While it’s true that bank programs for long term investor financing have changed quite drastically over the past 2 years, the good news is that some banks are still lending money to investors!  Many of the banks who are still lending in the midst of the current credit crisis have changed or added terms associated with their loans.  While some of the term changes and new loan requirements are understandable (such as lower loan to value and requiring income documentation as well as decent credit history), many of the changes, at the borrower’s expense, make the loans much more favorable to the bank.  There is so much opportunity in the real estate market right now that investors need to take what they can get with regards to financing, but  understanding the terminology associated with the financing is vital to ensure the long term prosperity of your investment business.  I have defined some loan terms below and elaborated on how each term can work for you or against you. 

Loan to Value (LTV)- Represented as a percentage, this is the percent of a property’s value the bank will lend.  Common LTVs for investor loans are 70-80%.  Lower LTVs provide more cash flow to landlords (via lower monthly loan payments), but many investors opt for 75-80% in order to minimize the cash they must invest (tie up) in the property.

Amortization- This is the period of time in which the repayment of the loan is calculated, normally in even monthly payments.  A common amortization period is 25-30 years.  The shorter the Amortization period the quicker the owner builds equity by paying off the loan balance, but a shorter amortization period makes it very difficult for a rental property to cash flow because more of the loan is being paid back each month via a larger loan payment. 

Fixed Rate v. Variable Rate- It is very important to understand how your interest rate is calculated.  While there are some fixed rate options (conventional loans to qualified investors carrying very few mortgages), variable rate loans are more common for investors.  Normally these loans are fixed for 1, 3, or 5 years, and then adjust annually based on a rate index plus or minus a spread (Example- PRIME + 2.5% = 6.5% when PRIME is 4.0%). 

Caps- Only applicable for Variable Rate loans, a cap is the percentage limit your interest rate can change (up or down) in a re-adjustment period.  Example- On your rate reset date, based on the index & spread defined in your loan terms, your rate would increase from 5.50% to 7.50%, an increase of 2.0%.  But your loan has a 1.5% cap, so your rate will only increase to 7.0% for the next period.  This works the same way when interest rates are being lowered.  Caps limit the risk of your rate rising quickly, but similarly reduce the benefit if rates are going down. 

Floors- Only applicable for adjustable rate loans, a floor is a downward interest rate threshold that your rate cannot go below.  A floor, when part of loan terms, is usually set at or slightly below the initial rate.  This is VERY unfavorable to the borrower because while your rate will go up if interest rates rise, it will never drop below the floor threshold if interest rates fall.

Call Provision/Loan Term/Loan Length- The wording can very, but these terms indicate that the loan (sometimes at the option of the lender) must be repaid in full within a period of time shorter than the Amortization Period.  Example- Your loan is Amortized over 30 years (meaning your monthly payments are calculated to pay the loan to zero over 30 years), but your loan term (length) is only 10 years.  This means that within 10 years you have to sell the property or refinance (i.e., the bank earns more fees & can reset the loan terms) in order to pay off the loan.

Closing in Personal Name v. LLC- Conventional loans (that I’m aware of) do not let you close in the name of an LLC, but lenders who hold their loans in their own portfolio (meaning they do not sell them to Fannie Mae or Freddie Mac) will still allow you to close in the name of an LLC, and usually do not report the loan to the credit bureaus. 

Deposit Requirements- Some banks, especially smaller ones, are starting to require loan customers to keep a certain amount of money deposited with the bank.  While this helps the bank grow and be more profitable, it can cramp the investor’s business operations.

Closing Costs- This one’s pretty obvious, but still worth mentioning.  In order to compare 2 loans “apples to apples,” you must know the full cost associated with closing the loans.  The advantage of a better interest rate could be completely offset if the loan has significantly more costs associated with the closing (application fee, appraisal fee, document preparation charges, origination fee, etc.). 

So now that you’re armed with a general understanding of what type of loan terms exist in the market right now, you can confidently call up banks and inquire about their investor loan programs.  For investors who work with Ohio Rehab Loans for the purchase & fix up of properties, we assist them with the refinance process by connecting them with our bank contacts that do investor loans. 

Please note that this column reflects the opinion of Chris Knoppe.  Comments or questions can be directed to Chris.Knoppe@OhioRehabLoans.com. For more information about Ohio Rehab Loans visit www.OhioRehabLoans.com or call 614-433-0570.