Which finance option is best

General Real Estate Investing
1

Here are my options:

  • I have a GFE from a lendor for conventional financing 30 year fixed, 7.5 (market interest rate), 20% down. The problem with this is, after a couple of deals my cash is GONE.
  • Through a local bank, same rate as above EXCEPT they will allow me to put the 20% into a cd that I hold as collateral. Then I can refi and get the 20% back for other deals. I would just have to do closing costs 2 times as opposed to 1 time because of refi. Also, he said I could buy the property with a NEWLY established LLC as long as I’m personally responsible. This way, I don’t have to worry about transferring a property into an LLC later or worry about having established business history/credit. They also don’t care as much about income, credit, job history, etc… If I buy using the LLC, it won’t go towards my limit of 4 properties? Is there anything I need to look at when doing this kind of financing? I want to make sure that there are no “fine print” clauses that say something about not being able to refi for 12 months…

Any thoughts? I like the idea of just borrowing against a cd and then getting my 20% back so I don’t tie all my money up!

2

I might be missing some detail here, but why would the bank let you re-fi and essentially go 100% financing on the property?

3

Through a local bank, same rate as above EXCEPT they will allow me to put the 20% into a cd that I hold as collateral. Then I can refi and get the 20% back for other deals.

What happens here is that you pledge the CD as collateral. You still get all the interest the CD earns in the meantime. These loans are typically personal loans, with terms up to one year. After six months of title seasoning, you can cash out refinance to get your downpayment back. The refinance loan will be limited to a maximum of 80% (75% for some lender) of the appraised value, so you have to have quite a bit of equity in the property to begin with.

Also, he said I could buy the property with a NEWLY established LLC as long as I’m personally responsible. They also don’t care as much about income, credit, job history, etc… If I buy using the LLC, it won’t go towards my limit of 4 properties?

I think you will find that the bank will care about your income and credit score. They will run your credit and use your credit score to qualify for the loan. Yes, the loan will be in your LLC’s name, but your credit will be used to qualify because you will still personallly guarantee the loan.

The reason this loan won’t count against the Fannie Mae 4 property limit, is that this will be a commercial loan. Fannie Mae does not buy commercial loans, so it does not count against your risk profile for Fannie Mae. After all, if you default on this loan, it won’t be in Fannie Mae’s loan portfolio.

Commercial loans commonly use a 15 year amortization period (could be longer if you have an established track record), with a five year review. Every five years, the bank will essentially ask you to requalify for your loan. If you or the property fails to meet their loan risk criteria, your loan will be called due. Along with the 15 year amortization schedule, your interest rate will be a little higher than a residential mortgage loan, so your debt service will be higher than you would have with a 30-year loan. The higher debt service will squeeze your cash flow.

Just some things to consider when you do your cash flow analysis.

4

I was talking to a different mortgage company asking him what it would take to refi and like you said they would refi for 80%, BUT he said they would base this on the SOLD price if it’s within 12 months and NOT BASED ON AN APPRAISAL. So, if I buy a place for instance for 100k does this mean they would only refi up to 80% or 80k?? I asked him this question, and he said that I would only be out of closing costs a 2nd time and not be out of 20% down?

I need to find out if there is any seasoning timeframe. I’m not sure I want to do that either (that still ties money up for 6 months).

5

If the purchase price is $100K and you put $20K down, then you are financing $80K. If you refinance based on the sold price, then you are just refinancing the same $80K and not getting any cash out to “buy back” your CDs.

Interesting that they require one year of seasoning before they will refinance based upon appraisal. Just another indication that the credit markets are getting tighter and the underwriting rules are getting stricter.

6

Ok, just found out is is based on appraisal and not sales price. One big plus the local bank has over conventional (other than not putting 20% down) is the fact that the rate is only 6% as opposed to 7.5% I got from the broker…

7

Yes, refinances are usually based upon appraisal after a minimum holding period has been met. Until then, you may be limited to a rate and term refinance with no cash out. How long do you have to hold title before you can refinance with cash back at closing?

8

I think 12 months (at least that’s the case if I refi with the local bank). I’m not sure I want to refi if at all possible…they are offering a 5-10 year loan at 6% (as opposed to 7.875 I got quoted elsewhere) which boosts cash flow up an additional $150/month.

9

You need to be very clear on the financing terms you are being offered. A fixed rate commercial loan these days carries an interest rate in the 7.5% range.

There are commercial loans with rates fixed to the prime rate plus a margin. Since you are being offered 6%, the rate for your loan may be quoted as “prime plus one”. This means that every time the prime rate changes, your loan interest rate will also change. In effect, this makes your loan a variable rate loan. If you think the prime rate will stay at 5% (or lower) for the next several years, then go with this loan.

If you believe there is a realistic expectation that the prime rate will increase in the near future, especially if the Democrats control the Executive and Legislative branches of government after the next election, then the higher fixed rate loan may prove the better choice for a long term holding.

