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A Lenders Point of View
Based on an interview with Srdjian Gavrilovek, an investment banker in Atlanta, GA.
Lenders only make money when they lend money. Therefore, they want to borrow as much money as possible. However, there are criteria that borrowers must meet. Some loans will require high credit scores and a lot of income, while other loans will allow a lower credit score and less income. For the average buyer, it may be easier to get loans with government insurance such as FHA or VA. But in general, your mortgage lender will ask you to meet certain requirements to take out the loan.
There are four C credits. 1 – your credit history, 2 – cash flow; as in, what is your ability to repay the debt; 3 – Collateral – such as the items that will secure the loan. (collateral will help you determine how much money you can borrow)
4 – Character, comes down to stability. Someone who has been at their job for 10 or 20 years is considered a lower risk than someone who started their job last month. Ideally, they will have some assets in retirement accounts, brokerage accounts or cash accounts.
But this is less and less considered in today’s world of automated scoring systems that churn out answers very quickly.
Let’s consider these four C’s one by one. Credit history – in today’s world it is the number one thing to focus on. A good credit history will allow you to apply for the best deals. It will allow you to get stated income or no-document loans, get better interest rates, higher loan-to-value deals, and so on. Understanding how credit history works is probably the first thing you can do to help your investment career.
In the state of Georgia, we are entitled to two free credit reports per year which can be obtained from any credit bureau. The free ones do not provide a credit score.
I would definitely encourage anyone to spend $33 to get a “triple merge” report every six months and see what their average score is. http://www.equifax.com is a very useful website for beginners to refer to to learn a bit more about how the scoring system works and what will increase or decrease your scores.
I have reviewed literally thousands of credit files in my credit career. I noticed many mistakes. One of the most common mistakes I’ve seen is collecting $30 on a phone bill, gas bill, or medical bill. When you move, be sure to leave your forwarding addresses and get these final bills, because a $30 charge on otherwise perfect credit can knock your score by 50 points and can drastically affect the type of loan you can qualify for.
Cash flow will be translated into what they call a debt-to-income ratio. Your debt-to-income ratio is actually all of your debts added up, every car payment you have, every credit card payment you have, the mortgage you have, and every single item on your credit file.
What will count against you and not be on your credit report are contractual obligations to the government or court-ordered payments, such as child support.
If the lender is doing their job well, they should include taxes and property insurance and factor that into the debt-to-income ratio because it’s part of the real cost.
To calculate your own cash flow or your own debt-to-income ratio, pull your credit file. There will be three columns on your credit file. High credit, current balance and minimum payment.
A high credit card would be your credit card limit, your current balance would be what you owe to that particular lender, and the minimum payment is what the lender reports as your minimum obligation.
Most lenders today will increase your gross debt to income ratio up to 50% as long as all your debts, including the loan you are applying for, do not exceed 50% of your gross monthly income.
There are exceptions when you buy residential property. If you are actually going to live in the home and have excellent credit, the ratio can increase.
If you are already investing in real estate and have various homes; let’s say you have four houses for rent. Let’s say the rents for these rental homes are up to $2,000 a month. What does this mean for you when you are looking for a loan? Rents are usually never taken at face value.
Let’s say you receive $2,000 a month in rent for your properties. There are a few things your lender will ask you to check. The number one thing is whether you have just started receiving those rents. Many lenders will not allow you to use new rental income. At the very least, we will need leases for each property along with receipts to show that rent is actually being charged.
I would strongly advise you to collect your rents by check so that you can actually show the canceled check as proof of payment. If you receive it as cash, make the deposit separately from other deposits. I have seen a lot of clients who get cash from their tenants and keep some in their pocket for everyday expenses. When I pull their bank statements, I can’t find a consistent pattern of depositing that rent. So, I cannot prove that they are actually receiving rent on that property.
A lease is great, but if you have a lease with a liquidator who doesn’t pay you, it won’t help the bank or you. A copy of the rental agreement along with the last three checks you have received for that property would be the basic minimum that will be considered for it to count as income.
Collateral – There are two ways of viewing credit and two ways of borrowing – secured and unsecured. Unsecured lending is increasingly becoming the domain of credit card companies. Banks really aren’t in the market to make unsecured loans because they’re just not that profitable. There is not much incentive for banks to make unsecured loans.
When you use a rental property as collateral, depending on the strength of your credit, you can get 80% to 90% loan-to-value. Typically, for buyers with good credit, 90% is not a problem for their investment properties. When it comes to multi-family housing, many want to own it in their business name. This means that you have to look for loans that are for your business. Business loans are a completely different product and these loan deals are evaluated differently than single family homes.
Regardless of where your credit standing is now and how much cash you have, it’s clear that access to good sources of financing is the key to a successful investment business.
While seller financing and other creative options can allow you to buy real estate without cash or credit, professional investors know that good credit and cash are key. If you want to succeed as a professional investor in the long term, you must take the necessary steps to build access to good sources of financing.
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