?Asset Based Financing is a Type of Lending Not Well Understood

[Corey Dutton]

Asset based financing is not well understood by most real estate investors. Asset based financing is different from bank financing. The primary difference between the two is the way loans are underwritten. For a bank to approve a loan, not only must the property meet its qualifications, but the characteristics of the borrower must also meet their qualifications. Asset based financing, on the other hand, is qualifying a loan primarily based on the characteristics of the property and not those of the borrower. For a bank loan, a borrower must meet specific credit and income requirements. For an asset-based loan, in most cases, only the property is analyzed.

Recently someone came to me asking for asset based financing and did not understand how this type of financing works. He thought because he was buying a property for $250,000, but it was really worth $500,000, that we should give him a loan for 100% of the purchase price of the property. He was shocked when I told him that he still would need to bring some of his own cash into the purchase to close on it. Then he asked me, “Well, aren’t you an asset based lender?”

The answer is yes, we are an asset based lender. But just like everything in life, there’s no such thing as a free lunch. This borrower had no money to buy a property, not even enough money to cover the closing costs or realtor fees. He wanted us to give him 100% of the purchase price of the property as a loan, roll in our loan fees, and cover the closing costs too!! How easy would it be for that borrower to walk away from the property when things start to get tough? With no money into the property, what’s the incentive for him to hold onto it if it starts to have problems? Unfortunately for that guy, this is not how asset based financing actually works. No matter how much you think a property is worth when you buy it, you still need to bring money to the table on a new purchase, no matter what lender you talk to. Even if it’s just the closing costs or loan fees!!!

However, for a refinance loan, asset based financing does work like you would expect. A good example is a rental property that is owned free of any debt. The owner of the property wants to refinance the property using asset based financing because she doesn’t have good credit. Her goal is to buy a 5 plex with the cash out from the loan. In this scenario, we would lend the borrower the max we could on that property because it is an asset with true equity. The owner of this property is not going to walk away because she has years invested in both time and money into the property. This is a different type of scenario from the one I presented above. This borrower will not have to bring any money to the table to close on this loan, in fact, all of the money will go to her to use to buy her new 5 plex.

Are you an asset based lender with an opinion on this topic or something to add? Or are you a borrower who has questions about asset based financing? Please share your comments below. Would love to hear from you.