Find out what the 3 most important factors are in lending from our expert, Blake Yarborough.
When you’re in need of a loan, you want to show that you are a reliable borrower with cash flow and assets.
Mike: Welcome back to the flipnerd.com REI Classroom, where experts from across the real estate investment industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Blake: Hello. This is Blake Yarborough with Capital Concepts. I’m today’s host for the REI Classroom. Today, I’m going to talk about the three most important things in lending.
Mike: This show was sponsored by passiverental.com
Blake: They include the importance of credit, the importance of liquidity, and the importance of cash flows. First, I want to go ahead and talk about the importance of credit.
Typically, your credit is your credibility. Your credit is you willingness to pay your bills in your past. So as a creditor, they’re going to look and see how you’ve paid your bills before they lend you money. That’s what I meant by your credit is your credibility. Now it’s really important to look at your credit report. There are studies and the numbers differ, but some people say over 80% of the credit reports have errors in them. It may be errors on old accounts still staying open, errors where some bureaus say you’re current, but other ones reported you late, errors on addresses or items that aren’t even your credit and that gets into a whole other issue about identity theft.
But your credit is your credibility and you need to have at least a 680 score. I had a banker tell me, “Blake, everything over 700 is treated the same. It’s when you have a crooked letter in front of it is when we raise an eyebrow.” Now, what he meant by that is you know, a borrower with very low debt may have a 780 maybe even a little higher credit, but he goes and buys something that month and he’s charged up that credit and all of a sudden he’s down to 720 or 710. He still has excellent credit, it’s just that month his revolving debts may be high.
We typically use three bureaus when we’re looking at credit. Throw out the high, throw out the low go with the middle. And this is good because you could have something that you didn’t know about hit one of your bureaus. And you could have like a 750, 760 and all of a sudden something hit this one bureau and it loses 90 points. I’ve seen it happen. So all of a sudden, that one bureau’s at a lower standard. But fortunately, we go all three, but if you ever catch that, go to work, find a professional to take a look and see if they can correct the error because you don’t want to have two of your three drop because it’ll cost you a lot in the long run.
As far as lending, conventional loans, they want 660, really 680, the adjustments are pretty substantial there. When you get to your fifth property plus, you need a 720 for a conventional loan for investment properties five through 10. After that, the portfolio lending, try to just stay over 700. So that’s what I wanted to talk to you about the importance of credit.
The next thing is the importance of liquidity. The liquidity is the amount of cash you’ve got in your bank or the amount of money that you could reasonably put your hands on. The reason why banks and lenders put such importance on this is just in case, job loss, disability, unforeseen expenses. That way when life happens, these notes or bills are still going to get paid. Some banks look at the amount of liquidity that you have and say, “How many months can he pay all his bills if these properties go vacant?”
And that leads us into the next issue. Oh, wait before I mention that. A little liquidity thing. For a hard money loan, we want to make sure you have enough money to close, plus closing costs, as well as money to start the rehab. So that varies depending on how well you buy the deal. If you buy it, the least we want to see is probably $15,000 or so in the bank. On a conventional loan, your first investment property, they want to see six months’ reserves or liquidity, and two months for other properties on investment properties five through 10. Six months, principle, interest, taxes, insurance for all properties.
Now, when you start getting past 10 or you’re doing portfolio lending, it’s really more of a feel. Like me, I have over 100 units. I don’t need $600,000 in the bank for a bank to lend to me. It would be probably unwise for me to have that much money sitting on the sidelines not making money. But it has to be reasonable. So it’s kind of on a case-by-case basis.
Moving onto the last thing, importance of cash flow. It kind of ties into that liquidity thing. The importance of cash flow is just for . . . let’s say if something happens to you and your personal income. And there will be vacancies. There will be repairs you have to make. So for conventional underwriting, a lot of times we can offset the new payment of the new mortgage with 75% of gross rent. So you buy a $75,000 house and you rent it out for $1,000. Let’s say your payment’s $750, but if you rent it for $1,000 we can use 75% of the $1,000, $750 to offset the $750. So great thing about real estate, it pays for itself. Sales pitch. But anyway, that’s a belief of mine.
When we talk commercial lending, a lot of times they’re looking for something like 1.35 debt service. What that means is if your payment’s $1,000, you need the income for that property to be $1,350. Okay? So one of my examples that I’ve said in the past is if you’re going to buy one investment property, buy three. The thing is if you have one that’s $600 a month, you rent it out for $900 a month, well, you’re either 100% vacant or 100% rented. So if it’s vacant, then it goes against your personal income and you’d have to cover that in your debt ratio. But you have three and they’re each $600 a month and the rents are $900, if you have one goes vacant, the positive cash flows from the other two will make the third payment. So that’s where the importance of cash flow comes in handy in those situations.
Those are three main topics that I think kind of go across the board with lending and that’s why I wanted to bring them to your attention. Once again, thanks for joining me and I’ll talk to you soon.
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