Conventional loans are typically the hardest to obtain for real estate investors. Some lenders don’t allow income from investment properties to be counted toward total income, which can make global underwriting a problem for certain investors, especially those who already have several existing conventional, conforming real estate loans reporting on their credit. In these cases, the investor must look outside conventional funding for their investments. Two of the more popular choices for alternative financing are portfolio loans and hard money loans.
These loans are loans made by banks which do not sell the mortgage to other investors or mortgage companies. Portfolio loans are made with the intention of keeping them on the books until the loan is paid off or comes to term. Banks which make these kinds of loans are called portfolio lenders, and are usually smaller, more community focused operations.
Advantages of Portfolio Loans
Because these banks do not deal in volume or answer to huge boards like commercial banks, portfolio lenders can do loans that commercial banks wouldn’t touch, like the following:
- smaller multifamily properties
- properties in dis-repair
- properties with an unrealized after-completed value
- pre-stabilized commercial buildings
- single tenant operations
- special use buildings like churches, self-storage, or manufacturing spaces
- construction and rehab projects
Another advantage of portfolio lenders is that they get involved with their community. Portfolio lenders like to lend on property they can go out and visit. They rarely lend outside of their region. This too gives the portfolio lender the ability to push guidelines when the numbers of a deal may not be stellar, but the lender can make a visit to the property and clearly see the value in the transaction. Rarely, if ever, will a banker at a commercial bank ever visit your property, or see more of it than what she can gather from the appraisal report.
Disadvantages of Portfolio Loans
There are only three downsides to portfolio loans, and in my opinion, they are worth the trade off to receive the services mentioned above:
- shorter loan terms
- higher interest rates
- conventional underwriting
A portfolio loan typically has a shorter loan term than conventional, conforming loans. The loan will feature a standard 30 year amortization, but will have a balloon payment in 10 years or less, at which time you’ll need to payoff the loan in cash or refinance it.
Portfolio loans usually carry a slightly higher than market interest rate as well, usually around one half to one full percentage point higher than what you’d see from your large mortgage banker or retail commercial chain.
While portfolio lenders will sometimes go outside of guidelines for a great property, chances are you’ll have to qualify using conventional guidelines. That means acceptable income ratios, global underwriting, high debt service coverage ratios, better than average credit, and a good personal financial statement. Failing to meet any one of those criteria will knock your loan out of consideration with most conventional lenders. Two or more will likely knock you out of running for a portfolio loan.
If you find yourself in a situation where your qualifying criteria are suffering and can’t be approved for a conventional loan or a portfolio loan you’ll likely need to visit a local hard money lender.
Hard Money and Private Money Loans
Hard money loans are asset based loans, which means they are underwritten by considering primarily the value of the asset being pledged as collateral for the loan.
Advantages of Hard Money Loans
Rarely do hard money lenders consider credit score a factor in underwriting. If these lenders do run your credit report it’s most likely to make sure the borrower is not currently in bankruptcy, and doesn’t have open judgments or foreclosures. Most times, those things may not even knock a hard money loan out of underwriting, but they may force the lender to take a closer look at the documents.
If you are purchasing property at a steep discount you may be able to finance 100% of your cost using hard money. For example, if you are purchasing a $100,000 property owned by the bank for only $45,000 you could potentially obtain that entire amount from a hard money lender making a loan at a 50% loan-to-value ratio (LTV). That is something both conventional and portfolio lenders cannot do.