Finding a great lending partner can be a challenge for ordinary homebuyers as well as real estate investors. What many people don’t realize, however, is the wide variety of terms, number of lenders, and creative ways to finance properties. It’s important to realize that lenders are selling a product and that we, the buyers, are the customers. We have the luxury of shopping around for the best deal.
Here are the key questions to ask when looking for potential lending partners, whether you’re a newbie or an expert in the industry. That being said, real estate investors should have additional questions to ask, which we’ll talk about later in the article.
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Questions to ask during your mortgage lender search
1. What types of mortgages do you offer?
There are many types of loans and terms you should be aware of. One option might be better for you than another, so it’s important to know what the lender offers.
Conventional home loans involve a fixed interest rate across payments of 30, 20, or 15 years. The monthly mortgage payment can be lower than other mortgage types, but conventional loans often require higher credit scores and larger down payments.
Federal Housing Administration (FHA) loans are a great choice for those with lower credit scores, smaller down payments, and lower overall income. However, there are some requirements to receive this loan.
ARM loans, a shortened version of adjustable-rate mortgages, have interest rates that adjust over time, causing your mortgage payment to change month by month.
Veteran Affairs (VA) loans are for an active or retired service member or someone connected to a service member, such as an eligible surviving spouse. These loans don’t require a down payment and often have the lowest interest rates of any mortgage type.
2. What are your qualification requirements?
You will also want to know what a lender requires to qualify for a loan, including related to your credit and income.
They will look at your debt and income to calculate your debt-to-income ratio (DTI). Your income doesn’t need to be extremely high for you to qualify for a mortgage, provided that your debt isn’t high either.
Lenders also differ on the minimum credit score they require. Note that the higher your credit score, the more room you have to negotiate better loan terms.
3. What is your current interest rate and APR?
Interest refers to the added cost of money from any lender. Generally, the higher the interest rate, the more expensive the loan and thus the higher your monthly payments. The interest rate you are offered is based on your total mortgage amount, your credit history, and the type of loan you choose.
It’s important to also ask about their annual percentage rate (APR), which combines the interest rate with any additional fees from the lender.
4. What are your fees?
Many lenders charge additional fees. These can be called “documentation fees,” “underwriting fees,” “legal fees,” and so on. Homebuyers sometimes overlook these fees. Significant fees can certainly impact your closing cost total, so it’s important to understand any upfront expenses beyond interest.
5. Do you offer mortgage loan points?
Points can be thought of as interest that is paid in lump sums on a loan. One point is 1% of the total loan amount. For example, if you were to get a loan for $100,000 and the lender charged 3 points, you’d pay $3,000 on top of any other interest.
Keep in mind that mortgage loan points can be charged both upfront and periodically throughout the life of the loan. With any points, make sure that you understand the difference and the impact on your monthly payment.
As with low interest, all else being equal, investors and homeowners prefer to work with lenders that offer loans with low points. However, it could be worth it to pay more points for a loan if it enables you to have more favorable terms in other areas of the mortgage. For example, you might be willing to pay more points upfront for lower interest rates down the line or for a higher loan-to-value (LTV) ratio.
6. Do you offer a rate lock?
A rate lock on a mortgage means your lender agrees to keep the agreed-upon interest rate until closing, even if the market changes.
7. Do you offer preapproval or prequalification letters?
Prequalification estimates how much loan they might be willing to offer; however, these letters aren’t a guarantee from the lender. If you want a guarantee, you’ll need a preapproval letter. The lender will verify your income, credit score, and other financial history in the preapproval process. The amount you’re pre-approved for will be more accurate than what you’re pre-qualified for because lenders have seen your full finances.
However, either letter is beneficial depending on your needs.
8. What are your closing costs?
Closing costs are typically 2%–5% of your purchase price. These costs include appraisal fees, property taxes, mortgage insurance premiums, inspection costs, attorney fees, and origination fees.
9. Do you have a prepayment penalty?
If you pay your mortgage off early, you will want to know if there are additional fees. Some lenders include prepayment penalties because paying your mortgage off early means you’ll pay less interest to them.
More on lenders from BiggerPockets
Questions to ask after you’ve selected a lender
1. How much house can I afford?
A lender will give you a range of how much you can afford, but be careful not to buy the most expensive house you can. Aim for your mortgage payment, homeowner’s insurance, and any other housing-related fees to be 35% or less of your monthly net income.
2. How much will I need for a down payment?
Some loans, like VA loans, don’t require a down payment. Others, like FHA loans, require at least 3% down. It’s not necessary to pay the commonly discussed 20% down payment, but you’ll need to run the numbers and figure out what amount works for you and your lender. They’ll have an idea of how much you’ll need to put down at closing.
