The Pros and Cons of Conventional Real Estate Loans
Although conventional lending is perhaps the most common type of real estate loan, it may or may not be the best option for you. There are both advantages and disadvantages to be aware of before obtaining a loan, and the more aware you are, the better loan decisions you can make.
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
Low Interest Rates
There’s no denying it: conventional loans likely have the best rates you’ll find for long-term real estate financing. With investment loans usually .5 to 1 point higher than owner-occupied loans, you can borrow money at incredibly low rates (as of this writing, you can still get investment loans at less than 5% interest). This will help keep your mortgage payment low
and thereby maximize your cash flow.
Related: Conventional Mortgage Loans: The Basics on How They Work
When you borrow from a conventional lender, your loan will likely be able to extend for a long term, maybe even up to 30 years if you're buying a residential property. This can help keep your payment low, though it will also extend the amount of time you'll have debt on the house.
A conventional lender is in the business of lending, so the entire process is much more defined and professional than a relationship-based loan would be. This isn't the lender's first rodeo!
Max Number of Loans
Conventional loans may have great terms and rates, but real estate investors are capped on the number of conventional loans they can have. The current limit has been raised to 10 loans, though many investors are not even able to get to that limit because of the rise in their debt-to-income (DTI) ratios. In other words, for every loan you obtain (debt), the percentage of your debt to your W-2 income rises, until you are pushed out of the "acceptable" range defined by the conventional lender. I'll talk more about this DTI issue in the next chapter.
Conventional loans are not fast to obtain. Because of the legal scrutiny your loan must go through and the mounds of paperwork you'll must provide, the process of obtaining a loan can be arduous, usually taking 30 days or more.
Conventional lenders only want to lend on properties that are in good shape. This can rule out a lot of the best properties for investors, because we tend to focus on properties that are in terrible condition so we can improve their quality and value. If the property is missing any of the basic necessities for home living (for example, it has bad flooring, a poor paint job, a leaky roof), the bank will likely not fund the deal until the issue is fixed.
Not Very Entity Friendly
Conventional lenders are also not very fond of loaning on properties owned by an entity, such as an LLC or corporation, especially for residential loans. In other words, if you want to keep your name off the public record and add some asset protection by purchasing the property with your LLC, a conventional lender will likely never do it. You could, as many investors do, buy the property in your personal name and then transfer it to your LLC, but you put yourself at risk of having the “due on sale” clause called by the bank.
The due on sale clause is a part of nearly every mortgage paperwork that says, "If you sell or transfer the property, we have the right to call your loan due now or foreclose on you." This has been happening more and more lately in the real estate space, so I can't suggest that this is a good idea. Be sure to talk to a lawyer and CPA who can help you sort these types of issues out. But the point is this: conventional lenders don't like entities.
So, should you use a conventional loan? Personally, I love getting conventional loans if I can get them. However, those days have long since passed for me, because I've hit the limit on the number of conventional loans I can obtain. If you are still able to do so, I would definitely strongly encourage you to use a conventional loan for your next property. Very few financing strategies can live up to the low cost and stability of a conventional loan.
What kind of funding are you using for your portfolio?
Leave your input below!