Getting a loan to purchase residential investment property has become more difficult. The discussion below summarizes some of the options that still remain.
Conventional financing – If you currently own fewer than 4 residential properties, conventional financing (Fannie Mae or Freddie Mac) is still available to you. However, maximum leverage is 80% (20% down), and you have to put at least 25% down to get a decent rate. While underwriting guidelines state you can qualify with a credit score of 620, you need at least 680 to get anything approaching a good rate. A score of 740 or above will get you a nominal rate of about 6.5% on a 30y fixed rate loan. Expect to pay a higher rate for duplexes, triplexes, and 4-plexes.
The 4-property limit makes it difficult to acquire multiple properties with conventional financing. (As an aside, I heard a rumor about a month ago that one or both of Fannie and Freddie are considering easing this restriction, but I have heard nothing to corroborate this rumor.) Thus, it is important to look at alternatives that are available in this tight credit market.
Local Banks – Local banks picked up some of slack in financing investment properties last year, but I’m hearing more and more from my banker friends that they have stopped. Many of the banks are scared to make real estate loans right now because of potentially falling home prices and increased foreclosures. I also understand regulators are putting pressure on them to stop lending on real estate, especially “speculative” real estate. If you can find a local bank willing to lend on investment property (when I say local, I’m suggesting smaller banks, banks with maybe only a couple branches – not the Bank of America down the street), count on no better than 75% loan-to-value and very strict underwriting rules. They will want to see liquidity – “cash in the bank” (not necessarily their banks). The idea is that these “reserves” will cover you if you’re unable to keep the property rented or you have unforeseen expenses.
Rehab and Hard Money Lenders – This is private money and generally expensive money. Expect to pay 3 to 8 points and 10% to 18% interest. These are short term loans. The lender expects you to flip or refinance the property in a short period of time, usually a year or less. That begs the question why would anyone use these lenders? Well, they specialize in helping investors pick up foreclosure properties, especially ones that require some rehab work. Most of these lenders will lend based on the ARV (after repair value) of the property, and many will lend up to 100% of the acquisition and rehab costs. Most restrict the loan-to-value to around 65% (maybe a little higher) of the ARV. So, if you agree to purchase a property for $50k, and the property needs $25k in rehab, you could conceivably purchase the property with little money out-of-pocket if the ARV was around $125k. (But, remember, the lender orders the appraisal.)
That all makes it sound easier than it is. Liquidity is a HUGE issue for rehab lenders. They generally want you to have money in the bank sufficient to cover at least half the rehab costs plus 3 to 6 months of interest payments plus the closing costs (points plus other fees). This is even if the ARV is sufficient to absorb these costs into the loan. They don’t want to foreclose on the property, so they want to make sure you have enough cash to cover everything, foreseen and unforeseen. Other personal financial factors are not as significant. A credit score of at least 640 will grant you consideration, but higher scores and higher incomes improve your chances.
One final comment on rehab and hard money lenders: In the last couple months, I have noticed several of them have stopped funding residential properties. I don’t know why, but I suspect it stems from concern about real estate prices.
Seller Financing – Sometimes, the property seller will agree to take a lien against the property rather than cash at closing. This is more likely if the seller currently has no lien against the property or if the seller is having a hard time selling the property. There are no rules for seller financing. The financing terms are whatever you and the seller negotiate into the contract.
I hear from my realtors friends that there are some real bargain properties out there. These are the financing options available to you. While they are quite restrictive, I have talked to many investors who are making them work to their advantage.
As a closing comment, I want to mention that some investors are choosing to move their 401k money into real estate. This requires a special lender with an appetite for this sort of thing. Fortunately, a few such lenders do exist. I will save the details for another blog.