The reason it shouldn’t have much affect is that I’ve primarily been using a different lender for my most recent houses, so I have no dependence on this particular bank. But, it was nice having a backup financing option, and I also really liked the guy who I was dealing with over there.

The only loan I currently have with them is on The Second Chance House, which should get paid off in the next week or two when we close on the sale; so I don’t expect there to be any major drama around my loan getting sold, dealing with the new bank (or FDIC), etc.

My biggest question now is how I get to the $100 I had in a checking account at the bank. I’ve heard that the bank’s assets were sold to SunTrust Bank…I’ll have to stop into my local branch next week to see what hoops I have to jump through to get my $100…

Anyway, the point of this post is to discuss some of the various types of financing I’ve seen. I’m not a financing expert, so don’t take my word for anything you read below; I’m just relaying my experiences to date. I’ll be sure to add updates to this post in the future.

So let’s get to it:

Traditional Financing

This type of loan is generally done through a mortgage broker or bank, and the lender may be a large banking institution or a quasi-government institution (Freddie Mac, Fannie Mae, etc). The requirements to qualify for a loan are based strictly on the borrower’s current financial situation — credit score, income, assets, and debt. If you don’t have good credit, reasonable income, and a low debt-to-income ratio (i.e., you earn a lot compared to your monthly obligations), you likely won’t qualify for traditional financing.

Benefits: The benefits of traditional financing are low-interest rates (generally), low loan costs (or points), and long loan durations (generally at least 30 years). If you can qualify for traditional financing, it’s a great choice.

Drawbacks: There are a few drawbacks to traditional financing for investors, some major:

• The biggest drawback to tradition financing is what I stated above — it’s difficult to qualify these days. Just a year or two ago, you could have qualified under a “sub-prime” variation of traditional lending, where income and credit were less of an issue; but given the sub-prime meltdown (many of these borrowers defaulting on their loans), these sub-prime options have gone away. So, unless you have good credit, income, and small debt, you’re better off not even bothering with trying to get traditional financing these days.
• Traditional lenders generally require that at least 20% be put down as a down payment. While this isn’t always true, investor loans with less than 20% down can be tough to find via traditional lending these days.
• As an investor, it can be difficult to deal with traditional lenders who don’t necessarily understand your business. For example, a house I closed on last week with traditional financing almost fell-through because the lender wouldn’t provide the funds until the hot water heater in the investment property was working. As an investor, it’s common that I’ll buy houses with broken hot water heaters (among other things), and I can’t generally expect the seller to fix this for me, especially when my seller’s are usually banks. In this case, I had to fix the hot water heater before I even owned the house, which is not something I want to do on a regular basis.
• Traditional lenders take their time when it comes to appraisals and pushing loans through their process. It’s best to allow for at least 21 days between contract acceptance and close. As an investor, you often want to incent the seller to accept your offer by offering to close quickly; with traditional lending, that can often be impossible.
• If the lender will be financing through Freddie Mac or Fannie Mae (and most will), there will be a limit to the number of loans you can have at one time. Currently, that limit is either 4 or 10 loans (depending on whether it’s Freddie or Fannie), so if you plan to be an active investor going after more than 5 or 10 properties simultaneously, you’ll run into this problem with traditional lending at some point.
• There are no traditional loans that will cover the cost of rehab in the loan. If you plan to buy a $100K property and spend $30K in rehab costs, that $30K will have to come out of your pocket; the lender won’t put that money into the loan.

Portfolio/Investor Lending

Some smaller banks will lend their own money (as opposed to getting the money from Freddie, Fannie, or some other large institution). These banks generally have the ability to make their own lending criteria, and don’t necessarily have to go just on the borrower’s financial situation. For example, a couple of the portfolio lenders I’ve spoken with will use a combination of the borrower’s financial situation and the actual investment being pursued.

