Starting a Mortgage Finance Company

13 Replies

One of the aspects of the real estate industry that interests me is the abundance of niches. I'm excited by the different ways in which entrepreneurs can pursue opportunities in this industry. I'm interested in exploring the mechanics of starting a mortgage finance operation to originate, underwrite and fund loans to investors to purchase, refinance and/or rehab non-owner occupied SFR's and small multi-family property (<20 units) in California.

While I've participated exclusively as a borrower of capital to purchase investment property to date, I like the idea of using my capital to make loans secured by real estate. The real estate finance market for small scale investors seems less efficient and I wonder if it may offer better opportunities for competitive returns than traditional real estate investment avenues such as purchasing SFR's or small/medium multi-family property to rent. Additionally, my experience with banks and other traditional mortgage lenders has been frustrating. I've found their lending standards unreasonable and experienced an unwillingness to explore (or inability to comprehend) creative financing options, especially when investment property is concerned.

For some time I've wondered if the market for non-conforming real estate finance and investor loans is underserved. Since I seldom encounter discussions along the lines of "how do I become the bank?", I've struggled to gather adequate insight into the mechanics of starting a mortgage finance business and becoming a lender. I'm curious to hear from the private lenders, nonbank finance professionals and mortgage originators:

  • What moved you to pursue this side of the real estate industry? What appeals to you about this aspect of the real estate industry?
  • In mortgage lending, how is growth of a lending operation constrained? Is the scale of lending operations limited to personal capital and capital pooled from other private investors or are bank lines of credit a viable source of funds to use to originate new mortgages? What is the typical size of these lines of credit and what factors determine access to and volume of revolving funds that can be used to originate mortgages?
  • What are the key challenges to starting out as a lender?
  • What are the key challenges in growing a mortgage finance operation beyond finding credit worthy borrowers, complying with state and federal regulations and evaluating the quality of collateral to lend against?
  • What resources do you recommend to those looking to start a mortgage finance operation?
  • Are there legal firms specializing in helping entrepreneurs start mortgage finance businesses?

I don't seek trade secrets or sensitive competitive insight. Consider this as an honest inquiry into the basic dynamics of mortgage lending. I'm interested in getting started as a mortgage lender as I suspect there may be an opportunity to build a small/medium business in serving small time investors. Before jumping in blind, I want to qualify whether it's worth pursuing or if it's plagued by complexity, constrained by red tape and/or has unreasonable capital requirements that constrain growth. Any advice to a newbie looking to qualify this as a worthwhile endeavor would be greatly appreciated.

I would suggest doing some private lending to see the details of the business. In addition to actually lending you will meet others doing the same. You are correct in that there is a market for small loans to real estate investors. The problem will be scaling. If you use OPM's to finance investors you are in a new world of regulation. Hope peer to peer lenders, brokers and others can chime in with more detail on this subject for @John

Originally posted by @John Jacobus :

One of the aspects of the real estate industry that interests me is the abundance of niches. I'm excited by the different ways in which entrepreneurs can pursue opportunities in this industry. I'm interested in exploring the mechanics of starting a mortgage finance operation to originate, underwrite and fund loans to investors to purchase, refinance and/or rehab non-owner occupied SFR's and small multi-family property (<20 units) in California.

While I've participated exclusively as a borrower of capital to purchase investment property to date, I like the idea of using my capital to make loans secured by real estate. The real estate finance market for small scale investors seems less efficient and I wonder if it may offer better opportunities for competitive returns than traditional real estate investment avenues such as purchasing SFR's or small/medium multi-family property to rent. Additionally, my experience with banks and other traditional mortgage lenders has been frustrating. I've found their lending standards unreasonable and experienced an unwillingness to explore (or inability to comprehend) creative financing options, especially when investment property is concerned.

For some time I've wondered if the market for non-conforming real estate finance and investor loans is underserved. Since I seldom encounter discussions along the lines of "how do I become the bank?", I've struggled to gather adequate insight into the mechanics of starting a mortgage finance business and becoming a lender. I'm curious to hear from the private lenders, nonbank finance professionals and mortgage originators:

  • What moved you to pursue this side of the real estate industry? What appeals to you about this aspect of the real estate industry?
  • (1) In mortgage lending, how is growth of a lending operation constrained? Is the scale of lending operations limited to personal capital and capital pooled from other private investors or are bank lines of credit a viable source of funds to use to originate new mortgages? What is the typical size of these lines of credit and what factors determine access to and volume of revolving funds that can be used to originate mortgages?
  • What are the key challenges to starting out as a lender?
  • What are the key challenges in growing a mortgage finance operation beyond finding credit worthy borrowers, complying with state and federal regulations and evaluating the quality of collateral to lend against?
  • What resources do you recommend to those looking to start a mortgage finance operation?
  • Are there legal firms specializing in helping entrepreneurs start mortgage finance businesses?

I don't seek trade secrets or sensitive competitive insight. Consider this as an honest inquiry into the basic dynamics of mortgage lending. I'm interested in getting started as a mortgage lender as I suspect there may be an opportunity to build a small/medium business in serving small time investors. Before jumping in blind, I want to qualify whether it's worth pursuing or if it's plagued by complexity, constrained by red tape and/or has unreasonable capital requirements that constrain growth. Any advice to a newbie looking to qualify this as a worthwhile endeavor would be greatly appreciated.

