Lending Advice
by Various Authors
Q. Is now the right time to refinance?
A. Now is a great time to explore refinancing, especially if your existing debt is adjustable. As most people are well aware, the Federal Reserve has been raising rates, which means if you're on an adjustable loan, your payments have been increasing of late. The good news is that long-term rates have not been increasing. A few years back, adjustable-rate mortgages were great because there was a big difference between floating-rate mortgages and fixed-rate mortgages. That spread has compressed and today's fixed rates are comparable to adjustable rates.
In order to avoid further increases to one's mortgage payment, the best thing to do is refinance with a fixed-rate mortgage and lock in today's low fixed rate. The choices that one has are abundant and debt is readily available in all forms. Many owners are electing to refinance with interest-only debt. On the other extreme, we are seeing increasing popularity of self-liquidating or fully amortized loans.
These are two extreme examples, but they do provide the flavor of the options that now exist. Historically, fixed-rate loans had a 10-year term and borrowers were seeking maximum proceeds. Today's demands differ and the capital providers have adjusted. Cash flow has become a very high priority for borrowers given the cash-flow volatility we have seen in all property types. Such loans are of interest to those who are very focused on using real estate as a vehicle to pass assets on to the next generation. Fully amortized loans will eventually be debt-free and all cash flow will go to the ownership of the asset. In addition, fully amortized loans are also a good strategy for those who seek some debt diversity in their portfolio. It can be extremely problematic if a multi-asset borrower has all debt coming due within a short time period.
Now is an ideal time to strategize on how to maximize the efficiency of the available debt options. If one waits too long in this increasing rate environment, the options might not be as promising.
– David Levine
Q. How does a wraparound work?
A. A "wrap," as it is called in the industry, is a second trust where the provider assumes the payments of the first trust. Say you have a $2 million first trust with a 5% interest rate, and you want to sell your property. You agree to sell it for $4 million. The buyer would want to finance up to 80% of that value and would want an additional $1.2 million. Since the rate on the first is low, the buyer might want to keep the existing first trust in place. A wrap lender might quote a rate of, say, 6% on the entire loan balance ($3.2 million), make the payments on the first trust and keep the spread for himself. The advantage of this is that you don't have to incur the cost of refinancing the first trust and may be able to retire the wrap loan quickly from cash flow, and still have the low-rate first trust (be careful: most loans have due-on-sale clauses).
– Richard G. Thornton
Q. Lenders say they can provide a loan up to 80% loan-to-value. But when it all shakes out, it is more like 60–65% loan-to-value. Why?
A. There is no one answer to that question. Depending on the property type, there are separate and distinct approaches to how a lender will underwrite your loan.
For residential properties of up to four units, the lender will underwrite using entirely the income of the borrower and his or her ability to carry the proposed debt service (along with other current debt obligation), up to the lender's debt-service ratio limits. The lenders with the most attractive terms and conditions usually will allow a combined 40-45% debt-service ratio. Additionally, there are alternative lenders that will go up to a 50-55% debt-service ratio, but higher rates will have to be paid.
Significant leverage can be obtained for buildings of up-to-four units. Lenders will lend up to 95% of value (and in some cases more) if you meet their debt-service (and credit) requirements.
For residential buildings of five units or greater, or commercial properties, the lender will underwrite and determine the maximum loan amount solely by the current income of the subject property. There are no rules of thumb for the loan-to-value that can be obtained for income properties. Each property's resume is unique and thus each available loan-to-value is unique. The property's current income after subtracting vacancy and expenses, factoring in the given lender's debt-service requirements (varies depending on property type) and their current underwriting interest rate, will determine the maximum amount of a debt the property can support. Using this underwriting spreadsheet will thus determine the maximum loan obtainable for your property. Not withstanding all the above, lenders will generally cap out at 75% loan-to-value.
There are a few variances to the above guidelines, such as an exceptionally strong borrower and/or a non-rent-controlled market. But these underwriting variances are very much the exception.
The value of a quality mortgage broker is that they have available to them a full roster of lenders and loan programs. Thus they are able to determine which lender will underwrite your loan most favorably for the maximum benefit for you and your property's resume.
– Rene Boisvert
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Consult the advice of a lending professional for any specific problem. David Levine is with ARCS Commercial Mortgage Co., 415-981-9700 x 214. Richard G. Thornton is with Reilly Mortgage Group, 925-287-0764. Rene Boisvert is with Boulevard Equity Group, 510-444-8420 or rene@boulevardequity.com. Copyright © 2005 by the San Francisco Apartment Magazine. All rights reserved.