Because some portfolio lenders (also called “investment lenders”) have the expertise to actually evaluate investment deals, if they are confident that the investment is solid, they will be a bit less concerned about the borrower defaulting on the loan, because they have already verified that the property value will cover the balance of the loan. That said, portfolio lenders aren’t in the business of investing in real estate, so they aren’t hoping for the borrower to default; given that, they do care that the borrower has at least decent credit, good income and/or cash reserves. While I haven’t been able to qualify for traditional financing on my own due to my lack of income, portfolio lenders tend to be very excited about working with me because of my good credit and cash reserves.

Benefits: As mentioned, the major benefit of portfolio lending is that (sometimes) the financial requirements on the borrower can be relaxed a bit, allowing borrowers with less than stellar credit or low income to qualify for loans. Here are some other benefits:

• Some portfolio lenders will offer “rehab loans” that will roll the rehab costs into the loan, essentially allowing the investor to cover the entire cost of the rehab through the loan (with a down-payment based on the full amount).
• Portfolio loans often require less than 20% down payment, and 90% LTV is not uncommon.
• Portfolio lenders will verify that the investment the borrower wants to make is a sound one. This provides an extra layer of checks and balances to the investor about whether the deal they are pursuing is a good one. For new investors, this can be a very good thing!
• Portfolio lenders are often used to dealing with investors, and can many times close loans in 7-10 days, especially with investors who they are familiar with and trust.

Drawbacks: Of course, there are drawbacks to portfolio loans as well:

• Some portfolio loans are short-term — even as low as 6-12 months. If you get short-term financing, you need to either be confident that you can turn around and sell the property in that amount of time, or you need to be confident that you can refinance to get out of the loan prior to its expiration.
• Portfolio loans generally have higher interest rates and “points” (loan costs) associated with them. It’s not uncommon for portfolio loans to run from 9-14% interest and 2-5% of the total loan in up-front fees (2-5 points).
• Portfolio lenders may seriously scrutinize your deals, and if you are trying to make a deal where the value is obvious to you but not your lender, you may find yourself in a situation where they won’t give you the money.
• Because portfolio lenders often care about the deal as much as the borrower, they often want to see that the borrower has real estate experience. If you go to a lender with no experience, you might find yourself paying higher rates, more points, or having to provide additional personal guarantees. That said, once you prove yourself to the lender by selling a couple houses and repaying a couple loans, things will get a lot easier.

Hard Money

Hard money is so-called because the loan is provided more against the hard asset (in this case Real Estate) than it is against the borrower. Hard money lenders are often wealthy business people (either investors themselves, or professionals such as doctors and lawyers who are looking for a good return on their saved cash).

Hard money lenders often don’t care about the financial situation of the borrower, as long as they are confident that the loan is being used to finance a great deal. If the deal is great — and the borrower has the experience to execute — hard money lenders will often lend to those with poor credit, no income, and even high debt. That said, the worse the financial situation of the borrower, the better the deal needs to be.

Benefits: The obvious benefit of hard money is that even if you have a very poor financial situation, you may be able to a loan. Again, the loan is more against the deal than it is against the deal-maker. And, hard money lenders can often make quick lending decisions, providing turn-around times of just a couple days on loans when necessary. Also, hard money lenders — because they are lending their own money — have the option to finance up to 100% of the deal, if they think it makes sense.

Drawbacks: As you can imagine, hard money isn’t always the magic bullet for investors with bad finances. Because hard money is often a last resort for borrowers who can’t qualify for other types of loans, hard money lenders will often impose very high costs on their loans. Interest rates upwards of 15% are not uncommon, and the upfront fees can often total 7-10% of the entire loan amount (7-10 points). This makes hard money very expensive, and unless the deal is fantastic, hard money can easily eat much of your profit before the deal is even made.

Equity Investments

Equity Investment is just a fancy name for “partner.” An equity investor will lend you money in return for some fixed percentage of the investment and profit. A common scenario is that an equity investor will front all the money for a deal, but do none of the work. The borrower will do 100% of the work, and then at the end, the lender and the borrower will split the profit 50/50. Sometimes the equity investor will be involved in the actual deal, and oftentimes the split isn’t 50/50, but the gist of the equity investment is the same — a partner injects money to get a portion of the profits.

