1. Collateral (property characteristics) – check whether that property meets the criteria (number of units, condition, location, etc) of the lender you intend to use
2. Amount and source of down payment and reserves – lenders like to see their borrowers put at least some of their own cash into their properties at the time they buy them and enough reserve to cover 2 to 3 months of mortgage payments
3. Capacity (monthly income) – monthly income from employment and other sources, as well as the expected NOI of the property you’re financing
4. Credit history (creditability) – good credit expands your possibilities
5. Character and competency – education level, career advancement potential, job stability, dependability, etc
6. Compensating factors – persuade a lender to approve your loan, emphasize your positives and play down or explain away negatives
^McLean, Andrew, & Eldred, Gary W. Investing in Real Estate. 5th ed. New Jersey: John Wiley & Sons, Inc, 2006
09 July 2010
6 Mortgage Underwriting Standards
07 July 2010
Owner-Occupancy Financing
Owner-occupants pay lower interest rates than investors. To qualify, you must tell the lender that you intend to live in the home for at least one year. For investors, the strategy would involve living in the home for one year, then renting it out, and repeating the process. You could also move into a new property and find a good tenant for your current home.
^McLean, Andrew, & Eldred, Gary W. Investing in Real Estate. 5th ed. New Jersey: John Wiley & Sons, Inc, 2006
06 July 2010
High Leverage Financing
With leverage you can increase your return on investment and build wealth faster than if you paid 100 percent cash for your properties. But leverage also increases risk. Highly leveraged acquisitions expose you to greater potential loses.
In theory, the more you borrow and the less cash you invest in a property, the more you increase your cash returns. Besides annual income, your rental properties will appreciate in value over a period of years. When you add returns from annual net rental income and appreciation, high leveraged properties may produce phenomenal annual rates of return.
Managing risks
1. Buy bargain-priced properties
2. Buy properties that you can profitably improve
3. Buy properties with below-market rents that you can raise to market levels within a relatively short period (6-12 months)
4. Buy properties with low-interest financing such as mortgage assumptions, adjustable-rate mortgages, buy downs, or seller financing
5. Buy properties in up-and-coming neighborhoods that are soon to be revitalized
6. When all else fails, to reduce the risk of high leverage to a comfortable level, increase your down payment to achieve a lower loan-to-value ratio and lower monthly mortgage payments.
7. Never expect the value of real estate, stocks, or any other type of investment to increase by 10, 15, 20 percent year after year
8. Beware of negative cash flows
9. Don’t overextend yourself
10. Even when the financing looks good, avoid overpaying for a property because you invite financial trouble
^McLean, Andrew, & Eldred, Gary W. Investing in Real Estate. 5th ed. New Jersey: John Wiley & Sons, Inc, 2006
05 July 2010
How Amortized Loans Work
If you borrowed $100,000 from a lender with an agreement that at the end of 30 years you would repay the original loan amount plus 7%, then your total repayment would be $107,000. This is not how mortgage loans work, as mortgages utilize a nominal interest rate (the interest rate per year).
The interest rate of 7.00% per year is compounded 12 times a year, resulting in a monthly rate of 0.58% (dividing 7.00% by 12).
To calculate the interest due for a given month, the monthly rate is multiplied by the current loan balance. If you borrowed $100,000 at 7%, at the end of the first month your interest due would be $583.33 ($100,000 x (0.07 / 12)).
Monthly Payment Calculation
LB(0) = Original loan balance (the $100,000.00 you borrowed)
ID(1) = Interest due at the end of the first payment period
I = Effective interest rate per payment period (0.07 / 12)
ID(1) = LB(0) * i
PP(1) = Principal part of the first monthly payment (the part that goes toward the loan balance)
PMT = Monthly payment
PP(1) = PMT - ID(1)
LB(1) = Loan balance after the first payment
LB(1) = LB(0) - PP(1)
LB(1) = LB(0) - (PMT - ID(1))
LB(1) = LB(0) - (PMT - LB(0) * i)
LB(1) = LB(0)*(1 + i) - PMT
LB(2) = Loan balance after the second payment
LB(2) = LB(1)*(1 + i) - PMT
LB(2) = (LB(0)*(1 + i) - PMT)*(1 + i) - PMT
LB(2) = LB(0)*(1 + i)^2 - PMT*((1 + i) + 1)
LB(3) = Loan balance after the third payment
LB(3) = LB(0)*(1 + i)^3 - PMT*((1 + i)^2 + (1 + i) + 1)
LB(n) = Loan balance after n payments
LB(n) = LB(0)*(1 + i)^n - PMT*((1 + i)^(n-1) + ... + (1 + i) + 1)
The sum of the finite series: 1 + a + (a^2) + (a^3) + ... + (a^n) is (1-a^(n+1))/(1-a)
Now, with a simple re-arrangement, our equation for loan balance after n payments becomes
LB(n) = LB(0)*(1 + i)^n - PMT*(1-(1 + i)^n)/(1-(1 + i))
LB(n) = LB(0)*(1 + i)^n - PMT*((1 + i)^n-1)/i
LB(0) = Loan balance after 360 payments which is $0.00
LB(0)*(1 + i)^360 = PMT*((1 + i)^360-1)/i
PMT = i * LB(0)*(1 + i)^360 / ((1 + i)^360-1)
PMT = (0.07/12) * 100000*(1 + 0.07/12)^360 / ((1 + 0.07/12)^360-1) = 665.30
The first 9 months of an amortization schedule for a $100,000, 30 year, 7%, fixed-rate mortgage will look like this:
19 June 2010
18 June 2010
Glossary - T
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Tax deduction
A tax break given by the government. Mortgage interest, loan points and property taxes can be deducted.