(1) What is going to constrain you is that, from what you've said, these will be non-salable mortgages. If no one buys them on the secondary market, giving you back that money to lend to the next REI, it means you actually have to sit there and collect interest for 10-15+ years before you have enough back to re-lend to the next person. If you hypothetically charge 10% interest only and 2% upfront, it'll take eight years to recoup the funds you lent out. Let's say you want to compete directly with us Fannie/Freddie folks and offer rates in the 4s to REI. Great, now it's way more than eight years before you can originate the next loan. This is because you do not have unlimited money. We do have unlimited money, because we flip that debt right to Fannie/Freddie and get all of our funds back, and then some, the moment escrow closes. 

EDIT: I have spoken with note-buyers. But they do not pay a premium for that debt the way Fannie/Freddie do. They buy the debt at a discount, so if you do a $200k loan and charge 2 points upfront, they might be willing to buy it from you for $185k. $185k + $4k = $189k = you just lost $11,000.

Not trying to be a wet blanket, but I suspect it'll be better for you to think of this early rather than be caught off guard by it.

Crowd funding platforms are currently be used as a way to scale the SFR investor loan market. This is bringing a local business national. However, these platforms lose some of the flexibility of local, individual underwriting standards. The end result is institutional higher risk lending, rather than private financing.

The larger a business in this field grows, the more institutional it becomes.  Platforms built for peer to peer lending have evolved to where 90% of the loans are being made by large private equity funds.  When a certain volume is reached, economies of scale dictate institutional involvement.  

@John Jacobus - I think it's great that you're thinking about this. We've been working for the past few months on starting up a mortgage lender to focus on rental property finance (one of the niches you mentioned).  I agree with @Chris Mason that you need to be able to continually turn over your capital, but I don't think we should automatically assume that the loans you make with be non-saleable.  There are investors who will buy non-traditional mortgages, but typically they will want to buy them bundled together in packages of at least a few million dollars.  This means you'll need a good amount of capital to start out, and you'll need to be efficient with your capital markets effort in selling your closed loans so that you can keep lending.

To try to answer your questions more directly, in my opinion the biggest hurdle is capital.  Lending is a very capital-intensive business.  It is possible to get financing from banks, such as a warehouse line, but typically they won't want to go through the effort of giving you a line unless it's at least $5 million.  And they aren't going to give you $5 million if you don't a) have some of your own capital and b) have at least enough of a business and track record to make them comfortable that you can operate your business and pay back whatever they lend you.  

If you'd like to connect directly on this, feel free to shoot me a message.  We're located in NYC as well, so we'd be happy to connect and discuss more about this with you.  

@Eddie T. thanks for checking out our site.  You're right that we offer a loan product similar to Lima One's. We do offer a few additional loan options, such as adjustable rate loans and shorter-term interest-only balloon loans.  We're also trying to differentiate ourselves by putting the entire application and underwriting process online, helping borrowers close quickly and easily. 

Have you worked with Lima One on their rental loan products? We'd be open to any other feedback, comments, or questions you have.  Thanks for reaching out.  

@George Despotopoulos Their Minimum loan amount is 45k compared to your 50k I am not sure if you are able to offer any loan products under 40k? Maybe a 10 year product? 10 years fixed amortized over 20 ballon in 10. I know a lot of investors who would jump on a loan like that. Is your company able to offer portfolio loans? Say for example I have 5 properties i want to place into one loan all owned by 1 LLC. Also Lima One has raised the closing costs recently which has turned off quite a few of investors so if your closing costs and rates are lower then theirs you should pick up alot of business.

@Eddie T. Our minimum is $50k, but it's possible to grant exceptions if there are compensating factors, such as a higher percentage down payment.  We don't currently offer a 10-year balloon product, but it's an interesting thought.  Do you think borrowers just prefer a shorter loan than a normal 30yr, or is there another reason they would prefer a 20yr amort / 10yr balloon?

We don't offer portfolio loans, but we allow for multiple loans to one borrower, so your LLC could take a different loan for each property.

Are your properties in New York? If you'd like to connect to have a more detailed discussion, my email is in my signature. 

@George Despotopoulos The reason I bring up a 10 year product is because I understand that you must eventually package these loans and sell them to hedge funds so they must be attractive to the end buyer and at the same time offer a product that landlords actually want. Borrowers definitely prefer 30yr fixed but if you can offer some benefits for example lowering the 50k threshold for a 10year fixed their are several people on this site struggling to finance their rentals and would take that option. For me a portfolio loan is best if I have 5 50k properties in my opinion it is not cost effective to go out and pay 5 separate closing costs. I rather pay 3-4k Once then 5 times. 

One other product that many people on here are also actively looking for is a Line Of Credit Program secured by real estate that they already own free and clear.

@Eddie T. thanks for the feedback, all very helpful info!  You're right that we do plan to package our loans and sell to investors, and I agree with you that a shorter loan is more attractive to them.  I like your idea of a 10-year balloon, so we're going to look into that.

I totally understand where you're coming from on the multiple closing costs thing. We'll have to look into a portfolio product for investors like you who own multiple properties.

We don't plan to offer lines of credit - I think it would be tough to compete with banks on that product...i agree it's a good option for investors who own a property free & clear, just not our bread & butter.  

Thanks again for connecting and for your thoughts!

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