Benefits: The biggest benefit to an equity partner is that there are no “requirements” that the borrower needs to fulfill to get the loan. If the partner chooses to invest and take (generally) equal or greater risk than the borrower, they can do so. Oftentimes, the equity investor is a friend or family member, and the deal is more a partnership in the eyes of both parties, as opposed to a lender/borrower relationship.

Drawbacks: There are two drawbacks to equity partnership:

• Equity partners are generally entitled to a piece of the profits, maybe even 50% or more. While the investor doesn’t generally need to pay anything upfront (or even any interest on the money), they will have to fork over a large percentage of the profits to the partner. This can mean even smaller profit than if the investor went with hard money or some other type of high-interest loan.
• Equity partners may want to play an active role in the investment. While this can be a good thing if the partner is experienced and has the same vision as the investor, when that’s not the case, this can be a recipe for disaster.

The good news is that the appraisal came back very solid, at $75K. I’m paying $61K, plus getting a $2500 credit towards rehab, so essentially my purchase price was $16,500 less than appraised value. Not too bad!

The harder part of closing was the result of my financing this one; I came to realize over the past week that the bank I’m working with (a small, local bank) probably isn’t very used to dealing with investors. First, the appraiser found that the hot water heater wasn’t working (duh! it’s a foreclosure!), and the bank decided that this needed to be fixed before they would go to closing. They didn’t seem to care that the A/C and furnace weren’t working, the stove wasn’t working, and the roof was caving in…just that the hot water wasn’t working. They originally insisted that I get this fixed before closing — in other words, before I owned the house.

While I got them to agree to put off final inspection until today (the day after closing), it turns out my HVAC guy couldn’t do the work today, so I actually had him come in to replace the hot water heater yesterday, a couple hours before I closed on the house. While he was there, he decided to also replace the furnace and A/C (I don’t think he knew I didn’t own it yet), so I basically spent nearly $4K in repairs before I even owned this house. I realize this was a really bad idea, but it was easier than arguing with the bank about getting to closing. Since I can pay cash as a back-up plan, there’s essentially no chance I wouldn’t close, so it wasn’t a huge risk to do some rehab a couple hours before the closing — but it’s still a habit I won’t get into. Luckily it didn’t turn out to be an issue.

The next thing that the bank/attorney pissed me off with is how they handled my having an out-of-state partner who co-signed the loan. First, they said that I needed to get a Power of Attorney (POA) signed and notarized, to allow me to sign for my partner on the closing documents. I sent my partner the POA on Tuesday, and he was going to overnight back to me on Wednesday, just before the close yesterday. I get a call on Wednesday morning from the lender saying the head closing attorney refused to allow a POA, saying he can’t be sure I have my partner’s best interest in mind, as we’re not related, so I can’t sign for him.

What the hell is that about?!?! If my partner is willing to sign over POA to me, he apparently believes I have his best interest at heart, and if I don’t, he’s apparently willing to take that risk. Why should the closing attorney step in?

Ridiculous.

Next, the closing attorney says that my partner will have to sign and get notarized all the closing docs and overnight them back (all with about 5 hours notice, as closing was less than 24 hours away at this point). Luckily my partner’s wife is a notary, so we figured this would be no problem. But then the closing attorney said that because my partner and the notary are related, she can’t be the notary for this. What the hell is that about? A notary is just a legal witness…how is a marital relationship a conflict-of-interest when it comes to being a witness?!?!?

Anyway, the closing attorney finally did the right thing and had another notary (that they found) go to my partner’s office, get the docs notarized, and then send them back herself. So, at least my partner didn’t have to go out of his way to accommodate this ridiculousness.

After all the hassle of getting signatures and getting the water heater fixed, we closed at 3pm yesterday and the closing appraiser was able to do a final inspection late yesterday to verify the hot water heater had indeed been fixed. So house #2 is official…

I knew that the big banks likely wouldn’t be able to help me much, considering I didn’t have any income, so I decided to start with the smaller, local banks. Surprisingly, a number of them were very receptive to my business plan and my investing approach, and said that they would consider providing some type of financing for my investments. While that was good, what they proposed wasn’t going to go far enough based on my investment goals (at least 6-10 houses in Year 1).