Title
The actual legal document conferring ownership of a piece of real estate.
Title company
Firms that ensure that the title to a piece of property is clear and provide title insurance.
Title insurance
A policy issued to lenders and buyers to protect any losses because of a dispute over the ownership of a piece of property.
Glossary - R
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Real estate investment trusts (REITs)
The trusts are publicly traded companies that own, develop and operate commercial properties.
Refinancing
The process of replacing an older loan with a new mortgage that has better terms.
Glossary - P
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
PITI (Principal, Interest, Taxes, Insurance)
When a buyer applies for a loan, the lender will calculate the principal, interest, taxes and insurance. The figure is designed to represent the borrower's actual monthly mortgage-related expenses.
Property tax
Property taxes are calculated at about 1.5 percent of the current market value.
Property tax deduction
The U.S. tax code allows homeowners to deduct the amount they have paid in property taxes.
Property value
The value of a piece of property is based on the price a buyer will pay at a certain time.
Purchase agreement
A document which details the purchase price and conditions of the transaction.
Glossary - O
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Open house
A marketing tool in which a listing agent opens a house for view.
Open listing
A property given to a number of brokers to market at the same time.
Origination fee
A fee charged by most lenders--also called points--for processing a loan. A point is 1 percent of the total loan amount.
Owner financing
A transaction in which the seller of a property agrees to finance all or part of the purchase.
Glossary - M
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Margin
The lender's "retail markup" on the mortgage. For example, if the index rate for an adjustable-rate mortgage is 5 percent but the lender has a 2.5 percentage-point margin, the rate the borrower will pay is 7.5 percent.
Market value
The price that a piece of property sells for at a particular point in time.
Maximum financing
A loan amount within 5 percent of the highest loan-to-value ratio allowed for a property.
Mortgage
A legal document specifying a certain amount of money to purchase a home at a certain interest rate, and using the property as collateral.
Glossary - L
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Landscape
A home's surroundings can range from a shrub-studded emerald lawn to a native-plant xeriscape. It is a major component of curb appeal.
Lease
A binding agreement that contains the terms and conditions of a renter's occupancy.
Lease option
A lease that contains the right to purchase the property for a specific price within a certain time frame.
Leverage
The use of a small amount of cash--a 5 percent or 10 percent down payment--to buy a piece of property.
Liabilities
A borrower's debts and financial obligations.
Lien
A claim laid by one person or company on the property of another as security for money owed.
Liquid assets
Cash and all other assets that can be converted to cash relatively quickly. Liquid assets can include money in savings and checking accounts, money-market accounts, and most certificates of deposit.
Loan -to-value ratio
A technical measure used by lenders to assess the relationship of the loan amount to the value of the property
Glossary - H
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
HUD-1 Uniform Settlement Statement
A closing statement or settlement sheet that outlines all closing costs on a real estate transaction or refinancing.
Home equity loan
A loan that allows owners to borrow against the equity in their homes.
Home inspection
An examination of a home's construction, condition and internal systems by an inspector or contractor prior to purchase.
Homeowners' association
A group that governs a modern subdivision or planned community. An association collects monthly fees from all owners to pay for maintenance of common areas, handle legal and safety issues, and enforce the covenants, conditions and restrictions set by the developer.
Homeowners' insurance
This insurance includes hazard coverage for any damages that may affect the value of a house, in addition to personal liability and theft coverage.
Glossary - F
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
FHA loans
Mortgages that are insured by the Federal Housing Administration. The FHA's 203(b) loan program provides low-rate mortgages to buyers who make a down payment as small as 3 percent. The agency also operates loan plans for investors and purchasers of rural property.
Fannie Mae
The official name of the Federal National Mortgage Association, it is a congressionally chartered, shareholder-owned company that buys mortgages from lenders and resells them as securities on the secondary mortgage market.
Federal Housing Administration (FHA)
This government agency operates a variety of home-loan programs. Its most popular is the Sec. 203(b), program, which provides low-rate mortgages to buyers who make a down payment as small as 3 percent.
First mortgage
The primary mortgage on a property that has priority over all other voluntary liens.
Fixer-upper
A house that needs refurbishment or remodeling It usually sells at a below-market price.
Freddie Mac
The common name for the Federal Home Loan Mortgage Corporation, a congressionally chartered institution that buys mortgages from lenders and resells them as securities on the secondary mortgage market.
Fully amortized adjustable-rate mortgage
A mortgage that amortizes, or pays down, the balance of a loan.
Glossary - E
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Earnest money
Money a buyer gives with an offer to purchase a property. Also called a deposit.
