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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 their money when they loan money. Therefore, they want to loan as much money as possible. But, there are qualifying criteria that borrowers must meet. Some loans will require high credit scores and lots of income, while other loans will permit a lower credit score, and less income. For the average buyer, government insured loans such as FHA or VA may be easier to get. But in general, your mortgage lender will ask you to meet certain underwriting requirements for your loan.
There are four C’s of credit. 1 – your Credit History, 2 – Cash Flow; as in, what is your capacity to repay the debt; 3 – Collateral- as in what item(s) are going to secure the loan. (the collateral will help determine how much money you can borrow)
4 -Character, it boils down to stability. Someone who has been at their job for 10 or 20 years is considered a lesser risk than somebody that started a job last month. Ideally, they will have some assets in retirement accounts, brokerage accounts, or cash accounts.
But this is considered less and less in today’s world of automated scoring systems that spit out answers very quickly.
Let’s address these four C’s one by one. Credit history- in today’s world that is the number one thing to focus on. A good credit history will allow you to apply for the best deals around. It will allow you to get stated income or no doc loans, get better interest rates, higher loan to value deals and so forth. Understanding how credit history works is probably the number one thing you can do to help your investing career.
In the state of Georgia, we are entitled to two free credit reports per year that can be obtained from any of the credit bureaus. The free ones do not provide the credit score.
I would definitely urge anyone to spend $33 to get a “tri-merger” report once every six months and to see what their median score is. http://www.equifax.com is a very helpful website that novices can turn to learn a little more about how the scoring system works and what will bring your scores up or down.
I’ve looked at literally thousands of credit files in my lending career. I have noticed many errors. One of the most common errors that I’ve seen is a $30 collection for a phone bill, the gas company or a medical bill. When you move be sure to leave forwarding addresses and get these final bills, because a $30 collection on otherwise perfect credit can knock your score by 50 points and can make a drastic impact on what kind of a loan you can qualify for.
Cash flow is going to be translated into what they call debt to income ratio. Debt to income ratio is basically all your debts added up, every car payment you have, every credit card payment you have, mortgages you have, and every single item that is on your credit file.
The things that will be counted against you that will not be on your credit file are contractual obligations to the government or payments by court order, such as child support.
If the lender is doing their job right, they should be including the taxes and insurance on the property and counting that in the debt to income ratio because that is part of the real cost.
To calculate your own cash flow or your own debt to income ratio, pull your credit file. There’s going to be three columns on your credit file. High credit, the current balance and the minimum payment.
High credit on credit cards would be your credit card limit, current balance would be what you owe to that specific lender and minimum payment is what that lender is reporting as your minimum obligation.
Most lenders today will go up to 50% on gross debt to income ratio so as long as all your debts, including the loan that you are applying for, do not exceed 50% of your gross monthly income.
There are exceptions to that when you’re buying residential real estate. If you’re actually going to live in the home and you have excellent credit the ratio can be stretched.
If you are already in real estate investing and you have variety of homes; let’s say you have four rental homes. Let’s say that those rental home rents add up to $2,000 a month. What does that mean to you when you’re applying for credit? Rents are usually never taken at face value.
Let’s say you’re receiving $2,000 a month in rent on your properties. There are several things your lender is going to ask you to verify. The number one thing is whether you have just started receiving these rents. A lot of lenders will not allow you to use new rental income. At the bare bones minimum we’re going to need leases on every property along with checks to show that the rent is actually being collected.
I would strongly, strongly advise you to collect your rents in the form of a check so that you can actually show a cancelled check as proof of payment. If you get it as cash, do a deposit separately from other deposits. I’ve seen a lot of clients that get cash from their tenants and keep some in their pocket for day to day expenses. When I pull their bank statements, I cannot find a consistent pattern of that rent being deposited. Hence, I can not prove that they are actually receiving rent on that property.
The lease is great but if you have a lease with a deadbeat that’s not paying you it won’t help the bank or you. A copy of the lease along with the last three checks that you received on that property would be the bare bones minimum that’s going to be looked at for counting this as income.
Collateral – There are two ways of looking at credit, and two ways to borrow -secured and unsecured. Unsecured lending is becoming more and more the realm of the credit card companies. The banks are really not in the market to make unsecured loans because they’re just not that profitable. There’s not too much incentive for banks to do unsecured loans.
When using rental property as collateral, depending on the strength of your credit, you can get an 80% to 90% loan to value. Typically, for buyers with good credit, 90% is not a problem on their investment real estate. When it comes to multi-family dwellings, a lot of people want to own them in their business name. This means you must pursue loans which are for your business. Business loans are a completely different product and these deals are evaluated for loans differently than single family houses.
Regardless of where your credit is now, and how much cash you have, it is clear that having access to good financing sources is the key to a thriving investing enterprise.
While seller financing and other creative options can allow you to buy property with no cash or credit, professional investors know that good credit and cash are king. If you want to succeed for the long haul as a professional investor, you owe it to yourself to take the necessary steps to build your access to good financing sources.
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