10

Hmm, he failed to specify that the rate was variable. Is there danger that this rate could go sky high? That was one of the reasons I was leaning towards this was because the rate was only 6%. Also because I don’t have to tie up 20% into the property.

11

Look and see if there is a cap to how much and how frequently your rate can change. For instance, can it go up only 1% max each year or 3%?
Also be careful to not fall into the “oh we’ll be better off 3 years from now when this resets to a higher rate and we can refi for a fixed rate then” argument that many Americans did and are now regretting.

12

But your 20% is still tied up. You can’t redeem the CDs without paying off your personal loan.

13

But it’s only tied up till I refinance (which my broker said I could do without seasoning. The refi would go against appraised value and not sale price.

Looks like I would need to refinance anyway because the bank doesn’t have 30 year financing. Only 12 month, 5 year, 20 year. I plan to do the 12 month financing and then refi after repairs…

What does appraisal prices usually come in at??? My county has this thing appraised at 220k, HOWEVER market value according to sale comps are all over the place but probably around 170k. Repairs needed are 10k.

14

You are making the assumption the appraisal is going to come in high enough to allow you to pull all your money out leaving you with none of your own money in the deal. You never did say what the bank’s LTV limit was based off the appraisal. You just said they would base it off the appraisal and not sales price. Appraisals are pretty much a racket IMO. They always seem to come in just where they need to be in order for the buy to get the loan. If your bank only goes to 80% of appraisal and that appraisal comes back close to your purchase price, you’re still 20% in the deal anyway.
Does your county have it APPRAISED at 220k or ASSESSED for taxes at 220k? The county assessment may or may not be anywhere close to what your appraisal value will be.

15

I don’t think you completely understand what you are being told.

Refinances are always done against appraisal. The lender will order a curent appraisal, so it does not matter what the tax assessor, an old appraisal, or even three month old comps says your property is worth. The lender will only look at what its appraiser says your property is worth in the prevailing market at the time you apply for the loan. What is pertinent to you is whether you are taking cash out of your equity with the refinance.

The first refinancing option is to just refinance your current loan balance (perhaps to reduce the interest rate and/or extend the loan term, with the goal of reducing the monthly debt service) without taking any cash out. This is called a “rate and term” refinance. The current loan balance is the amount of your new loan after refinancing. Many lenders have a “limited cash out refinance” which allows you to roll your settlement costs into the loan balance, but you are not walking away from the settlement table with any cash in your pocket. A rate and term refinance often can be done with just one day of title seasoning. The refinance amount will be limited to a certain percentage of the appraised value of the property. If property values have fallen and the maximum LTV is 75%, you may not be able to refinance your entire loan balance.

The second refinance option is the “cash out” refinance. With this option, you are not only refinancing your current loan balance for a lower interest rate and/or a longer term, but you are also increasing the amount you borrow – that is “cashing out” some of your equity in the property. Once again, the refinance amount will be limited to a certain percentage of the appraised value of the property. If you originally borrowed $80K to purchase a $100K property, you either brought $20K cash to the settlement table or collateralized other assets to borrow $20K in a separate loan.

If the lender will only allow 75% LTV on a cash out refinance, then your property will have to appraise for approximately $134K for you to be able to borrow $100K to refinance your first mortgage and to get enough cash to pay off your separate loan.

For some time now, cash out refinances have required at least six months title seasoning, but, lenders have begun tightening up the rules. Many are now requiring one year title seasoning before they will allow a cash out refinance.

Make sure you talk to your loan broker to clarify all these points as they may pertain to the loan program you are considering. Also, make sure you fully understand what a 1, 5, and 20 year loan really is and what the amortization period is for each loan term and what the balloon payment will be for each loan. Additionally, ask whether the 20 year loan has a 5 year review and what that means to you if the bank decides to call the loan due at the end of five years.

Once you have a complete understanding of the loan terms and all its variables, shop your commercial loan among other lenders. Don’t just take the first offer you get. See if you can do better with a competing lender.

Lastly, don’t ignore the Fannie/Freddie conforming loans. A full doc, conforming, 30-year fixed rate consumer residential mortgage loan will usually have better terms than a commercial loan.

16

Thank you very much for the post/responses! Great post and on point.

The only thing I see wrong with the 30 year fixed rate consumer is that I have to tie my money up and that dries upmy cash for future deals. As far as the appraisal, I don’t see it being a problem appraising for at least 134k. The sold comps are at about 200k for similar properties.

I do need to clarify those points you made about the different loan types. My plan was to do a 12 month loan and then refi right after I finish the repairs. I did talk to a broker and he said there would be no problem doing a refi on appraised value vs sale price before 12 months.

As long as the appraisal value is there and I don’t have to wait 12 months, then I don’t see it as an issue to get a commercial loan?