Equifax
Equifax Credit Information Services, Inc., is one of the "Big Three" credit-reporting bureaus that operate nationwide. Address: P.O. Box 740249, Atlanta, GA 30374.
Equity
A determination of the value of a property after existing liens are deducted.
Escrow
A neutral third party holds the documents and money involved in a real estate transaction and ensures that all conditions of a sale are met.. Escrow also refers to a special account that a lender establishes to hold monthly installments from the borrower to cover property taxes and insurance.
Glossary - D
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Deed
The legal document that transfers ownership of a piece of property.
Deposit
Money given by the buyer with an offer to purchase property. Also called earnest money.
Down payment
The amount of money a buyer agrees to give the seller when a sales agreement is signed. Complete financing is later secured with a lender.
Duplex
A structure that consists of two separate family units.
Glossary - C
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Cash flow
The amount of cash a rental property investor receives after deducting operating expenses and loan payments from gross income.
Closing
The final procedure in which documents are signed and recorded, and the property is transferred.
Closing costs
Expenses incidental to the sale of real estate, including loan, title and appraisal fees.
Commission
The negotiable percentage of the sales price of a home that is paid to the agents of the buyer and seller.
Compound interest
The interest paid on the principal balance in a mortgage and on the accrued and unpaid interest of the loan.
Contingency
A condition specified in a purchase contract, such as a satisfactory home inspection.
Credit report
A credit bureau report that shows a loan applicant's history of payments made on previous debts. Several companies issue credit reports, but the three largest are Trans Union Corp., Equifax and Experian (formerly TRW).
17 June 2010
Glossary - B
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Balance sheet
A statement that shows the assets, liabilities and net worth of an individual.
Balloon loan
A mortgage in which monthly installments are not large enough to repay the loan by the end of the term. As a result, the final payment due is the lump sum of the remaining principal.
Bankruptcy
A proceeding in which an insolvent debtor can obtain relief from payment of certain obligations. Bankruptcies remain on a credit record for seven years and can severely limit a person's ability to borrow.
Bargain sale
The sale of a piece of property for less than market value.
Glossary - A
A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | X | Y | Z
Agreement of sale
A document the buyer initiates and the seller approves that details the price and terms of the transaction.
Amortization
The process of paying the principal and interest on a loan through regularly scheduled installments.
Amortization tables
Mathematical tables that lenders use to calculate a borrower's monthly payment.
Annual Percentage Rate (APR)
The cost of the loan expressed as a yearly rate on the balance of the loan.
Annuity
The payment of a fixed sum to an investor at regular intervals.
Appraisal
An opinion of the value of a property at a given point in time.
Appreciation
An increase in the value of a home or other property.
16 June 2010
Resources
Comp Sales
Credit Information
Financial Calculators and Spreadsheets
Foreclosures and Repos
Home Improvement
Home Inspection
Homes for Sale
Insurance Information
Law Information
Mortgage Applications
Mortgage Information
Mortgage Providers (Underwriters)
Real Estate Information
School Data
City and Neighborhood Data
stats.bls.govusacitylink.com
venus.census.gov
census.gov
crime.org
bjs.ojp.usdoj.gov
Comp Sales
dataquick.comlatimes.com
propertyview.com
[your tax appraiser/assessor web site]
Credit Information
creditaccuracy.comcredit411.com
creditscoring.com
econsumer.equifax.com
experian.com
ftc.gov
myfico.com
qspace.com
trasunion.com
Financial Calculators and Spreadsheets
hsh.comloan-wolf.com
moneyweb.com
mortgage-minder.com
Foreclosures and Repos
all-foreclosure.combankhomes.net
bankofamerica.com
bankreo.com
brucebates.com
fanniemae.com
4close.com
homesteps.com
hud.gov
premierereo.com
treas.gov
va.gov
Home Improvement
askthebuilder.combhglive.com
hardware.com
hometime.com
housenet.com
michaelholigan.com
Home Inspection
ashi.orgcreia.com
Homes for Sale
buyowner.comcyberhomes.com
fsbo.com
houseandhome.msn.com
homes.com
homeseekers.com
ipix.com
owners.com
realtor.com
Insurance Information
cpcu.comstatefarm.com
insure.com
Law Information
lectlaw.comlexis.com
nolo.com
municode.com
Mortgage Applications
eloan.comfhatoday.com
interest.com
loanweb.com
mortgageauction.com
mortgage101.com
mortgagequotes.com
Mortgage Information
hsh.comloan-wolf.com
mortgageprofessor.com
Mortgage Providers (Underwriters)
fanniemae.comhomesteps.com
hud.gov
va.gov
Real Estate Information
trumpuniversity.comarello.org
inman.com/bruss
ired.com
johntreed.com
ourfamilyplace.com
realtor.com
rebooksandseminars.com
stoprentingnow.com
School Data
schooolmatch.comschoolreport.com
14 June 2010
Formulas
ROI (return on investment) = NOI / Cash Investment
Total ROI = (NOI + Appreciation) / Cash Investment
Annual mortgage payment = NOI / DCR (debt coverage ratio)
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