without going to a bank and going through an underwriting process. Another reason why the seller may be willing to do so is if they are wanting to convert their asset into a fixed monthly income. This is sometimes attractive to sellers who are looking to retire from the investing career, and prefer a steady stream of cash flow to a lump sum payment. They also get to collect interest on loan payments which would otherwise have gone to a bank. Sellers that expect to be in a low tax bracket can split their sale proceeds across a long time period, placing them into a lower tax bracket compared to them receiving a (large) lump sum payment in a year. This trades off the availability of money for a longer time to repay, so it is something that not all sellers would be open to. But it is always reasonable to ask.

Assets that are usually sold this way are mobile home parks. My understanding is that they are otherwise difficult to finance (although I do not have first hand experience, so take with a grain of salt), and seller financing may not only be the only way for a non-cash buyer to buy into the property, but may also be the only way for a seller to attract prospective buyers. However, with the eyes of large financial institutions and funds turning from high end to all aspects of real estate, the landscape here is changing too.

Jumbo loans

Jumbo loans are loan products that look like government backed loans, and quack like government backed loans, but are actually portfolio loans. Jumbo loans are all too familiar to investors or home buyers living in geographical locations with notoriously high real estate prices–coastal cities like New York, San Francisco and Seattle being typical examples. While the conforming loans These loans are typically available to high net worth professionals for buying–to some opinions overpriced–homes in expensive coastal cities. The qualification criteria for jumbo loans are by and large similar to those of conventional loans, with the obvious exception of very different loan limits.

Adjustable rate mortgages (or ARM)

A popular loan product is an adjustable rate mortgage (ARM). This loan product is somewhat more similar to the loans one can typically get in Europe. ARMs usually have a period of fixed rate (sometimes called a “teaser” rate since those are usually lower than competing fixed-rate loans), usually 3 or 5 or 7 years. Thereafter, the rate is adjusted in regular intervals, usually in 1 year increments. This is usually denoted as 3/1 or 5/1 or 7/1 ARM. When rates are adjusted after the expiration of the initial period, a number of limitations apply to the interest rate. The initial adjustment cap limits the initial adjustment of the interest rate. The subsequent adjustment cap limits each subsequent increase. And the lifetime adjustment cap limits the total amount of interest rate increase over the lifetime of the loan.

Commercial loans

This label includes a vast swath of portfolio loans, originated by private companies: banks, lending houses, funds and the like. Commercial loans can be used to finance pretty much any real estate purchase, provided that the parameters of the deal conform to the lender’s underwriting standards. Different lenders place different weight on various parameters of a deal depending on the intention of the borrower. Parameters that enter the lender’s deliberation process (usually called “underwriting”) include: the borrower’s income, creditworthiness, past financial performance, personal financial statement, and past experience with the type of business plan proposed in the acquisition. The parameters that concern the property itself are: the purpose of the property, the geographical location, past performance–usually proven through the so-called T12 or the “trailing twelve” months financial statement as well as rent roll (list of tenants, evidence of vacancy, rent amounts and contract begin and end dates)–the profit and loss statement (or P&L, which represents the account of the income and expenses on the property for usually at least the past year, sometimes two).

With commercial loans, almost any parameter is negotiable. This is in contrast to conventional loans, where parameters are by and large determined by the FNMA selling guidelines. Although there also is some play, as lenders have some leeway to adjust the rates and other loan costs, based on how much they want you as a customer. Your desirability as a customer depends not only on you and your project, but also on how close the lender is to achieving their lending goals for the current period. This means that it pays to shop around for the best deal for a loan, just as you would be inclined to do this in case of any other purchase. This is called competitive bidding, and it sometimes helps in negotiations to make it clear to the lender that you are asking multiple lending houses to compete for your business.

What documentation is required to back up the borrower’s application. This includes a number of document types, depending on the type of loan and intent:

Commercial loans are usually recourse loans, and are in many cases the only way to finance 5 or more units of residential real estate that requires less than $1,000,000 to finance. The upside is that the paperwork is usually less than the conforming loans, the lender contact points are more efficient and business oriented–but also expect you to be too. The lenders are usually fine to close in the name of a company, but will require personal guarantees, and will want to know the debt service limitations for your property. An upside of closing the loan in the name of a company is that the loan never appears on your credit report–this way you can extend your creditworthiness as much as needed to support your real estate business plan.

Non-recourse loans

Once your investment acquisitions go over about $1M of debt, another source of financing becomes available to you. For amounts starting from about $1M to over $100M, there is a big variety of non-recourse loan programs. In non-recourse loan programs, the property itself becomes the only collateral for the loan. That is, the personal financial situation of the borrower becomes secondary–though not entirely irrelevant.

These loan products are again underwritten by government agencies, allowing the lenders to offer unusually good terms despite the large amounts of debt involved. This web page offers a detailed overview of these loan programs, and there are at least a few dozen of them.

Let us line up a few typical characteristics of non-recourse loans:

Loans such as these are a critical tool for financing large acquisitions, by single investors, an investor group, or a syndication. Having at least a rough idea of the options available adds to your real estate investor toolkit and opens up options for making various kinds of deals work.

Bridge loans

Bridge loans are short-term loans (typically 12 to 24 months) taken out if for whatever reason the property is not eligible for long term financing. A typical example would be a “rehab” acquisition of an apartment complex. When the property requires extensive renovation, or is distressed, it is ineligible for long-term debt. This is where bridge loans come in. They take more risk, but allow you some breathing room to rehabilitate and turn a property around, and then refinance into long term debt. Bridge lenders have a variety of options and will tolerate risky properties, in exchange for appropriate relatively higher fees and interest rates compared to long term debt.

Private money

In short, this is debt that you take on from private individuals that are willing and able to lend to you. The terms here are basically whatever you agree with your lender, subject to some regulation, such as usury laws which determine the maximum interest rates, and the “approved federal rate” (AFR), which determines the minimum interest rates.

The upside of private money is that, depending on the relationship you have with your private money lender, the lending process can be relatively uncomplicated. If your private money lender knows you and your abilities well, they might be prepared to lend to you based on the relationship alone, regardless of the parameters or the risk levels of the deal.

The downside is that the private lender needs to be motivated to lend the money to you (vs investing it somewhere else). This usually means that such loans will charge high points and higher interest rates when compared to institutional loans.

Conclusion

This has been a quick tour of the lending landscape that you may be seeing when looking for appropriate financing for your real estate acquisition. Main takeaways are:

Good luck in your real estate endeavors!