This article provides general background information for residential real estate investors to make reasonably informed decisions about the merits of using a mortgage broker to arrange loans for purchases, sales, refinances, cash out transactions, rehabs or construction projects, as well as for personal needs.
Understand brokers and the services they provide
On the most basic level, mortgage brokers act as intermediaries between a borrower and a lender. While some loans a broker may arrange are also available directly from a lender, many lenders work only through brokers.
In addition to negotiating loans with third party lenders, some brokers also perform the role of a lender and self-fund loans.Most banks provide a very limited range of mortgage loan products; usually a mix of the standard conventional loans (fixed, adjustable, balloon and buy down), a few portfolio loans with less strict underwriting, and one or more credit lines.
A typical mortgage broker will have 20 to 50 times the number of loan products, frequently having all that a bank has to offer and many, many programs that banks do not provide at all.The additional products that brokers provide frequently have much more liberal underwriting guidelines which will allow these loans to have one or more of the following features:
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Cash out up to 100% of the value of the property
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Debt ratios of 50% and higher
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Availability to borrowers whose recent credit history includes serious derogatory information (late mortgage payments, judgments, liens, foreclosure, etc.)
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No income verification
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Refinances with very little seasoning
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New employment permitted
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No employment permitted
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Other major deficiencies
With a larger number of lenders and programs to choose from, brokers can often find the ideal balance between cost, loan terms, liberal underwriting standards and speed.
Most mortgage brokers are very knowledgeable about all phases of the loan process. Since brokers are commonly paid only when they close a loan, they have great incentives to package the loan applications correctly and to intercede when the inevitable snags occur.
Though not every problem is curable, many are. Brokers typically maintain good working relationships with appraisers, title companies, underwriters and the other professionals often needed in the process.
If you need an appraisal done quickly, an opinion from an underwriter, a closing at your home or office, a payoff from a creditor, correction of inaccurate credit reports or a letter explaining credit problems a good mortgage broker can either handle the problem for you or advise how best to accomplish the task.
Additionally, most brokers know when to contest a low appraised value and when to dispute a turned down loan application and, failing those challenges, which lender to try next.
Consider strengths and limitations of particular brokers and establish relationships before you need them
It is the rare company or individual that can be all things to all people. But many brokers can come close. The critical determination is whether or not they will meet your needs. Though not always possible, the best time to shop for a broker is before you actually need one.
They can…
- Evaluate your ability to get various kinds of loans;
- Uncover credit problems that may be correctable;
- Point out strategies to reduce your debt and/or debt ratios;
- Inform you of the consequences (if any) of assuming additional debt not related to real estate;
- Help you deal with the late payments on your credit from a loan you co-signed;
- Suggest purchase scenarios that fit with your capabilities;
- And guide you towards putting together a loan package that, with minor updates, will allow you to apply for and close on loans in the shortest amount of time.
Additionally, the loan application forms and statements of net worth that they can provide will help you better understand your financial position.
By talking to several brokers you gain valuable insights into their style and methods of conducting business, their ability to communicate what you need to understand, the types of loan products they have available, the costs of the various loans, the level of their expertise and the quality of their references.
If you are established with a bank, compare their products and service with the offerings of the brokers as well.
Determine the benefits you need
The more precisely you can define what it is you want to accomplish, the more likely a broker can provide what will serve you best. Is the loan needed for a relatively short term? Perhaps a balloon or adjustable product will be less expensive overall.
Do you need to close in under one week, to finance with none of your own money, to get cash out at the closing when you buy? A broker who funds their own loans or who arranges hard money loans may be the answer.
Do you want to pay interest only, be able to pay down the principal and borrow again without reapplying for a loan? Brokers can arrange credit lines.
Is the loan for a buyer who doesn’t have cash? The broker may suggest ways around the dilemma. Do you need to consolidate debt to create more cash flow or need to negotiate short payoffs on liens or buy six properties in 3 months or get a loan while you are facing foreclosure? Ask a broker for assistance.
Understand the basics of lending and underwriting
Historically, most lenders have felt that the safest real estate loans are those provided in circumstances where:
- some portion of the equity (usually the purchase down payment) is supplied by the borrower,
- with a principal amount not exceeding 80% of the appraised value or the purchase price (whichever is lower),
- on owner occupied, residential single family properties,
- with urban lots five acres or under,
- in areas with recent sales of comparable properties,
- made to borrowers with no credit delinquencies,
- and who have enough verifiable income such that their housing expense (principal, interest, property taxes, hazard insurance) does not exceed 28% of their gross monthly income.
And such that their total monthly debt payments (housing expense plus payments for auto, credit cards, school loans, child support, etc.) do not exceed 36% of their gross monthly income and who have been employed in the same line of work for at least two years. Conventional, conforming loans would meet these guidelines.
Mortgage loan products (also called mortgage loan programs) are designed and created to fill the needs of a group of borrowers and to provide the lenders with a particular yield (return on their investment).
Typically, the riskier the lender perceives the type of loan to be and the group of borrowers to be, the higher return they will require. The higher return is necessary to maintain profitability after they cover the higher costs of collecting delinquencies and the higher losses they expect to incur due to the greater numbers of defaults that come the more a loan deviates from the “safe” standard above.
The availability of loans with less restrictive guidelines tends to change over time. From 1990 through the date this article is written (early 1997), non-conforming lenders have made available an ever increasing array of products with higher risk factors–loans that make borrowing as an owner occupant or investor easier.
Higher debt ratios, lower credit quality, higher loan-to-value ratios, shorter seasoning, less strict income verification are features of some of these newer loans.If time tends to show that the lenders have misjudged the profitability of these programs or if the government intercedes for some reason, these programs may become more restrictive or disappear altogether.
There are thousands of loan products that have more lenient standards than the “safest.” The more lenient (and, therefore, risky) the standards, the more expensive the loans tend to be.Some combination of higher interest rates, higher points and/or prepayment penalties are typically used by lenders to increase their yield to the point where the extra income covers the added risk and provides a better assurance of profitability.
Also, when the risk for default is high, lenders will demand a greater margin of safety by way of a lower loan-to-value ratio.
Familiarize yourself with various loan products
Loan products are tools. Each one has a different purpose. Using the right tool for the job always makes the task much easier. Take the time to learn about the available loan products in your area, and you may find yourself closing more deals this year.