Acquiring a residential property is a smart move to diversify your investment portfolio and create a low-effort stream of income. Most mortgage brokers understand that, like all investment routes, the commercial real estate market has its challenges. The primary challenge is financing, as having enough funds to purchase a property is essential. Prospective investors often seek conventional bank loans or property loans, which are not always successful.
If you are a mortgage broker exploring options to present to clients who have been unable to secure financing, read on. This article explains why banks reject property loans for investment properties and what to do in the aftermath of such an occurrence.
Major Reasons Banks Deny Property Loan Applications
Banks deny investment property loan applications for various reasons, including poor credit history and insufficient income. A high debt-to-income ratio, inadequate collateral, and unstable employment history also raise concerns. Understanding these reasons can help borrowers improve their chances of approval. Here are 6 reasons why banks turn down credit applications for investment properties:
1. Poor/Insufficient Credit History
A poor credit history paints potential borrowers as high-risk to lenders. Low credit scores typically go hand in hand with a record of missed or late payments. This red flag conveys that a client will likely exhibit poor financial behavior. Hence, banks tend to steer clear, especially since stricter requirements typically accompany investment property loans.
2. Investment Property Loans Are Riskier Than Home Loans
The rationale for tethering this belief is simple. Homeowners care more about keeping their actual homes than property owners care about holding on to investment properties. Should a borrower default on a home mortgage, they stand the chance of losing their home.
Thus, borrowers with home loans have a greater incentive for repayment. However, investment property loans may not have as strong a hold on borrowers. Hence, the bank’s reluctance to finance a real estate investment.
3. Valuation Discrepancies
When it comes to financing loans, banks generally seek to mitigate risk. Accordingly, when an individual applies for an investment property loan, the bank conducts an appraisal to determine the property’s current market value. If the property is worth less than the purchase price, the bank might reject the loan. This helps the bank avoid lending on an inflated purchase value and ensures that the property can serve as adequate collateral for the loan.
4. Resale Value
If your client’s chosen property lacks marketability or is in poor condition, the bank may not be able to finance the purchase. From their perspective, it’s a risky venture. If the borrower defaults on the loan, the lender would have to sell the property to compensate. For this reason, the bank has to ensure that if a resale becomes necessary, the process is as hitch-free as possible.
5. A High Debt-to-Income Ratio
Loan applicants with prior debt are not a particularly welcomed demographic among most banks. People already in debt are more likely to struggle with repayments on new debts. Rather than assume this is the case for all individuals in debt, lenders use the “debt-to-income” ratio to assess creditworthiness.
This metric weighs a borrower’s monthly income against their monthly debt payments. A low ratio is indicative of a good balance between debt and income, meaning they might have the capacity to handle additional credit.
6. Inconsistent Income/Employment
A stable source of income is a baseline requirement for securing any loan. Banks need to ensure that potential borrowers have a consistent monthly cash inflow. This way, borrowers can make timely payments on their loans. Your client needs 6-12 months of work history or 2-3 years of self-employment to secure a portion of the property value.
What To Do After A Loan Is Rejected
If a client’s loan application is rejected, there are several steps you should take to prevent this from happening again. First, educate the client on the reasons for the rejection. Then, guide them through the necessary actions to improve their chances of approval in the future. Here are the steps you should follow:
Review Your Client’s Application to Find Out Why
As a mortgage broker, you must let your client know not to reapply instantly. If they do so and their application is repeatedly rejected, this causes inquiries on their credit that can harm their score. Instead, review their application with them to uncover why they got rejected. It could be a combination of factors or a single overarching problem.
This could be a sky-high debt-to-income ratio, an excessively rundown property, or simply a “weak” net worth with inadequate liquidity. Whatever the case, in a situation like this, your first task as their mortgage broker should be to pore over their application to shine a light on why their loan was denied.
Carefully Examine All Documentation
Investment property loans require a borrower to have done their due diligence on the various aspects of the venture. Your client’s financial statements have to be in order, as well as all the documentation relating to the property’s condition and valuation. Mortgage brokers have to work with investors to ensure their paper trails are solid, both in their existence and the information contained within the files.
Plug Existing Gaps
If your client would like to apply again later, fixing the problem(s) that brought about their rejection is the natural next step. You can work with them to improve their creditworthiness and overall financial record and to ensure that their documents are all in order. This improves their eligibility with lenders and is generally a good idea.
Building a better credit profile is a long game, and sometimes, clients might not be able to play. If such a situation arises, as a mortgage broker,, you have on your hands the task of helping a client explore other options for commercial real estate loans, such as a hard money loan.
Hard Money Loans: An Alternative to Bank Funding
If a client applies for an investment property loan and gets rejected by a bank, it doesn’t mean other lenders will also reject their application. A mortgage broker can suggest alternative funding options like a hard money loan. This may prove to be a better choice than a conventional loan in certain contexts.
Also known as a bridge loan, a hard money loan is a type of short-term mortgage loan that is mainly used to purchase real estate. The property acts as collateral for the loan. This means that the application is evaluated based on the value of the property rather than the client’s credit profile. Instead of a bank or a private company, an individual usually plays the role of the lender.
What Clients Need To Know About Hard Money Loans
For starters, hard money loans are short-term loans, which means they have to be repaid quickly, making them riskier for borrowers. Loan terms range between 1 and 3 years as opposed to the 15 to 30-year repayment period attached to traditional loans.
If borrowers default on payments, hard money lenders are within their rights to claim the property the loan paid for. Additionally, due to the greater risk to lenders, the interest rates on these loans are higher than usual.
On the flip side, however, getting a hard money loan is far easier and faster than a bank investment property loan. Hard money lenders can approve and issue funding within ten days, a far cry from the month-long (or even lengthier) wait associated with banks.
The other big advantage of working with hard money lenders is that they aren’t as strict with credit scores and employment history.
Qualifying For A Hard Money Loan
First, when it comes to hard money loans, lenders generally prefer seasoned investors. Additionally, they pay close attention to the property’s value to confirm that it can be resold. Finally, hard money loans may require larger down payments as proof that borrowers are genuinely committed to the investment.
Get A Hard Money Loan With Capital Max
Capital Max is an investment and fund placement firm focusing on alternative investments and working with clients to provide loans for investment properties. Our hard money loan options can accommodate individuals with a less-than-stellar credit history looking to acquire commercial real estate. If a traditional bank loan isn’t the path for you, you can reach out to the team to uncover more details. Contact us at 855-302-2748 to get a hard money loan.