Choosing a loan can mark an exciting time in your real estate investment career. Seeking a loan likely means you’ve found a property you can’t wait to buy, and whether it’s the first property to become part of your investment portfolio, or your tenth, it can be invigorating to begin imaging and planning for the future of the property
However, it can also be stressful to choose a loan. There are so many lenders out there with so many different options available that trying to find the one that is right for your needs and unique situation can be overwhelming. With so many factors to weigh and consider, it can be easy to lose track of what you should be focusing on. Here are four factors to consider when evaluating multifamily loans.
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1. How Does the Loan Work?
There are several different types of loans you may be eligible for, and they all come with their own terms and conditions. For example, there are FHA and VA loans, which are government-backed, and have different eligibility requirements, rules, and restrictions than a conventional loan or bridge loan.
When you are considering a loan, be sure to research or ask about these three factors:
Interest Rates
An interest rate can make or break the affordability of a loan for a lot of people. That’s why it’s important to know what the rate is for each loan you look into. For some federal loans, it could be as low as 3%, while for conventional loans, it can be as high as 10% or more. This is a huge range and can greatly impact your monthly payments.
Loan Terms
How long is the term of the loan? It could be a traditional 15 or 30-year repayment period but don’t assume that will always be the case. Bridge loans, for example, are designed to be repaid quickly, with terms lasting anywhere from a few months, to three years.
Prepayment Penalties
Suppose you come into some extra money, or your property is generating more income than you anticipated. This is great! You may want to pay off or pay down your loan more quickly. However, some lenders include a prepayment penalty, which means doing this will cost you. And sometimes it can cost you a lot. Always know what a lender’s prepayment policy is before applying for a loan.
2. How Much Can You Get?
There are a few calculations lenders use to determine if a potential client is likely to be able to make payments on time, or if they will be at risk of defaulting. As an investor, you should also know these calculations and use them to assess your own situation before applying for a loan.
Loan-to-Value Ratio
The loan-to-value ratio, often referred to as LTV, is a simple calculation that compares the amount of your mortgage to the amount the property was appraised for. If you’re able to, putting down a larger-than-average down payment can help reduce your LTV ratio. This can influence whether a lender chooses to lend to you, and whether they’ll require you to secure private mortgage insurance.
Debt Service Coverage Ratio
Commonly known as DSCR, this ratio equation works to determine how much income your investment property does or will generate, compared to the payments you will owe.
The formula to calculate it is as follows:
Annual net operating income / annual debt payments = DSCR.
This seems like a simple calculation, and it is, but there are a couple of steps to complete before you can calculate it. First, subtract your annual operating expenses from your annual revenue to determine your annual net operating income. Next, add your principal payments, interest payments, and lease payments to determine your annual debt payment.
Once you have these numbers, plug them into the equation to get your DSCR. Keep in mind that most lenders look for a DSCR of at least 1.2-1.5. If you fall below this threshold, you may still be able to secure a loan, but you’ll probably have to put up some extra collateral.
3. How Easy is the Lender to Work With?
When securing a loan, you’re entering into a long-term relationship with your lending institution. What kind of partner will they be? Will they make your financial life easier, or more of a hassle? Consider these two factors when choosing your lender:
Track Record of Timely Loan Closure
By the time you finally finish all of your research and decide on a loan, you’re ready to get to work. Unfortunately, how quickly things move depends on your chosen lender. Before making a choice, look into the lender’s track record to find out how long it usually takes them to close a loan. In most cases, the quicker the better.
Customer Service
It’s important to know that if you need to get in touch with your lender about your loan, or need any kind of assistance, they’ll be available. Lenders that prioritize customer service will be easier for you to work with, and, all other factors considered, should be prioritized in your search.
4. How Well Does the Loan Fit Your Needs?
In the midst of all the research and comparisons you’ll be doing, it can be easy to lose sight of the most important factor to consider: does it meet your needs? The perfect loan for someone else might not be the best match for you. Making a choice is an individualized process, and you should keep that top-of-mind.
Your Financial Situation
When going through the loan selection process, it’s important to be honest with yourself about your current and future financial landscape. Know how much your property will cost to not only purchase, but also to update and maintain in the way you desire. Then find the sweet spot between taking out too little to pay the bills, and taking out so much you can’t afford payments.
Your Investment Goals
At the end of the day, the most important thing to consider is how a loan will help you meet your investment goals. If you don’t lose sight of this, you’ll be able to make an informed decision, and end up with the right loan for your own, individual situation.