basic question about mortgage loans

10 Replies

I feel dumb for asking this given how I once had a mortgage.

But.. let's say you bought a house for less than it was worth. So you have equity built in. And let's use real numbers. This mythical house was bought for $76k but it is worth $100k. So when you go to a lender for the loan, do you have to put down any money? You already have 76% LTV. It's the same as if you bought the house for $100k and put down $24k (> 20%).

@Terrence Evans , I'm a little bit unclear. Are you referring to a purchase or a refinance? I've not had to refi yet, but there are typically origination fees, closing costs, things of that nature when purchasing. Some can be rolled into the loan, some not. If you're buying, I think there are still going to be some costs, but they shouldn't be exorbitant. Hope this helped some, though others can probably be much more specific than I. Good luck and happy investing!

No.  The loan is a % of purchase price, or appraisal, whichever is Lower.  Period.

@Terrence Evans

Unfortunately, banks don't believe it's possible to get a good deal on a real estate purchase, so they're going to assume the purchase price is the value of the property. As crazy as it sounds, yes, you'll have to bring in a down payment based on the discounted purchase price. 

Ok, I guess I'm a bit confused... if the loan is a percentage of purchase price, and that percentage is presumably less than 100% LTV (or loan-to-purchase, rather)+closing costs, how does he not pay anything? There's a possibility I'm missing something there...

Originally posted by @Chad Clanton :

Ok, I guess I'm a bit confused... if the loan is a percentage of purchase price, and that percentage is presumably less than 100% LTV (or loan-to-purchase, rather)+closing costs, how does he not pay anything? There's a possibility I'm missing something there...

 As @Wayne Brooks pointed out, when buying a house, the bank will use the lower of the purchase price or the appraisal price.  So in the OP's example, as far as the bank is concerned, the loan will be based on the $76k purchase price (not the $100k it may or may not actually be worth).   

ok.. that's what I thought. Bleh.

Chad, I wasn't talking about auxiliary closing costs just the down payment

so let me ask a slightly current question.

Let's say I come across a deal where the owner had to move quickly and they sell their house at a discount. It is worth 600k but they sell it to me for 520k. I use a hml to buy it. Btw the property needs nothing as it was rehabbed a year ago. Ok what if I do a basic paint and carpet rehab for less than 10k. And instead of selling it, I do a cash out refi for its "arv price" (600k) pocketing 70k less closing costs and hml holding costs.  I could then live in it, rent it, and/or hold and sell at a later date as long as it still rises slightly in value. Any problems with this thought process? If this is common, forgive me.

Originally posted by @Terrence Evans :

so let me ask a slightly current question.

Let's say I come across a deal where the owner had to move quickly and they sell their house at a discount. It is worth 600k but they sell it to me for 520k. I use a hml to buy it. Btw the property needs nothing as it was rehabbed a year ago. Ok what if I do a basic paint and carpet rehab for less than 10k. And instead of selling it, I do a cash out refi for its "arv price" (600k) pocketing 70k less closing costs and hml holding costs.  I could then live in it, rent it, and/or hold and sell at a later date as long as it still rises slightly in value. Any problems with this thought process? If this is common, forgive me.

You "USUALLY" need to wait for 6 months before they consider ARV Price, and they will only give you a portion of ARV price (not your hypothetical entire 600k). Say it's 75%, that will only be 450k instead of 600k, so you still have money parked in this deal (or HML's money parked in the money).

My suggestion is to think it more thorough first.

@Terrence Evans

You asked about a hard money loan. A hml will base the loan on the ARV, even at purchase. They will however generally require 30%-35% equity, so your hypothetical cash out at 100% of ARV scenario will not work. You mentioned living in the property, no hml in their right mind would make a loan against an owner occupied residence, way too much government regulation and risk in these types of loans.

There are what this website refers to as private lenders. They are generally friends and family, folks you have come to know on a personal level, with money to invest. Your scenario might work with a private lenders, it all depends on what you can talk them into. They are in many cases naive (not stupid, just not RE knowledgeable) and willing to do almost anything you ask to get an interest rate higher than what a bank offers. HML's source money from private lenders as well, the difference is private lenders are vetted by the hml for suitability, and better protected in the sense that a hml would not allow such a loan as you describe, it's way too risky.

Beginning investors have a hard time with this because they aren't starting out with a basic real estate education, listening to podcasts, Youtube, reading forums and blogs. 

So, let's start at the beginning, market value, you need to look up the legally accepted definition which can be found on RE appraisal sites. When certain conditions are there, knowledge of the parties, sufficient marketing time in an open market, etc. the price struck is the market value. In a buyer's mind, you may see a property as a killer deal, well, if it meets the definition, it's not, you are paying fair market value. 

All transactions are considered to be along the lines of meeting the fair market value requirements, if the deal doesn't you have other issues, like fraud, predatory transactions, tortuous conduct or they can be distressed sales which do not reflect prices in an open market and for whatever reason, the property will be viewed as being worth what the price agreed to for the sale. If we must assume an owner was an idiot, not of sound mind, not prudent, then we have other issues to contend with. 

What is the ARV? It's the market value less costs and expenses of repair or improvement to bring a property to its highest economic value, it is the fair market value less the costs to allow that property to compete in the market. You can not raise the market value beyond what can be shown in the market, so you have a ceiling to work under.

Any lender must assume that you and the seller were prudent, dealt fairly, had somewhat equal knowledge, that time on the market was sufficient to expose the property to the market in order to sell  it, because if they get it back, they will have to expose the property to the market as well. 

The assumption, and rightly so, is that a property is worth what it sells for, not the value a buyer sees as their value to them, lenders don't lend on a buyer's perception of value.

Now comes the rule Wayne mentioned. loans are based on the lower of cost or market price, this is a dead fast accounting rule under generally accepted accounting principles (GAAP) that all banks follow as well as any prudent lender. 

Under  GAAP, an asset is booked at the lower of cost or market value at the time it is acquired. For any asset to be shown at a higher value, time must elapse to allow the asset to be compared in a new market environment, if you buy an asset today, you can't validate a higher value until the market conditions of today have changed. For stocks, a very efficient market that is highly liquid, that increased value might be shown the next day, but real estate is not as an efficient market, it takes months to validate price changes, it is also not a liquid asset as it takes time and expense to dispose of a property.

As David mentioned, a hard money lender is not a credit lender as much as they are an asset based lender, they may make a loan based on what a value might be, but they will have other concerns as well and they don't provide long term financing.

So, when you hear some ignorant guru investor type saying he just made $40,000 buying a property at a discount, understand they don't have a clue about recognizing valuations or market value concepts, we call that stuff puffing, exaggerations on the deal they just did because in reality, what ever they paid was most likely the true value. Individuals are not required by law to follow GAAP, that's where you get the investor puffing a deal, registered lenders are required to follow GAAP. The professional side of the industry follows GAAP. Courts recognize GAAP. The IRS recognizes GAAP. 

Now, you can buy a distressed property or one from a distressed seller, that price will not meet the definition of market value, you might get a killer deal, but again, lenders can't lend on distressed valuations, they certainly don't want to be a distressed seller! Distressed sales may sell below a market value, for lending, that sale price is the value, you can not claim instant value as your equity, not in that market period. 

Some lenders will accept market conditions changing in 6 months, that would be in an active market, the standard followed is 1 year, which is where the seasoning requirement comes from to hold title. 

Study the basics or real estate to understand the real estate industry......please. :) 

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