Real Estate Loans
Once in a while, I like to touch on the basics. But if this is obvious stuff, skip to the next post. Here are the questions I’ll be answering:
- What is a real estate loan?
- What loan programs are available today?
- How do I qualify?
- What are the hidden costs and benefits of a loan?
1. What is a real estate loan?
A real estate loan allows you to buy a property whose purchase price (or, value) is a lot more than you have in cash. Banks and mortgage companies will lend you large sums of money so that they earn loan origination fees, plus fees for selling your mortgage to a third party, who then collects interest on your loan.
2. What loan programs are available today (as of 4/21/2016)?
For a single family home as your primary residence, you can put anywhere between 3.5% to 25% cash down, or more. If you put down less than 10% of the purchase price, you will likely have to pay hefty mortgage insurance up to 1.75% of the total loan up front, plus 1% annually. These loans are usually 30-year fixed loan (your interest rate doesn’t change for the life of the loan) and government regulated.
For a duplex the same rules apply, except you’ll pay mortgage insurance if you put down less than 20%.
For 3-4 units as your primary residence, the same rules apply, except you’ll pay mortgage insurance if you put down less than 25%.
If any of the above are investment properties only and not primary residences, you have to put down 25% minimum.
For any residential income properties with 5 or more units, you must likely put down around 50% in order to qualify for a loan, based on today’s market. For five or more units you must get a “commercial loan” which is based on the gross annual rental income, and therefore varies by how much your property currently cash flows. These loans are usually amortized over 30 years, but the interest rate is fixed for a shorter time period (usually around 7 years).
3. For 1-4 units, you qualify partially based on the rent, but mostly based on your average annual income over the past two years (the rent counts toward your income). Banks use a standard formula to determine if your annual income is enough to secure the loan, despite these loans usually being non-recourse.
By contrast, for 5 or more units, your personal income is not a factor because the loan is based on gross annual rent from the subject property. This makes these properties better for investors who can’t show regular income on their tax returns.
4. The hidden cost of your loan is obvious: all the interest and mortgage insurance you pay during the life of your loan adds up.
The hidden benefit of your loan is twofold: if your rental income is covering your mortgage and expenses, that 75% LTV (loan to value) that the bank gave you is turning into money in your pocket over the course of the loan. In other words, if your interest rate is less than the your annual return on your loan, you are making money off the loan.
Make sense? If not, feel free to ask any questions you may have at: davidlbrundige@gmail.com