Designing the best rental loan | Think about real estate

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A series of articles on navigating the world of private lending

Many real estate investors lack the tools available to customize a rental loan and achieve their investment goals. Make sure you’re not one of them.

The fundamentals of a long-term rental loan are similar to those of a compliant consumer mortgage. Most investment borrowers can receive a fixed rate for a set number of months, along with a monthly payment obligation.

But let’s go beyond the basics to look at how you can tailor the loan to your plans. The following discusses the investment strategies and features available to optimize your loan.

Loan to value

When deciding on your loan amount, the lender has Loan to Maximum Value (LTV) guidelines for your property type and borrower profile. In today’s world of private lending, it’s typically 80% LTV for purchases and no cash refinances and 75% to 80% for cash refinances. Sometimes investors consider the balance between keeping their capital in the property and the amount of positive cash flow they will receive monthly.

Example: $200,000 property

Consider a $150,000 loan at 5.25% with a monthly principal and interest payment of $828.00, or a $120,000 loan at 4.75% with a monthly principal and interest payment of 626 $.00.

Here’s your decision to make: do you lock in $202 a month in improved cash flow for 30 years or do you take the extra $30,000 in cash?

Here’s the break-even calculation: $30,000 / $202 = 148.5 months to recoup the $30,000 through lower monthly payments.

Adjustable Rate Mortgages (ARMs) vs. Fixed Rate Mortgages (FRMs)

Most lease lenders offer a variable rate product as well as a 30-year fixed rate option. In today’s low rate environment, it’s crucial to know when to consider a variable rate mortgage versus a fixed rate mortgage. Here are some considerations:

  • Short and medium term holding. When you hold the property for a few years, it makes sense to take the slightly lower interest rate offered by ARM products.
  • You plan to refinance again. If you are sure to refinance again soon, an ARM loan may be preferable. For example, if your credit score is lower than you’d like and you’re not getting the best rate, an ARM gives you time to improve your score and refinance in the future. Another example would be if you are planning to make improvements to the property. This could allow you to obtain long-term financing once the improvements are completed and the value of the property increases.
  • The rate difference is significant. Currently, the rate difference is approximately 0.25% between a 30-year fixed rate and a 5/1 Adjustable Rate Mortgage (ARM). An ARM 5/1 is fixed for the first five years, then it adjusts once a year thereafter. With our current historically low rates, most investors choose to lock in the rate for 30 years, unless they plan to sell or refinance within the next five years.

Rate and Fee Options

Private lenders usually offer a base rate, which may or may not come with origination fees. These origination fees usually range from 0% to 2% before a borrower has the ability to pay more or less to adjust the rate up or down.

For example, suppose the borrower pays extra to raise the rate from 5.375% to 4.875% for a loan of $150,000. The total cost to redeem the rate is 1.375% of the loan amount or $2,062.50. The payment difference is $56 per month. The calculation of the break-even point is as follows:

$2,062.50 (buy-back cost) / $56 (monthly payment improvement) = 36.83 months or approximately three years to break even. Borrowers will need to consider their holding period for the property to determine if redeeming the rate makes sense.

Longer or shorter prepayment penalties

Your holding period is an important consideration when determining a prepayment penalty period that the borrower is comfortable with. A prepayment penalty is calculated based on a percentage of the outstanding loan balance.

Prepayment penalties generally range from three to five years. Selecting a borrower can make the interest rate or fees on a rental loan better or worse. The most cited prepayment penalties are 5% for five years and the five-year declining prepayment penalty. The declining prepayment, or “54321,” is a penalty that starts at 5% in the first year, then decreases by 1% each year thereafter until it expires at the start of the sixth year of the loan.

Most lenders offer options to shorten, extend or modify the prepayment penalty period depending on your investment strategy. This allows you to pay a higher rate or fee to reduce the prepayment penalty period to just one year. Investors may want to consider this option over a short-term bridge loan for properties they plan to sell in the next one to three years. In many cases, the rate of a long-term loan, with the shortening of the prepayment penalty, is higher than the standard bridge loan.

Additionally, many lenders offer seven-year prepayment penalty options. These options can lower the rate or fees on a loan and are good if you’re planning a very long deferral.

Interest only or depreciable loan

“Interest only” means that the monthly payment is only the accrued interest for the loan. Lenders often offer an interest phase of five or ten years followed by a shortened amortization period.

Investors with a short-term holding horizon may consider this option. Since there is no significant repayment of principal created in the first five years of a 30-year amortizing loan, this strategy can maximize cash flow and capture property appreciation during the period. of detention.

Many borrowers with a long-term holding horizon choose the amortizing loan structure, with the goal of letting their tenants’ monthly rent payments pay off the loan balance for them.

Individual or Portfolio Rental Loan

When a borrower owns multiple rental properties, they may need to consider whether it is best to finance them all as single property loans or bundle them into an overall portfolio loan.

Lenders offering general or portfolio loans usually have release clauses for the repayment of a single rental property from the pool. This allows a property to be released from the loan obligation. Typically, lenders require 120% of the loan amount associated with that property, in the pool, to pay it off from the group.

Example: Property value: $100,000

Loan amount associated with the property: 70% LTV = $70,000

Cost required for release (120% x $70,000) = $84,000

Therefore, an additional $14,000 is deducted from the sale proceeds of the property, which the lender will use to reduce the principal balance of the existing loan. Importantly, it is not a prepayment penalty since the extra funds are used to pay off the outstanding loan.

Another option is to use individual loans on each property. Lenders may have underwriting fees of $500 to $1,500 per property. If you have five or fewer properties to finance, it might be a good idea to apply for individual loans and negotiate lower underwriting fees.

When designing a rental loan, it is important to study your loan options and better support your investment strategies. Be sure to connect with a trusted broker or lender that has these capabilities. A great financial partner can help you save time and money and increase your profitability.


Damon Riehl is the founder and CEO of Investment Property Loan Exchange. He has over 35 years of lending experience across a wide range of asset classes, including commercial and residential mortgages, small business and construction loans.

Riehl has held senior leadership positions as Head of Commercial Lending for Ocwen Mortgage, Head of Unsecured Lending for Citibank, Global Mortgage Leader for GE Capital, and Head of Building Products at Fannie Mae. He is a Fellow of the Harvard Joint Centers for Housing Studies.

Riehl has built six de novo lending platforms and used this knowledge to create and grow Investment Property Loan Exchange and FinTech platform LoanBidz.com.


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