17

Ballgum - I would double check with the lender. When they say that they are going to use appraised value make sure that they mean a new appraisal done at the time you refinance. I was discussing refinancing options with few lenders recently and they told me that I would be able to refinance up to 80% of appraised value after 6 months. Only after I asked several questions I finally understood that they were not going to order a new appraisal. When they referred to appraised value they were talking about the appraisal done at the time of my original purchase, not a new appraisal.

All three lenders I talked with told me that they would get a new appraisal only after 12 months.

Good luck!

18

The only thing I see wrong with the 30 year fixed rate consumer is that I have to tie my money up and that dries upmy cash for future deals.

The money you are tying up is the 20% downpayment you are bringing to the settlement table. You can still use your bank CDs to get the 20% downpayment from a personal loan and use an 80% LTV consumer residential mortgage loan for the rest of the purchase price.

far as the appraisal, I don’t see it being a problem appraising for at least 134k. The sold comps are at about 200k for similar properties.

If the comps are there when you plan to refinance, you can still cash out refinance a residential consumer mortgage loan after 6 to 12 months of title seasoning depending upon the lender.

I do need to clarify those points you made about the different loan types. My plan was to do a 12 month loan and then refi right after I finish the repairs. I did talk to a broker and he said there would be no problem doing a refi on appraised value vs sale price before 12 months.

Refinances are always done on appraised value. The seasoning timeline determines whether or not you can take cash out of your equity with the refinance.

As long as the appraisal value is there and I don’t have to wait 12 months, then I don’t see it as an issue to get a commercial loan?

I never meant to suggest that a commercial loan is an issue. I am only suggesting that a commercial loan is often more expensive in the long run. If you can qualify for a Fannie/Freddie conforming residential mortgage loan, why not get that instead. Unless there is a new Fannie/Freddie rule that limits your ability to refinance, you still have all the same refinancing options that you describe with a commercial loan.

19

Can you please explain further what you mean by this? I don’t quite follow… My point was that if I use my 20% for a down payment, then that 20% is tied up in the property. Are you saying maybe that I can cash out refi down the line (after seasoning) and pull that money back out??

I was talking to a broker and he said that I wouldn’t have to wait and I could refi (based on appraisal) right after making repairs for up to 75-80% LTV. The reason I said based on appraisal in the previous sentence is because another broker I talked to said it would be based on sales price within the 1st 12 months, BUT the broker I spoke to today said it doesn’t matter and I can refi based on appraisal right after making repairs…

20

Refinances are ALWAYS based upon appraised value and are usually limited to a maximum of 80% of appraised value, although some lenders are lowering the maximum to 75%.

The question to ask this broker is whether you will be allowed to refinance for more than your loan amount without any title seasoning. You can usually refinance your loan amount without title seasoning as long as that amount does not exceed 75% (or 80%) of the appraised value of the property. The title seasoning requirement comes up when your refinance lets you walk away from the settlement table with cash in your pocket.

Your strategy is to get two loans, one on the property itself and a second loan on other assets you own. The second loan is not tied up in your property, but ties up your bank CDs. Later you plan to consolidate the two loans into one to free up the bank CDs. I am just saying that your first loan does not have to be a commercial loan. Your strategy will also work if the first loan is a consumer residential loan.

True, the interest rate for the commercial loan seems better right now but you have no assurance that the rate will stay better. If the prime rate goes up next month, your commercial loan rate may also increase. You need to make sure that this commercial loan does not have a variable rate (probably linked to the prime rate).

I suspect the commercial loan does have a variable rate simply because the rate is just 6%. A 20 year fixed rate commercial loan will probably have a rate that is much higher and will also charge you a couple of points.

If you can refinance as soon as the repairs are completed, refinancing into a variable rate commercial loan may not be your cheapest financing approach. I am suggesting that a Fannie/Freddie conforming residential mortgage loan, is probably a better alternative for your refinance, even if you started with a commercial loan, as long as you are comfortable with the title seasoning requirement for the refinance loan.

Let’s assume that the cash out refinance will have a title seasoning requirement between six months to one year, regardless of whether your loan is a commercial loan or a consumer residential loan.

If this is the case, then why not just start with the consumer loan to begin with. If you are willing to pay the points associated with a commercial loan, I wonder if you get a fixed-rate consumer loan that also charges less than 6.5% if you pay the same number of points?

If the answer is yes, then the 30 year fixed rate consumer loan will have a lower debt debt service than any of the commercial loans you are discussing. With the 30-year fixed rate loan, you can use the increased cash flow to pay off your second loan on the CDs in a year or two and never need to refinance any of your loans.

If you tabulate all the loan costs, both for the original loan and for the loan refinance, and factor in the debt service for the loans, the consumer loan will usually have a lower cost of funds than the commercial loan.

If you get a 30-year fixed rate Fannie/Freddie conforming loan to begin with, your higher cash flow and the money you would spend on refinancing could be used to pay off the loan against your CDs and free up that asset. No refinancing required.

You have several options to explore. The cheapest option is not always the one with the lowest initial interest rate.