Financing Options
By Paul Esajian on September 25, 2013
In a perfect world, we would all begin our investing careers with a nest egg to facilitate future purchases. Unfortunately, we don’t live in a perfect world. One of the biggest obstacles for new investors is finding financing. Your deals start and end with the financing. You can do everything else right, but if you can’t secure financing, all of your efforts are for naught. It seems like it was decades ago when there were investment programs that would allow you to buy properties with no money down and without verifying income or assets. Those programs are now ancient history. In today’s market, you need at least a 20% down payment, coupled with a score near 700 and a low debt to income ratio. Before you look for any property, you had better know where and how to obtain financing.
There are basically two ways to obtain financing, and both of them require a significant amount of money down or collateral. The most popular method is getting a bank loan through conventional mortgage financing. However, receiving financing is certainly no guarantee. Any approval is based on four main factors: credit score, income, assets and down payment. Your credit score is the starting point in the approval process. Your credit is scored by the three major credit reporting companies: Equifax, Transunion, and Experian. Your score is based on a scale of 350-850, with 850 being the highest. Timeliness of payment, amount of revolving debt and the number of accounts you have determines your credit number. If you are maxed out on your debt, but pay everything on time, your credit score may not be as high as you think. Most investment programs require a minimum middle score of at least 680, with 720 being the magic floor with certain lenders.
The second factor is based on your ability to repay the loan. If you are investing part time, you probably still receive a W2 income. If you are a full time investor, you file as self-employed and go off your 1040 income amount. As a generality, lenders will take your adjusted gross income and use that number as your qualifying income. This is where being creative with your taxes may inhibit you from getting a mortgage. Lenders look to see that your total monthly payments on your mortgage, plus other revolving debt (auto payments and credit cards), is less than around 32% of your gross income. At 32%, it does not allow for much wiggle room, especially if you are carrying other debts or mortgages.
How much you have in asset reserves is the third factor lenders will acknowledge. Six months of your mortgage payment is a minimum number required. Any money in checking, savings, stocks, bonds or 401k can be used as an asset. Some lenders will go so far as to show that the asset can be liquidated on a month’s notice. Without these assets, even a 780 credit score and a low debt to income ratio may not be enough to secure a loan.
Lenders have done away with the 100% financing programs. Currently, 20-25% of the purchase price is required as a down payment. This money has to be documented and verified when you present your offer. The money usually has to be liquid and in some cases in an existing account for six months.
If you cannot get a loan for any one of the reasons mentioned, you still may be able to find financing for your deal. The amount of money needed to start investing is viewed as an obstacle. Your mortgage broker, realtor, accountant or attorney should be able to refer you to a private money lending option. Private money refers to an individual or group that lends money that is not a bank. Private money groups typically look for some percentage of the purchase price in assets. You may or may not have to liquidate it, but you have to have it available. You will be paying a premium for having to go this route. The interest rates and fees will be much higher than a bank. Here is where you have to ask yourself if it’s worth it to make less on a deal that you are not financing.
The very first thing you need to do, if you decide you want to be an investor, is to secure financing. Most realtors will not show you any properties without a pre-qualification letter or proof of funds. If you cannot get approved, find out the reason why and see what you need to do to correct it. It never hurts to reach out to private money financing, just to make contact and see what their process is. Once you have financing in place, finding the right property becomes the easy part.