Tag: Conventional Finance

Pre-Foreclosures and What to Know

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Are you tired of chasing properties on the MLS and not getting your offers accepted?  We were too and finally our first off-market opportunity showed up on our laps.  It showed up in the form of a pre-foreclosure from a divorced couple that were desperate to save their credit.  My broker approached us after two other offers we placed on houses fell through due to being outbid in a highly competitive market.

The broker represented the seller and of course represents me.  He walked the property and already knew how I analyze properties due to the countless hours we spent looking for good deals.  He undersold the property as requiring simple cosmetic improvements, a new roof, garage door, and some other improvements.  As with anything, I valued his opinion, but knew my experience in construction is more vast than his.  Ideally, I wanted to conduct a property inspection first, but we were racing the clock…in this case…the foreclosure date.

Banks and Foreclosures.  The bank told the listing broker that the property must be under contract by 1 July or it would be sold at auction on the Courthouse steps.  We later learned the seller didn’t communicate clear enough with their broker, because the bank never received the purchase agreement, loan payoff amount request, or communicated the closing date to the bank.  This mishap almost proved costly in closing the deal because it forced us to close on 1 July.

The Loan That Never Was.  Originally, we tried to get conventional agency financing with a 20% down payment which requires an appraisal and significant amount in closing costs that includes:  lawyer fees, title searches, appraisal costs, loan origination fees, penalties for low finance amounts, etc.  For the agreed upon purchase amount of $78K, this amount would equal about $6K with a total cost of $84K.  We knew this amount with the CAPEX (Capital Expenditures or initial repairs) would force us to leave money in the property after a cash-out refinance, but we were confident with the ability of renting the property at our target amount of $1K for the 3 bedroom/2 bathroom house.  We had to pay for the appraisal in advance and the report was to be completed by 21 June with a 1 July closing.  The lender didn’t receive the report until the morning of 28 June…exactly 3 calendar days prior to closing.  As we waited, the lender and broker grew worried and reached out for an extension with the bank.  This is when we learned the bank DIDN’T know the property was under contract and required 72 hours to produce the loan payoff amount.  Additionally, NC law requires a 72 hour period for the lender to show the seller the Closing Disclosures (CD) prior to closing.  At this point we busted these time windows and we began scrambling for an all cash deal as part of the back-up plan…in the event the bank didn’t agree to the extension.  Shortly after I would learn none of that mattered.  The LATE appraisal report came back with a low appraisal value and conditions that I was well aware of with a rating of C5 that my lender would affectionately refer to as the equivalent of being hit by a hurricane.  Basically, the lender could NOT finance the property.  Instantly, we switched gears to an all-cash deal.

Show Me the Money.  While we waited for conventional financing to be approved, we were forced to leave money in separate accounts since we were looking at personal financing due to the loan amount being less than $75K, but more than $50K (Commercial Loan minimums are $75K).  So now we had money in personal accounts as well as in the business account.  On closing day, the sellers signed their documents with no issues and provided the little they could afford.  Now it’s our turn, payment options include certified check(s) or wire transfers.  Due to the previously stated issues, we went with the wire transfer.  While all of this transpired, my broker and I were nervous, because the bank communicated the money had to transfer and deed had to be registered with the county or they would place the property under foreclosure.  We successfully transferred the money, but with only an hour for registering the deed.  Thankfully, the Real Estate Attorney communicated with the bank attorney that all funds are present, documents are signed, and submitted for writing at the courthouse.  As of the next morning, we were listed as the new owners of our very first rental property.

Summary.  We learned so much during this period and here it is.

  • Plan for Contingencies (Financing, Inspections, Timelines)
  • Constant Communication with Your Team – Broker, Lender, Contractor
  • Get Construction Estimates Early and Often
  • Be Prepared for the Worst
  • Be Prepared to Walk Away

We knew this property would be a challenge especially after the initial inspection and the list of items that needed fixed.  We established a hard cutoff for maintenance at $40K.  We knew anything over this amount would require too long to pull our money out.  Remember, we plan to Buy, Rehab, Rent, and Hold for 10 years.  This is concrete for us and has proven to be our backbone in all of our decision making.  Additionally, through tons of prep work and communication with others we placed ourselves in a situation that allowed us to use all cash as a contingency.  IF this is not available to you, just get more creative, be proactive because hard money and other lending is available.