Late last week I made the decision to ask a friend of mine (who currently has a couple rental houses and a good income) if he’d be willing to partner with me on my investments. Basically, the deal was that if he’d co-sign the loans with me, I’d give him a percentage of the profits from my investments. The risk on his side was obviously his credit (if I ever default on any of the loans, it will hurt both of our credit); and the upside is that he will get part of the profits from all the investments I make without ever lifting a finger.

I went back to a couple of the banks I had been speaking with to see if having a co-signer with income would help me with my financing. The answer was that it would help tremendously, and I decide to move forward with one of the banks to submit preliminary loan applications (for both my partner and myself) to find out what the terms of loans we requested would be.

Essentially, the bank offered us two types of loans. The first — Purchase Loans — will be used to purchase properties. Once a properties is purchased using a Purchase Loan from the bank, I will use my own cash to rehab the property. Once the property is rehabbed and I get a tenant into the property, I use the second type of loan — a Refinance Loan — to refinance the property to pull out some or all of cash that I used to pay the down payment and the rehab costs. If I can get properties cheaply enough, I should be able to refinance to take out all the money I have invested, and still make a profit each month from the rental income, even after paying the mortgage. This would allow me to keep buying property after property withot investing much (if any) of my own money, but still turning a profit every month. Then, when I sell the property, I would pay off the loan, and keep the difference as my profit.

Financing my real estate investments have been my biggest challenge to-date (as I have no provable income), so getting past this hurdle is quite relieving!

Lots of “fun” stuff happened the past couple days:

1. Met with a couple more banks. While they aren’t going to be able to get me the financing I’d like, I may not be in a position to be too choosy; it looks like my best option so far (and I still have some more to speak with) will be high LTV (65-70%) on the purchase price of the property, not including rehab costs. So, if I buy a property for $80K and put $20K of work into it, I’d only be able to get a loan for 70% of the $80K, meaning I’d still be putting up about 45% of the total investment myself. Not great, but at this point, better than 100%.

2. I met a bank rep the other night at the local real estate investors association (REIA) meeting who does rehab loans. Basically, for a small down payment and a couple points, they’ll provide interest-only financing for 12 months at 10-13%. He offered me better terms if I was willing to keep a bunch of cash in a CD in his bank (currently paying 4.25%); specifically, he offered interest-only loans for 12 months with no prepayment penalty, no down payment, 9% interest and 1 point. Not bad compared to some other options, but the part that scares me is the 12 month balloon payment (have to pay off the loan after a year); there’s no guarantee that I’ll be able to refi in a year if the credit markets haven’t improved and my income situation hasn’t changed.

3. I had a great lunch meeting with an REO agent today. She lists a good percentage of the REO (foreclosed, bank owned) properties in the Atlanta area, and thought I had a great plan for acquiring and managing SFH properties. We discussed my goals, my buying criteria, and the areas I was interested in, and I think she’ll be able to bring me some great properties before they hit the MLS, or within 24 hours of hitting the MLS. Without exaggerating, this could be the difference between success and failure in my real estate endeavors. Additionally, she was tremendously pleasant to talk to, had some great insight into the Atlanta REO market, and I think we’d work really well together. I’m looking forward to working with her, and seeing some of the deals she can find.

4. I’m having lunch today with the agent/wholesaler I’ve been working with on a couple offers. He’s done a lot of rehabbing, and has experience as an agent, and I had suggested previously that maybe we should partner on a deal or two (I’d happily do much more of the work if he was willing to “be the brains” and teach me some of what he knows). He and his current business partner want to discuss this idea over lunch. While having partners isn’t a necessary part of my plan, I’m always happy to partner with smart and motivated people, and I think this guy is both.

