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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 money when they lend money. That’s why they want to lend as much money as possible. However, there are criteria that borrowers must meet. Some loans will require a high credit score and high income, while other loans will allow for a lower credit score and lower income. For the average buyer, it may be easier to get government-insured loans like FHA or VA. But in general, your mortgage lender will ask you to meet certain requirements to take out the loan.
There are four C credits. 1 – your credit history, 2 – cash flow; for example, what is your ability to repay the debt; 3 – Security – for example, which items will secure the loan. (insurance will help determine how much money you can borrow)
4 – Character, all the way to stability. Someone who has been at their job for 10 or 20 years is considered a lower risk than someone who started a job last month. Ideally, they will have some funds in retirement accounts, brokerage accounts or cash accounts.
But this is less and less considered 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, this is the first thing to focus on. A good credit history will allow you to apply for the best offers. It will allow you to get loans with stated income or no loans, better interest rates, higher loan to value deals and so on. Understanding how credit history works is probably the first thing you can do to help your investment career.
In the state of Georgia, we are entitled to two free credit reports per year, which can be obtained from any credit bureau. Free ones do not provide a credit score.
I would definitely urge anyone to spend the $33 to get the “three mergers” report every six months and see what their median score is. http://www.equifax.com is a very useful site for newcomers to refer to if you want to learn a little more about how the scoring system works and what will raise or lower your scores.
I have looked at literally thousands of credit files in my lending career. I noticed a lot of mistakes. One of the most common mistakes I’ve seen is collecting $30 on a phone, gas, or medical bill. When you move, be sure to leave forwarding addresses and receive those final bills, because a $30 charge on otherwise perfect credit can knock your score by 50 points and can drastically affect the type of loan you qualify for.
Cash flow will translate into what is known as the debt-to-income ratio. Your debt-to-income ratio is basically the total of all your debt, every car payment you make, every credit card payment you have, mortgages you have, and every single item that’s on your credit file.
Things that will count against you and not be on your credit file are contractual obligations to the government or court-ordered payments, such as child support.
If the lender is doing a good job, they should include taxes and property insurance and count that in the debt-to-income ratio because that’s part of the actual cost.
To calculate your cash flow or your own debt-to-income ratio, pull out your credit file. There will be three columns in your credit file. High credit, current balance and minimum payment.
High credit on credit cards would be your credit card limit, your current balance would be what you owe to a particular lender, and your minimum payment would be what the lender reports as your minimum obligation.
Most lenders today will increase your gross debt-to-income ratio up to 50% if all your debts, including the loan you are applying for, do not exceed 50% of your gross monthly income.
There are exceptions when buying residential real estate. If you will actually be living at home and have excellent credit, the ratio can increase.
If you are already investing in real estate and have different homes; let’s say you have four houses for rent. Let’s say these apartment rents are up to $2,000 per month. What does this mean for you when you apply for credit? Rents are usually never taken at face value.
Let’s say you receive $2,000 per month in rent for your properties. Your lender will ask you to verify several things. The first thing is whether you have just started receiving these rents. Many lenders will not allow you to use your new rental income. At a minimum, we will need leases for each property along with inspections to prove that rent is actually being collected.
I strongly, strongly advise that you collect your rents by check so that you can actually show the canceled check as proof of payment. If you get it as cash, make the deposit separately from other deposits. I have seen many clients who get money from their tenants and keep some of it in their pocket for everyday expenses. When I pull their bank statements, I can’t find a consistent pattern of depositing this rent. Therefore, I cannot prove that they are actually receiving rent for this property.
Leasing is great, but having a lease with an insurance company that won’t pay you won’t help the bank or you. A copy of the lease along with the last three checks you received for this property would be the minimum you will consider to count this as income.
Insurance – there are two ways of looking at credit and two ways to borrow – secured and unsecured. Unsecured lending is increasingly the domain of credit card companies. Banks really aren’t in the market to make unsecured loans because they just aren’t that profitable. There is not much incentive for banks to make unsecured loans.
When using a rental property as collateral, depending on the strength of your credit, you can get an 80-90% loan-to-value. Typically for buyers with good credit, 90% is not a problem with investment properties. When it comes to multi-family housing, many people want to own it in the name of a business. This means that you need to get loans that are for your business. Business loans are a completely different product, and these businesses are valued differently for loans than single-family homes.
Regardless of where your current credit standing is and how much money you have, it’s clear that access to good sources of financing is the key to a successful investment business.
While seller financing and other creative options can allow you to buy a property with no money down or credit, professional investors know that good credit and cash are key. If you want to succeed as a professional investor in the long term, you must take the necessary steps to gain access to good sources of financing.
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