My first 18 loans on 5-year balloon. Is this bad and how should I pivot?

Question

I have been working full-time RE,  BRRRR method on single-family homes in my local area for the past 4 years.

22 homes completed-  (2 sold) 20 long term rented.

My interest for this Post is my lending method thus far. I have used 2 local banks for all my lending so far. (Ive checked "some" other options but came back to these)

- I have qty18   5-year Balloon type loans for my current portfolio.  amortized 2@10yr, 8@15yr, 8@20yr

- avg cashflow $320/ home

-2 homes no loan

-2.1m Appraised value, 1.1m borrowed on above loans. Portfolio (LTV 56%)

Pros- to my lending choice so far.

(many of my homes come in right around the 100k appraisal mark in which many lenders are not interested in Less than 100k loans)

-  Very low loan orig fees-  total bank fees Avg $1071 per home.

- Does not require escro taxes and insurance.

I have attempted on 2 homes to go with online lending options, Both of which fell through and were a bit of a hassle.

With my BRRRR process, I have had enough funds to have 2 projects going at a time.  Although any delays in cash out morg from the completed reno has great potential to disrupt my process. Therefore these fell through mortgage process have a significant impact on my day to day.

The 2 loans, one DSCR and one 30yr conv., Ran into issues as there was not enough rental comparison data in my area. So he moved me to an alternate lending source that wouldn't need this rental comparison info. Fees (and escro) by the time I paid everyone had me at over 11K closing on a 105k home. I backed out and closed through local bank with total fees of 1800 including title search and bank fees. That would have been 9k of cash that I wouldn't have had to move into my next BRRRR, (that times my 18 loans would've brought my active bankroll down GREATLY).
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As implied by this Post I am worried that my current loan structure is subpar to what I should be shooting for.

I have quite a bit of equity in these properties so a refinance at balloon due will have some advantages but with the increased recent rates I will likely take a decently large hit on cash flow.

*** What loan structure and fees do you all commonly lock down and what would you recommend in my situation? ***

Thank you for your time. For real, thx!

Stacy Raskin · Answer

There are 30 year fixed DSCR loan products which gives more flexibility and piece of mind then a 5 year balloon payment. You can refinance a DSCR loan but not on a specific timeline depending on the loan you choose.

Some DSCR lenders will go down to a $75K value and a $50K loan amount. It's the same work to do a $55K loan as a $500K loan so the fees will be higher due to the loan amount but will still be much lower than what a lender or broker gets paid on a higher loan amount. Estimated lender, underwriting fees are around $4,800-$5,500 if on the lower end of the purchase price ($100K and below for example). This varies based on the DSCR lender. This doesn't include Title or Escrow fees.

More on DSCR loans: DSCR loans won't use your income to underwrite the loan.

DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. Here's a bit more in detail about how rates are calculated for DSCR loans:1. Credit score- the higher the best. 760-780+ generally gets best pricing for investment property loans with most lenders. From there every 20 point increment affect pricing differently. So for example, a 761 credit score will be in the 760-779 credit category, then going down to 740-759 and so on.

2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.4. Are you cash flowing the property? More on how that is calculated below. Is your DSCR ratio greater than 1-meaning are you cash flowing (according to the lender's criteria of mortgage, property taxes and insurance (and HOA) if applicable). Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit. This criteria is for 1-4 and 5-8 unit programs. I've included an example below to help illustrate this.So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.See example below:DSCR < 1Principal + Interest = $1,700Taxes = $350, Insurance = $100, Association Dues = $50Total PITIA = $2200Rent = $2000DSCR = Rent/PITIA = 2000/2200 = 0.91Since the DSCR is 0.91, we know the expenses are greater than the income of the property.DSCR >1Principal + Interest = $1,500Taxes = $250, Insurance = $100, Association Dues = $25Total PITIA = $1875 Rent = $2300DSCR = Rent/PITIA = 2300/1875 = 1.23

If a purchase, you also generally need reserves / savings to show you have 3-6 month payments of PITIA (principal / interest (mortgage payment), property taxes and insurance and HOA (if applicable). If a cash out refinance, many lenders will allow the cash out to satisfy the reserves requirement.DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.

Happy to discuss further.

Jason Wray · Answer

Michael,

It's interesting to see that some investors still choose the 10, 15, or 20 year loan options. You are taking a 5 year ARM which means you have to refinance before 5th year. But you decided to take a 10, 15, 20 year term which means higher PITI payment and lower monthly cash flow? Now as a Banker I understand you will have a shorter pay off but you also have to take into consideration market declines.

If the market declines in any way or if your area suddenly gets hit with a higher than normal foreclosure/short sale values can drop. Then all of the extra money you paid over that 5 year time frame gets washed out the door. Its very risky in this market that we just came out of the "highest" in history of property inflation due to mostly the covid/pandemic.

I think the other flip side is trying to use the equity to buy more properties so in most cases letting the property appreciate or doing renovations is the safer way to get the equity up without essentially borrowing your own money back in 5 years.

You are hitting a point where local banks will not be able to help you due to your number of properties split between (2) banks.  This is where you will need DSCR, Portfolio, or a simple Blanket loan to put 10-15 properties into a true blanket/commercial loan.  That will help you remove what’s left on credit and make room to use portfolio/standard or DSCR.

When you are not using a local bank or credit union you are going to have to pay the typical origination fee's or points.  Its simply a cost of doing business and paying the fee's associated with the risk.

When you refinance I would look at the 30 year options and simply pay more each month when you can versus being obligated to pay more under a shorter term.