FUNDING
RENTAL LOANS
Designing the Best Rental Loan AN ARTICLE SERIES ON NAVIGATING THE PRIVATE LENDING WORLD
by Damon Riehl
any real estate investors miss out on the tools avail- able to help customize a rental loan and meet their investing objectives. Make sure you’re not one of them. The fundamentals of a long-term rental loan are similar to those of a conforming consumer mortgage. Most investment borrowers can receive a fixed rate for a set number of months, along with a monthly payment obligation. But let’s dive beyond the fundamentals to examine how you can tailor the loan to fit your plans. The following discusses investing strategies and features available to optimize your loan. LOAN-TO-VALUE When deciding on your loan amount, the lender has guidelines for the maximum loan to value (LTV) for your particular property type and borrower profile. In today’s private lending world, that is generally 80% LTV for purchases and no cash out refinances and 75%-80% for cash out refinances. Sometimes, investors consider the balance between keeping their capital in the prop- erty versus the amount of positive cash flow they will receive monthly. EXAMPLE $200,000 property Consider a loan of $150,000 at 5.25% with a monthly principal and interest payment of $828.00,or a loan of $120,000 at 4.75% with a monthly principal and interest payment of $626.00. Here’s your decision to make: Do you lock in $202 per month in improved cash flow for 30 years or take the additional $30,000 in a cash out? Here’s the break-even calculation: $30,000 / $202 = 148.5 months to recoup the $30,000 through lower monthly payments. ADJUSTABLE RATE (ARM) VERSUS FIXED RATE MORTGAGES (FRM) Most rental loan lenders offer an adjustable rate prod- uct along with a 30-year fixed rate option. In the current M
low-rate environment, it’s crucial to know when you should consider an adjustable-rate mortgage instead of a fixed-rate loan. Here are some considerations: • Short- to medium-term hold. When you will hold the property for a few years, it makes sense to take the slightly lower interest rate offered by the ARM products. • You plan to refinance again. If you’re confident you’ll refinance again soon, an ARM loan may be best. For example, if your credit score is lower than you’d like and you’re not getting the best rate, an ARM gives you time to improve your score and refinance in the future. Another instance would be if you plan on making improvements to the property. This could allow you to lock in long-term financing once the improvements are complete and the property’s value increases. • Rate difference is significant. Currently, the rate difference is about 0.25% between a 30-year fixed rate and a 5/1 adjustable-rate mortgage (ARM). A 5/1 ARM is fixed for the first five years, then it adjusts once per year thereafter. With our current historically low rates, most investors are opting to lock in the rate for 30 years unless they plan to sell or refinance in the next five years. RATEAND FEE OPTIONS Private lenders generally offer a base rate, which may or may not come with an origination fee. These origina- tion fees generally range from 0%-2% before a borrower has the ability to pay more or less to adjust the rate higher or lower. For example, assume the borrower pays additional to buy down the rate from 5.375% to 4.875% for a loan of $150,000. The total cost to buy-down the rate is 1.375% of the loan amount or $2,062.50. The payment difference is $56 per month. The calculation for the breakeven is as follows: $2,062.50 (Cost of Buydown) / $56 (Monthly Payment Improvement) = 36.83 months or about three years to break even. Borrowers will need to consider their hold
54 | think realty magazine :: may – june 2022
Made with FlippingBook Online newsletter