5. An “Internet friend” of mine (someone who posts on one of the same forums that I often frequent) has been investing large-scale in SFHs for several years now, and has probably learned all the lessons I would likely be learning the hard way. She lives and invests in Florida, and was kind enough to invite my fiancee and me down to Florida to chat, see how she runs her business, ask a lot of questions, and likely learn enough to avoid many of the mistakes I would otherwise make. We’re hoping to arrange something either in the next week or after the wedding, and I’m really looking forward to it.

6. My fiancee and I came to the decision that it would be in our best interest for at least one of us to get our real estate license. This would allow us to access the MLS (the service where all the for-sale properties are listed) and to earn a percentage of the commissions that move around when we purchase/sell properties. For various reasons that I’ll touch on in a later post, we’re thinking she’ll probably be the one to get her license.

One option I have is to partner with someone who has income and can co-sign for loans. While I would certainly consider this alternative if that partner were also either going invest cash in my business or actually work with me on deals, I’m not thrilled with the idea of giving out equity to a partner who only is going to be used to co-sign loans; I’m not sure it’s worth giving away 15-25% of my profits just so I can get financing. While I previously considered partnering with a contractor friend of mine who was hoping to bring both cash and credit (the ability to co-sign) to the business, it turns out he isn’t able to provide either. So, while I very well may sub-contract him to help me out on some projects, it doesn’t look like we’ll be partnering just yet…and I still have the problem with the loans.

Some other investors I’ve spoken with have suggested that I may want to meet with some local banks in my area (these banks service their own loans, so they can choose to loan to someone like me if they want to, without having to jump through hoops or deal with red tape), and figure out if there is any way they’ll work with me. So today, I threw on some nice pants and button-down shirt, and visited a couple local banks. The response I got wasn’t as bad as expected…

First, I met with my current financial institution, a big national bank that I promise everyone has heard of. As expected, they said there probably wasn’t anything they could do for me, but they did give me the name of the regional commercial loan coordinator to speak with, in cash she could figure out something creative.

Next, I went to a local bank down the street that currently has about 4 branches altogether. I’m quite certain they service their own loans, so if they really wanted to loan to me, they could. The gentleman I met with first asked me some basic questions, if I lived in the area, what my business model was, whether I had any experience, etc. Hearing that I had no experience, I think he was about to write me off. But, I pulled out a copy of my business plan and my personal financial statement, and seeing that I had done some preparation and wasn’t just wasting his time, he was happy to continue the conversation. We had a great chat, but in the end, his response was that they may be able to provide some low LTV loans (65-70% of the purchase price), but would only consider it once I had the property(s) purchased and ready to be refinanced.

My last stop was at another local bank; when I walked in, I was the only customer in the bank, and when I asked to speak with someone about “real estate investment loans,” everyone who worked there hesitated, as if they were all hoping they wouldn’t be the one who had to speak with me. Perhaps they have a lot of investors walking in the door these days who they can’t really help. Ultimately, one woman stepped forward and told me that, while she only had a couple minutes until an appointment, she could speak with me. Learning my lesson from the last bank, I immediately pulled out my business plan and personal financial statement, and the woman quickly warmed up to me. She offered to make a copy of the business plan, and when I told her she could keep that copy, she acted surprised and said, “Most people don’t come in here that prepared.” I guess that was a good sign…

We chatted for a few minutes, and after discussing my business model, the volume of loans I’d likely need, and my time frame, she said that, she may be able to arrange some pre-approved financing at about 70% of after-rehab appraised values, assuming I got get tenants using their approved leases and positive cash flow. We set up some time later in the week to review my previous years’ tax returns, and some other financial data, and we’ll go from there. Hopefully we’ll be able to put something together (either commercial financing, lines of credit, or both), but at very least, I’m more confident that when push-comes-to-shove, I’ll be able to get at least some financing on my properties assuming I’m successful at getting tenants with positive cash flow.

I also learned the lesson that most people probably don’t walk into banks prepared with the information the loan officers need (financial statements, business plans, etc). So, having that information prepared will go a long way towards getting the loan officer to really take you seriously…