Finding a great lending partner can be a real challenge for real estate investors. What many investors don’t realize, however, is the sheer variety of terms, number of lenders, and creative ways to finance investment properties available. It’s important to realize that lenders are selling a product, and that we as investors are the customer. We have the luxury of being able to shop around for the best deal.
For this article, I’ve spoken with experts in the lending industry and learned about some of the key questions to ask when looking for potential lending partners. I hope that this list of questions and a description of what to look for in a lender’s answers helps you in your decision making process.
When it comes to financing, remember that there is usually a give and take. Favorable interest rates might mean that you have to bring more money to the table. Quicker access to financing might mean more stringent or specific property criteria. Finding the right mix of terms, advantages, and costs will depend on your investing goals and your experience level.
With that, here are some key questions to ask lenders.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
7 Questions Real Estate Investors Should Ask When Selecting a Lender
Question #1: What are your terms?
There are three key terms to look for when choosing lenders to work with. These three terms are Loan to Value (LTV), interest rate and points. Below, I’ll describe what each of these terms stands for and why they are important to real estate investors.
a) Loan to Value (LTV)
In real estate investing, loan to value is a ratio that compares the total size of the mortgage you take out to purchase a property compared to the market price of the asset. For example, if I purchase a property for $100,000 using an $80,000 loan, my loan to value ratio is $80,000 to $100,000. In percentage terms, my financing is at 80% LTV.
As a rule of thumb for investors, the greater the LTV, the more advantageous the financing. If I have $20,000 to invest, the lender that offers 80% LTV gives me more purchasing power than the lender that offers 70% LTV. At 80% LTV, I can purchase a property worth as much as $100,000. At 70% LTV, I’d need to bring an additional $10,000 ($30,000 of my own money total) to the table to purchase that same $100,000 property.
My purchasing power increases with lenders that offer higher LTV ratios.
b) Interest Rate
Interest refers to the cost of money from any lender. Interest expense is a large part of most real estate investors’ monthly payments and can significantly impact monthly cash flow. Generally, the higher the interest rate, the more expensive the loan, and the higher your monthly payments.
Real estate investors are looking for the lowest interest rates possible when it comes to financing investment properties. That said, investors are often willing to pay more interest to have more favorable terms. For example, I might be willing to pay more interest to a lender that offers an 80% LTV than to one that offers just 70%.
Points can be thought of as interest that is paid in lump sums on a loan. One point is 1% of the total loan amount. For example, if I were to get a loan for $100,000 and the lender charged 3 points, I’d pay $3,000 on top of any other interest.
Keep in mind that points can be charged both up front and periodically throughout the life of the loan. With any points, make sure that you understand the difference and the impact on your cash flow.
Like interest, all else being equal, investors prefer to work with lenders that offer loans with low points. Also like interest, investors are often willing to pay more points for a loan if that enables them to have more favorable terms in other areas of the mortgage. For example, I might be willing to pay more points up front for lower interest rates down the line, or a higher LTV ratio.
There are other terms that investors need to inquire about beyond these. These are simply three key terms that will give you a good way to compare potential lenders initially. If lenders are extremely variable in how favorable they are in offering these types of terms, it might be a good idea to inquire about the other advantages or disadvantages that working with that lender will result in for you, the borrower.
Question #2: Are there any additional fees outside of interest and points?
In addition to points and interest discussed previously, many lenders charge other, additional fees. These can be called “documentation fees,” “underwriting fees,” “legal fees,” etc. These fees are sometimes overlooked by investors. Significant fees can certainly impact total return on any investment, and investors need to understand any expenses beyond interest up front.
Question #3: What does your funding timeline look like?
The next factor that investors should consider when looking for a quality lender is how fast that lender can turn around a loan. Does that lender pre-approve loans? How quickly will the lender be able to process documentation and guarantee access to financing?
Some deals need to be moved on quickly, and the faster a lender can get money to fund the deal, the faster investors can close on deals or complete projects that build equity or increase cash flow.
Question #4: What are your loan and property criteria?