Find the Money. Make The Offer.

There are varying opinions and schools of thought when it comes to funding any project. I am going to discuss the approach I am taking for the first one…Conventional Funding.  As of now, I have gathered information on various financing options, whether it is conventional, hard money, portfolio, it doesn’t matter. My goal is to identify my level of affordability before placing offers.  Based on cash on hand, I know I have the 25% down required for a $125K-150K purchase.  This information along lets me know exactly what market I should look into before finding a property.  I know my target range and it sits well in my business plan for marketing areas.  If this criteria wasn’t met then I would continue to save funds to reach this goal.

For lenders that serve conformed loans, which are in line with industry guidelines set by Fannie Mae and Freddie Mac, it’s important to understand friction points in the loan application process. These rules are strict due to the issues that arose during the sub-prime mortgage issues in 2008. This situation gets complicated when the property targeted is no longer a single-family house. So if you are like me and choose a duplex, 3-unit, or 4-unit property, the simplicity of a conventional loan for investment property comes with additional interest and inquiries from the bank.  They are likely to tack on penalties, restrictions, and insure you have more liquid assets.

At the minimum most lenders want assured that you have proof of funds for the following:

  • 25% down payment
  • Closing costs (not covered by seller)
  • 3-6 month cash reserves
  • Debt-to-income ratio below 43% for qualified buyer

Note:  I don’t bring up credit score, because you should focus to be in the mid to high 700’s. I highly recommend focusing on building your own personal credit before going any further.  Higher credit scores bring instant credibility with any lender and will make them work harder for you.  Just like someday your hard money will work harder for you. 

Debit to Income Ratio

“Don’t live beyond your means.  Don’t buy more than you can pay for.  Don’t expect to get rich quick.  And don’t confuse salesmen for friends or advisers.”

-Charley Reese

Your debt-to-income ratio should be affected predominantly by current mortgages and be mindful banks are required to adjust the ratio based on number of family members in the house. At the end of the day, the bank wants to make sure you can make the payments of the investment property and your critical bills without starving. It is good to know that the new mortgage is added in this valuation. If the income from current tenants in the new property is required, it will require additional paperwork provided by the seller to substantiate steady occupancy in order for underwriters to approve based on the new debt-to-income ratio. This valuation is much easier in larger multi-family houses because there are typically extensive income/expense statements associated with those properties.

Without throwing shade at specific lenders, I will say that I reached out to a couple big name mortgage lenders in hopes of receiving an investment loan. I received pre-approvals, but then I found a 3-unit which was no longer supported by the same investment property. After working with my good friend and Real Estate Broker, he and his wife (Real Estate Team) provided contact information for local mortgage lenders. I immediately reached out to one and noticed a significant shift in the personal approach to the conversation. The local lender explained the minutia that halted the big company, but found a way to get the pre-approval letter I needed to move forward with my offer.

The Offer

The offer is for a 3-unit property. Two tenants occupied and one vacancy with some tenant roll information to understand current net income and possible income with full occupancy. After walking the property, I have identified three key areas to raise appraisal value (equity) in the property. At least one area is a maintenance concern which justifies a reduced offer price of $10,000 below asking. Additionally, the property has sat on the market for nearly a year which for most is concerning, but for me isn’t based on potential improvements and increased cash flow. So the current offer is focused on the Seller knowing these items:

  • conventional loan
  • 25% down
  • Seller provides max 2% closing costs
  • $1,000 Escrow

The offer requires working with the seller/seller agent to insure the purchase agreement has the appropriate information and the right format. For instance, this property the seller “prefers” a commercial agreement over residential due to the level of detail in the document. However, due to the lender and loan type being used a residential agreement with additional provisions is the only way the offer can be submitted. Now let the negotiations begin!