Understanding Conventional Financing & how to get it
Alright, I’ll just throw it out there and hopefully not feel too dumb when the answers start rolling in. I hear a lot about the 10 conventional loan limit. I have 4 single family houses and 2 loans (2 houses/loan). I’m nearing completion of a 5th house & I am wanting to find my best financing option for this property. Some background….When I started & was trying to find financing for the first property, no one would give me, what I think of as, conventional financing. I was constantly referred to the “business loan department”. I recently verified for sure one of my existing loans is considered a business loan. Maybe I am incorrect when I think of conventional financing as a typical owner occupied loan. So my question is, what exactly is this conventional financing I keep hearing everyone refer to & how is everyone getting conventional financing for investment properties? I get the feeling I need to misrepresent my intentions when I discuss a potential loan with a mortgage officer.
As an aside, this last unit is in a college town. Although not part of the original plan, my daughter has moved into it (@ a discount but not free). I toss out this information just in case it leads to a different set of options.
Look forward to hearing what I am missing.
I think the term just means a regular mortgage - there are basically 2 types of mortgages - conventional and commercial. You can have up to 10 conventional as an individual, and as many commercial as you can get approved for. Conventional are usually much lower APR and a good way to start out (but you need commercial if you want your LLC to own the property/etc.) - if you go through big banks you get the people we are not used to dealing w/ investors and may refer you to the wrong places - good options for conventional for investment properties are Finance of America, and if you want to go commercial - Lima One. I've used both and zero issues.
Thanks for your input @Gavin Davie. That’s pretty much what I was thinking. I will check into Finance & Lima. Thanks for those as well. With all of that said, it still leads me to the next question…how is everyone managing to get regular (conventional) mortgages on their investment properties? Nearly every lender (large & small/local and regional) I spoke with over the last 2 years refers me to the commercial lender as soon as they hear rental. I’d prefer using up all of my conventional loans simply to help improve cash flow before I start down the commercial loan path. I’m not in a position to try any variation of house hacking. So that strategy isn’t a realistic plan for me.
Any additional advice is welcome.
Hi @Deak Smith. Sorry to hear you've had such a difficult time getting a conventional loan, and likewise an explanation on things. I'm an investor, as well as a loan officer for a large mortgage lender, based south of you in Asheville, North Carolina.
As mentioned, many people in my field don't have interest in juggling and/or learning the specifics of how to handle owners and purchasers of investment properties. They sometimes conclude that there won't be frequent enough opportunities for application and reinforcement of the knowledge required. And some have the notion that investor clients are a big pain regarding additional documents and qualification requirements, and likewise that such people are buying low-dollar homes (i.e., low commission for us) and only caring about the rate. I know that's very often not true though.
I hope the explanations below help. If you'd like to chat further, perhaps DM me and we can talk by phone.
Loans for homes can be classified as residential or commercial, the difference being the collateral. With residential, the focus is the resale value of the home. With commercial, the focus is the income production of the home, meaning as a business. And many commercial lenders do not lend on SFR.
For residential loans, there are various types and options. The most common type is "conventional," also known as "conforming." Conventional loans are purchased, after origination, by Fannie and Freddie (more often Fannie). Fannie and Freddie don't service the loans though, meaning the lender or whoever they sell the servicing to collects payments, deals with things like forbearance and default, etc. In lending, we apply conventional programs when credit scores are good to excellent, as the overall cost per month is cheaper than FHA when credit is good.
Next in popularity is FHA, the program we use when both credit scores and down payment are lower. Down payment can be low for Conventional as well (3% or 5%; 3.5% for FHA), but the rate and mortgage insurance are much higher if credit isn't too great. With FHA, HUD is the insurer, protecting the lender in the event of default.
VA is another popular program, and quite a great one, but only available to people that are serving or have served, and like FHA only available for primary residences. And USDA is the final popular "government" type program, and a great one regarding costs for the borrower. It's far less common that VA and FHA, in part because there are fewer people and properties that qualify for it.
Beyond that, credit unions and community banks sometimes have their own mortgage programs, sometimes referred to as "porfolio," which basically means they don't sell the loan to Fannie or Freddie and get their money back for sake of reinvesting.
As an investor, the only option we have from the list above, beyond the occasional credit union or community bank, when financing a property we will not occupy, is Conventional. Conventional has a "10 financed properties" rule, which means you cannot get a new Conventional loan if you currently are responsible for loans on 10 or more properties. That includes any type of loan, such as commercial, and any type of property, such as commercial.
While the 10 property rule is a common discussion, it's extremely rare that an investor's DTI still allows them to get a new loan when they have 10 properties. Meaning, at some point, typically after just a couple of properties, the investor's current homes, due in part to hefty write-offs on tax returns, drags down their DTI too much.
There are legit opportunities to keep DTI working for you, so that you can keep buying and using Conventional financing, if know how to plan and position yourself. This is where most lender personnel check out, as they just don't know the options.
For one thing, if your collective DTI isn't already too high to start with (i.e., 50% for the few of us that don't sell off our servicing; 43% or so for others), we can apply 75% of the appraiser's estimate of the long-term rent (sorry, no STR estimate allowed) to nullify most if not all of what the new home will add to your DTI. Second, if you've purchased a new investment home recently enough that it doesn't show on a tax return yet (and a tax return isn't yet due to show it), we can use 75% of the monthly rent rate (the lease must be annual) for that property as well, to help you qualify for the new property you're purchasing.
Beyond that, your other investment homes can help your DTI as well, but more often than not they actually don't help, because you write off too much of the wrong thing (ex: repair and maintenance). The following are the good write-offs, which we add back to your income in our calculations: depreciation (don't miss the opportunity here...many do...this alone will pay the CPA bill), taxes, insurance, mortgage interest, HOA dues, casualty loss (rare), and amortization (rare).
At this point you may be wondering, why use residential Conventional, and why go through the hassle, instead of going with Commercial. Commercial tends to mean a higher rate, a higher down payment (at least 25%, and often 30%), a much more expensive appraisal, and a longer process to close (which many sellers have no patience for...especially in today's market).
What if your DTI won't work for Conventional, or you're one of the very, very few people that has good enough DTI but has loans out on 10+ properties? Often times you're told the only option is Commercial, or hard or private money. Think of hard money being from a business/entity, and private money being from a person or two. That's just a generalization. Both hard and private money of course come at a hefty price, which means they often make great sense for short-term use, like a year or less, but often don't make sense of longer-term use. Rates for hard and private money tend to be above 10%, but some of my clients have had 20yr fixed hard money loans for as little as 7-8%.
There is a newer, better option that some of us offer though. It's called DSCR (debt service credit ratio). Like hard money it comes with a prepayment penalty and a little upfront cost or "points," but unlike hard money it's lower on rate (often below 5% these days) and friendlier to buy-and-hold. DSCR is like commercial in that it focuses on the rent potential of the property for collateral, rather than your income or DTI. Yet there's still a strong focus on your credit score. The down payment minimum is similar to Conventional (i.e., typically 20%...I know I mentioned 3% and 5% above, but the down payment is higher for Conventional if the home is investment rather than primary residence). The closing timing is similar, such as 30-45 days. There is no financed property rule. And unlike Conventional, you are allowed to title in an LLC.
On that note, with Conventional you're not allowed to title in an LLC. Some investors change the vesting after closing and making some payments, by QCD, but every mortgage has a "due on sale" clause regarding vesting changes, so the lender can demand payment in full when they receive notice of the change.
I hope this provides a little clarity. Happy to discuss further.