Some lenders will only fund certain types of properties, while others only work in certain geographic locations. A lender that only funds deals in certain areas of Southern California may have very different property criteria than a lender that only offers financing on properties in the Midwest. The California lender, for example, might not even be willing to look at short term financing requests for less than $150,000, while lenders in the Midwest might not want to look at anything over $150,000.
It’s also important for investors to understand how their lenders calculate After Repair Value, which types of properties lenders are willing to lend on (single family, small multi-family, commercial, raw land, etc.), and if lenders have any neighborhood or more specific location criteria. All else being equal, the lenders that work with a larger variety in the size of their loan offerings and the types of properties they are willing to loan on offer investors more financing opportunity.
Question #5: Do you offer both recourse and non-recourse financing?
Non-recourse financing is advantageous to the borrower. It means that the lender is only able to seize the asset with which the loan is collateralized and cannot go after the remaining assets of the borrower in the event of a default.
For example, let’s suppose I had a $100,000 loan on a $125,000 property, and the value of the property plummets to $80,000 and I default on my loan payments. The lender at that point would seize the property, sell it for $80,000 and eat a $20,000 loss on the $100,000 loan. If the loan was a recourse loan, then they might also seize my personal home, my car, and any other seize-able assets until the lender was fully repaid. With non-recourse financing, the lender will foreclose on the property, and I will lose the equity I put into the property, but my personal wealth outside the investment will not be at risk.
As with any advantage, the safety for the borrower when it comes to non-recourse financing usually comes with disadvantages in the form of higher interest rates, less access to leverage, and potentially more oversight from the lender.
Question #6: Do you provide funds for rehab costs?
In deals requiring extensive rehab, financing those repairs is a critical part of the investment. If the lender will not finance rehab costs or offers strict terms on rehab financing, investors will have to weigh those disadvantages with the other terms of the loan. It’s a good idea to ask what rehab costs the loan will cover, how you must document and present the rehab process to the lender, and how involved they will be in the construction or rehab phase of the investment.
Question #7: How knowledgeable are you on projects like the one I’m working on?
If you as an investor find a great deal, you are likely to see big benefits from working with a lender with experience in your area of interest. For example, a flipper that found a great deal for a rehab single-family residence (SFR) in Denver, CO is likely to get much more favorable terms from a lender with years of experience funding those types of projects than from a lender that primarily finances commercial properties in another part of the state or country. The specialized lender might offer lower interest rates, require less documentation, move quickly, charge fewer points, or provide other advantages to the investor because they recognize a great local deal as a lower risk loan.
This might be the hardest question for investors to quantify. Because the answer is subjective and will boil down to a judgment call on the part of the investor, I’m providing a list of follow-up questions that may help investors gauge the knowledge of potential lenders. These questions are how I would phrase them if I were a SFR flipper from Denver, CO and would obviously need to be tailored to the specifics of each investor’s individual situation:
- How long have you been lending to investors in the residential space here in Denver?
- How much have you lent to local residential real estate investors in your history?
- Do you use your own funds to lend to investors, or do you match loans with other (potentially less experienced) lenders?
- How committed are you to lending to residential real estate investors, and what amount of your time is spent lending in the residential space vs. commercial properties or other ventures?
- How are you capitalized — what is the source of the money you are funding my project with? What is the size of your AUM (assets under management)?
These questions will give you a feel for how large or flexible the organization is, how experienced the lender is, and how strict the lender will be on terms. Depending on your project type, you might prefer to work with a small, self-funded lender who can move quickly on projects in a narrow range, or a large, well-capitalized firm that can offer lower rates or larger loans, but might have more specific criteria for deals that they finance.
Like most things in real estate investing, there is no one-size-fits-all approach to choosing the right lender. Every lender has its unique advantages and disadvantages, and finding the right one to work with will depend on your specific goals, geography, and the deals that you find. I hope that these seven questions provide a basis for investors’ research into lending partners.
What do you think? Do you have any additional questions that investors should ask local lenders?
Ask your questions in the comments section below!
Lastly, I’d like to thank our friends at B2R Finance for all of their help in writing this article and helping me come up with a list of key questions that investors should ask potential lenders. Thank you!