Underwriting & Elements of a Home Loan: Part Two  

There are difference aspects of the financial picture that are common in what makes a good mortgage loan. All of these elements have a degree of risk to the lender. Mortgage companies judge these risks and assign a credit grade to them. The higher the risk to the lender results in a higher rate to the borrower.

We will review those risks associated with investment property now:   Is this an owner-occupied or an investment property? It is much easier to purchase a home that you will live in than to buy an investment property. It is far easier to let a house go back to the lender if you don't live in it and rent it out. Homeowners will work very hard to keep the home, sweet home where Junior took his first steps.  

Part of the problem of the “Mortgage Meltdown” that is occurring across the country is that non-owner occupied properties were purchased with 100% financing.

It seems that in 2005, many, many homeowners decided to get into the act and buy a second or third home. The purpose was to hold the property for a short time and flip it or keep the property with the goal of using it for rental income. Without the fast appreciation of real estate there became less reason for investors to hold on to a property that might be costing them a substantial amount of money each month. If the rent being charged is far lower that what the payments actually are, it really is a no-brainer to let the property go. Letting a property go back to the lender will be another topic that I will cover on my 2nd blog site which is www.SouthernCaliforniaMortgageBlog.com.

Anyone who used 100% financing on a property that they planned to rent out would most likely need to be fed a grand or two to meet the mortgage payment each month. Feeding the investment one or two thousand dollars each month would have been the most conservative way to pay on that 100% financing.

Unfortunately, many of these new landlords used “pick-a-payment” type of loan or those with a very small minimum payment on the first trust deed or mortgage. Those 1%, negative amortization loans are those that are being demonized in the media now-a-days.

Negative amortization occurs when the entire interest payment is not made each month on the loan. On a $100,000 mortgage, the full mortgage payment at 6.5% would be $542 each month. The mortgages that have four different options for payments might have a minimum payment of only $162 each month! The $380 difference between the two payments would be added to the mortgage balance each month. After twelve months of this type of payment program, the mortgage balance will have grown to $104,560!

I cannot tell you how many new clients I have had to explain this to over the past twelve months. I have often needed let them know that the loan that they have been put into has a growing balance that will soon make choosing a payment each month no longer an option. That new payment could be five and six times higher than what they have been paying.

That information, along with the realization that the property is no longer worth what they paid for it, is the recipe for foreclosure. This is only one of the reasons for the “sub-prime mortgage” problem that you hear about in the media.

The 100% financing of rental property is one of the reasons for those foreclosures. Many of the borrowers were not educated or did not fully understand the kind of loan that they were getting. Unfortunately, many loan officers were not well educated about the type of loans they were selling to people.

The underwriting of investment property has reverted back to what it was about five to seven years ago:

For those with the very best credit scores, say 720 plus, 90% combined loan to value (CLTV) will enable investors to put just 10% down on the purchase of a property planned to be used as a rental. Those with lower scores may have to put up to 30% down.

In addition, the new owner will be required to prove that substantial reserves can be proven. Those additional funds must include the rental property payments along with the residence payments of the new buyer.

The income of the investor will likely need to be proved and the qualifying ratios will need to be within lender guidelines. The age of stretching those guidelines are behind us now.

Stated income and stated asset loans are available, but a very, very high credit score will be needed and even then, expect double digits on the interest rates for some loan products.

Another important factor for becoming an investor in rental property will be a history of managing investment property. The way to gain that experience is to move up from your current home and turn it into a rental. This is one of the better ways to get your experience as a landlord. The best interest rates will be for those who can put 20 to 30% down.

Managing property is not for everyone. Those who do it well have been, and continue to be, very conservative with their money. It is essential to pencil out the investment and to understand what your return on investment can be.

Real estate is an excellent investment over time. Even though values are soft across many parts of the United States, they bounce back. The same conversations that people are having today about the current state of the market have all been heard before. In the nineties and in the 60’s, buyers worried that the values would never improve and many owners were up-side down on their mortgages. However, the phrase“what goes up, must come down” works in the opposite. This is exactly what happened then and I would bet that it will happen again.

My favorite part about investment real estate is that it is inflation-proof income. A house that was purchased in San Diego for $100,000 in 1985 is worth around $450,000 now and the rent on that property has gone from $650 per month to $2,200. My professional for San Diego County investment properties is Maureen Moran with Coldwell Banker. Many of her clients are multimillionaires because of the properties that they own.

With all of the real estate on the market today, there are amazing properties available for great prices. Someone wanting to invest now can negotiate the very best of terms with a seller. Single family residences, duplexes, triplexes and four unit apartment buildings can all be purchased with a standard mortgage loan.

Any property larger than that is considered a commercial property and different laws and loan products will apply.

It is critical to get well thought out advice from seasoned professionals. Check with an area real estate agent, loan officer, and your tax advisor and carefully go through your plans until all of your questions are answered. If you don’t know someone, ask trusted friends and interview the professionals that you will need on your team.

Having an appraiser do a rental survey for you is an excellent idea too. This will give you the most accurate numbers as to what properties really are renting for versus what they are advertised at.

A well thought out plan to acquire real estate can be the very best plan for your retirement and for creating wealth.

"Tune in" on October 1st for the next installment of this post. We will discuss the importance of the credit profile and credit scores.  

You can also reach me at 619.701.4321. Thanks for continuing to read my blog posts. I appreciate your comments.