The Good, The Bad, and The Ugly of Institutional Lenders

When investors think of financing real estate deals, their first
thought is to use an institutional lender. And while I believe there
are cheaper, less risky and more effective means to fund a deal,  
institutional lenders definitely have their place.

Let’s start with my definition of an institutional lender: a company
in the business of making loans – secured and unsecured by real estate.

Banks are of course the first thought. They are great for financing
rental properties for the long term. The interest rates are relatively low;
points are fairly low; and payments can be amortized over 30 years.

You also need to understand the limitations with banks that can destroy
your deal and your business.

• They do not like ugly properties;
• They will not loan on uninhabitable properties (must have working kitchen & bath)
• They do not recognize Assignments of Contracts, so wholesalers – don’t allow your buyers to use banks)
• They are slow to close
• You never know what’s going to happen in underwriting – the loan may never get approved
• They base their LTV (Loan-to-Value) on the purchase price for new purchases – regardless of the value of the property.
• They typically will not loan additional dollars for rehab

 You can see that their service is really limited to a small niche for investors.

A source that investors often do not consider – or maybe it’s that they don’t remember – is home equity loans; signature loans; and even credit cards. These sources used individually or jointly can provide the additional funds necessary to complete funding for a deal. Don’t be afraid to explore all of your resources, just remember to pay yourself back on these loans when the property sells to keep these accounts available.

Finally, there are hard money lenders (HML). These lenders are in the business of making real estate loans to investors. They understand the property may be ugly and will require rehab; they will allow loan proceeds to be used for repairs; and they typically will allow the wholesaler to collect an Assignment Fee. They can usually close within 7-14 days with a simple underwriting process. Most HML do not report the loans to the credit bureaus as longs as payments are current so the borrower’s credit is not tied up.

Hard money lenders get a bad reputation however because of their rates and terms. Interest rates can range from 12%-20% with points (fee paid up front for the loan) ranging from 3%-10% of the loan amount. These are short term loans which usually mature somewhere between 90 days and two years requiring interest only payments in the interim with a balloon payment of the total balance at maturity.

Some investors refuse to use HMLs out of principle because their terms are so “hard”. I agree to some extent – if you have a better alternative certainly use it; but if the deal supports the cost of the financing and you have no other option except to pass on the deal and the profits; then I think it would be ridiculous not to use the HML.

As with any service, there are good and bad providers. Get to know the institutional lenders in your area, and keep them as an additional resource when the deal is appropriate for one of these type lenders.

In our next article, I’ll discuss the more creative types of financing.