Consumer vs Investment Property Mortgages
Offering investment property mortgages provides an excellent opportunity for residential mortgage brokers to expand their product offerings, service more clients, and grow their businesses. However, many mortgage brokers shy away from offering these mortgage programs to their clients.
When asked why they don’t provide investment property mortgages, many residential brokers say that they believe them to be more complicated than owner-occupied home mortgages. Others aren’t sure they understand investment property financing well enough to discuss it with clients. And a few brokers believe that closing investment property mortgages takes longer than home mortgage loans, so a lack of time is another principal concern.
Indeed, a fear of the unknown often overrides the fear of missing out. Most mortgage professionals want to expand their business by offering more products that serve a broader market out of concern that they are missing an opportunity. However, they also don’t want to alienate clients by providing poor advice. That’s understandable.
Are Investment Property Mortgages More Complicated?
The answer to this question depends on the type of investment property financed, how the building generates revenue for the investor and the lender chosen to fund it. Let’s compare the primary underwriting guidelines and forms used for consumer home loans and investment property mortgages.
Loan and Credit Applications
Residential mortgage brokers are familiar with the standard Fannie Mae 1003 Form used by nearly all lenders as a loan application form. Lenders also request a tri-merge credit report with the loan application to start the underwriting process.
At Velocity, we can use the same loan and credit application forms for investment property and commercial mortgages. There’s no difference here. In fact, we have an even simpler loan application that many of our brokers use.
Income Versus Revenue
Applicants for home mortgages must prove they have an income from which to pay their mortgage. The same is true for borrowers who wish to purchase an investment property. However, income for investment properties is based on the rent paid by tenants who lease the space from the owner/borrower instead of the borrower’ personal income. For businesses that own and use a commercial building to run their business, revenue comes from the business enterprise. Again, personal income is not considered in a commercial property mortgage.
With rental properties, obtaining the property’s rental income doesn’t require any additional work from the broker. The appraiser provides rental income data in the correct form for each property as part of the appraisal report. If the property is used by the borrower to run a business, a profit and loss statement, generated by the borrower, shows the revenue history of the business.
If you’re working with a lender that sells their investment property loans to a Government-Sponsored Enterprise like Fannie Mae or Freddie Mac, each property must meet specific thresholds to approve the loan. However, portfolio lenders that retain and manage their loan portfolio have the flexibility to approve loans that don’t fit some of these thresholds.
The Ability to Pay Off Debt
Expenses and debt payments are another part of the underwriting process for investment property loans. Residential brokers are familiar with a debt-to-income (DTI) ratio used to qualify borrowers for home mortgages. Investment property mortgages use a similar ratio known as the debt service coverage ratio (DSCR), sometimes called a DCR for debt coverage ratio.
A DSCR compares the property or business’s net operating income (revenue minus all expenses) to the total cost of servicing the mortgage debt (principal, interest and lease payments). A ratio of 1.2 means that the property or business earns 20% more than the cost of servicing its mortgage debt.
The DSCR for investment property loans measures the property’s ability to sustain its debt payments based on its cash flow in the same way that a DTI is used to measure the borrower’s ability to repay a home mortgage loan. Again, the concept is similar between the two types of properties.
Appraisals for investment and small balance commercial properties can range from simple and familiar to somewhat complex depending on the type of property being financed and its use.
For example, an appraisal for a residential 1-4 investment property is very similar to an owner-occupied single-family residence appraisal, with the addition of a rental survey that provides rental comparables and market rent levels for similar properties in the same area. Again, the underwriting for investment properties is focused on the market value of the property and its revenue-generating potential. Therefore, understanding comparable rents for similar properties is part of this process. Generally speaking, lenders will use the subject property’s current rents and/or market rents to determine the property’s ability to service the debt.
Appraising a multi-family building is similar, except that the lender must review rent rolls, operating statements and leases. However, it still boils down to the market value of the property and its revenue-generating potential as compared to similar properties in the area.
Appraising mixed-use buildings includes an additional level of complexity since these buildings often include both residential and commercial units. While real estate investors will typically act as the landlord for both the residential and commercial tenants, some borrowers will live in one of the residential units and operate a business out of the commercial space. Velocity simplifies this process and uses a pre-selected list of appraisers that are experts in valuing this type of property. There’s not a lot for the broker to do since a tenant analysis is part of the appraisal.
Generally speaking, appraising the value of commercial buildings used for investment purposes follows the same process of evaluating rent rolls, operating statements and leases. While some brokers may feel a bit intimidated by these types of documents, Velocity can help you obtain and review them during the underwriting process.
Bottom line, if you are already familiar with appraisals for home loans, you’ll find the appraisal for investment properties to be fairly simple. Just remember that the appraisal will be based on the market value and revenue-generating potential of the building. As you move to larger properties, tenants and occupancy rates play a larger role. The best advice for brokers seeking to offer investment and commercial property mortgages is to start with what is familiar to you and rely on the lender’s guidance on more complex properties.
Traditional Versus Asset-Based Investment Property Mortgages
If you decide to jump into residential 1-4 investment properties to expand your business offering, it’s good to pick a niche, underserved audience of real estate investors. You’ll have fewer competitors with which to deal and a unique product offering to distinguish you from them.
For example, offering traditional investment property mortgages means you’ll have to compete with more brokers and a somewhat standard product that isn’t unique. This business strategy creates a commodity-based market where the lowest price usually wins. It may be better, and more profitable, to focus on the unique needs of self-employed investors and small business owners by offering asset-based investment property mortgages. It’s a niche group of underserved real estate investors with distinct needs.
What Are Asset-Based Investment Property Mortgages?
As its name implies, asset-based mortgages focus more on the value of the property and its revenue-generating potential and less on the borrower’s income and credit. Because of this, asset-based loans allow you to qualify self-employed real estate investors and small-business owners who are tough to qualify for traditional mortgage loans. These borrowers are not necessarily a credit risk; they simply don’t meet the income and credit guidelines for conventional mortgages.
The Advantage of a Direct Portfolio Lender
Wholesale lenders typically originate and sell their mortgages to a GSE, so they must follow the real estate, income and credit underwriting guidelines for GSE-backed loans. The combination of income, credit, non-recourse loans, and real estate restrictions makes it difficult for lenders to qualify self-employed investors and small business owners.
In contrast, direct portfolio lenders don’t sell their mortgages to GSEs and are free to set their own underwriting rules and often use an asset-based lending approach combined with a full-recourse loan. This lending approach enables brokers to qualify more self-employed investors and small business owners, giving them an advantage over other brokers and a niche market to target.
Do Investment Property Mortgages Take More Time?
Again, the answer to this question depends on the type of property financed. As a general rule, it takes more time to process a commercial property loan than a residential 1-4 investment property. However, unlike home mortgage loans where broker commissions are capped, investment and commercial property mortgage brokers are allowed to earn more, so the extra time is offset by a higher commission.
Do You Need to Know Everything Before Offering Investment Property Mortgages?
The answer is “no.” The differences between offering residential home loans and residential 1-4 investment property loans are small, and it’s okay to learn on the job. If you start by financing properties you already know, you’ll find the transition from servicing consumers to investors is relatively easy. Once you have a few deals under your belt, you can then move on to larger properties and even higher commission checks with the help of a good lending partner.