3. Will I need an escrow account?
An escrow account serves as an additional savings account managed by your lender. Each month, a part of your payment will go into the escrow account to pay for future insurance premiums and property taxes.
4. What is a loan estimate?
A loan estimate involves your total mortgage amount plus any additional closing costs. This can change for any number of reasons, so be sure to double-check it.
5. What is your loan processing time?
When looking for a quality lender, the next factor that you should consider is how fast that lender can turn around a loan. Does that lender preapprove loans? How quickly will the lender be able to process documentation and guarantee access to financing?
Some deals need to be moved on quickly, and the faster a lender lets you know, the faster you can close on your dream home or complete projects that build equity or increase cash flow.
6. Are there down payment assistance programs I can apply for?
There’s a variety of down payment assistance programs, but be sure to ask your lender which assistance programs they accept.
The Department of Housing and Urban Development (HUD) has a list of assistance programs to help you.
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Questions investors should ask their lender
If you’re a real estate investor or looking to buy an investment property, don’t forget to ask these additional questions to prospective lenders.
1. What are your loan and property criteria?
Some lenders will only fund certain types of properties, while others only work in certain geographical locations. For example, a lender that only funds deals in certain areas of Southern California may have different property criteria than a lender that only offers financing on properties in the Midwest. The California lender might not be willing to look at short-term financing requests for under $150,000, while the lender in the Midwest might not want to look at anything over $150,000.
It’s also important for investors to understand how their lenders calculate After Repair Value (ARV), which types of properties lenders are willing to lend on (single-family, small multifamily, commercial, raw land, etc.), and if lenders have any neighborhood or other specific location criteria. Lenders that offer a larger variety of loan sizes and have more types of properties they loan on can give investors more financing opportunities.
2. Do you offer recourse and nonrecourse financing?
Nonrecourse financing is advantageous to the borrower. It means that the lender can only seize the asset with which the loan is collateralized and cannot go after the remaining assets of the borrower in the event of a default.
For example, let’s suppose you had a $100,000 loan on a $125,000 property, and the value of the property plummets to $80,000, and you default on your loan payments. The lender at that point would seize the property, sell it for $80,000 and eat a $20,000 loss on the $100,000 loan. If the loan was a recourse loan, then they might also seize your personal home, your car, and any other legally allowed assets until you fully repaid the lender.
With nonrecourse financing, the lender will foreclose on the property, and you would lose the equity you put into the property, but your personal wealth outside the investment will not be at risk.
As with any advantage comes disadvantage. In this case, the safety for the borrower in nonrecourse financing usually comes with the disadvantages of a higher interest rate, less access to leverage, and potentially more oversight from the lender.
3. Do you provide funds for rehab costs?
In deals requiring extensive rehab, financing those repairs is a critical part of the investment. If the lender will not finance rehab costs or offers strict terms on rehab financing, investors will have to weigh those disadvantages with the other loan terms.
If you’re opting for a 403(k) renovation loan or a hard money or private loan, it’s a good idea to ask what rehab costs the loan will cover, how you must document and present the rehab process to the lender, and how involved they will be in the construction or rehab phase of the investment. Some may want to confirm funds are being used for construction.
4. How knowledgeable are you on projects like mine?
You, as an investor, are likely to see big benefits from working with a lender that has experience in your area of interest. For example, a flipper who finds a great deal for a rehab single-family residence (SFR) in Denver is likely to get much more favorable terms from a local lender with years of experience funding those types of projects than from a lender that primarily finances commercial properties in another part of the state or country. The specialized lender might offer lower interest rates, require less documentation, have a shorter approval process, charge fewer points or provide other advantages to the investor because they recognize a great local deal as a lower risk loan.
However, this might be a hard question for investors to quantify because the answer is subjective. Since this will boil down to a judgment call on the part of the investor, here is a list of follow-up questions that may help you gauge the knowledge of potential lenders.
- How long have you been lending to investors in the residential space here in [fill in your location]?
- How much have you lent to local residential real estate investors in your history?
- Do you use your own funds to lend to investors or match loans with other (potentially less experienced) lenders?
- How committed are you to lending to residential real estate investors, and what amount of your time is spent lending in the residential space versus commercial properties or other ventures?
- How are you capitalized? That is, what is the source of the money you are funding my project with? What is the size of your AUM (assets under management)?
These questions will give you a feel for how large or flexible the lending organization is, how experienced it is, and how strict it will be on terms. Depending on your project type, you might prefer to work with a small self-funded lender that can move quickly on projects in a narrow range. Or you might prefer a large, well-capitalized firm that can offer lower rates or larger loans with more specific criteria for the deals they finance.
As with most things in real estate investing, there is no one-size-fits-all approach to choosing the right lender. Every lender has its unique advantages and disadvantages, and finding the right one to work with will depend on your specific goals, geography, and the deals you find.
2021-08-24 15:30:00
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