Full Transcript for Are You Using the Wrong Loan for Your Rental Property?

as the rates are concerned, they increase the rates to really try to slow down real estate investors from using this loan. I know that there are some people that are using this for vacation, for college rentals as well, because you, you know, your child's going to be living there. So there is, that can work in that perspective, as long as you are planning on using it also as, you know, using it for that personal use. So just to be on the correct side of it, you just don't want to use this loan as, let's say, if you're going it strictly as an investment purpose and you do not have a kid going to school. So like, if you're like us, that's looking for an investment property down there, we can't use the 10% down vacation home loan because we're going to be running it full time to college students and we're not going to be using it. We don't have kids that are going to be using it. And so to be on the correct side of this, to make sure that you don't end up, you know, on the wrong side of, you know, any future investigations that may come down the pipe from this loan in the future. Just want to make sure that you're setting yourself up properly and not potentially setting yourself up for any bigger issues later down the road. Perfect. Perfect. I want to go back to something else you referenced a few minutes ago, because you know, so many creative ways and there's so many different ways for people to buy investment properties. You mentioned a DSCR loan for those that are new investors. Can you explain what that is? Yeah. And just to kind of do a side by side comparison between conventional and DSCR, show you what the differences are with conventional financing. It's all based off of our ability to repay the loan. And so we need to show, you know, pay stubs, tax returns, things along those lines to show that you can repay the loan. And with that, it's a full doc review on the DSCR loan. This is so it stands for debt service coverage ratio. And it's just it's a mouthful, but it's a fancy acronym for does the property cash flow. And this is the commercial real estate product that's been around for years. This is how all the big multifamily deals are done. And what we do is we actually it's for investment purposes only. So no primaries, no second homes. So only for business purpose, investment properties only. But we treat the property as a business and we look at the cash flow analysis of the business. And so what we're looking at is does the rent cover the mortgage payment, all in mortgage payment, principal interest taxes and insurance and HOA dues if there are any. And if the rent does cover usually relatively easy to qualify for because that shows the ability to repay the loan. That is the minimum requirement there. So with that being said, we don't need to look at tax returns. We don't need to look at pay stubs. We don't ask for any of that. And then one of the added benefits is we can close directly in an LLC where on conventional loans or any type of government financing, we have to close in your personal name. Some lenders like us allow our clients to move their properties into an LLC after they make their first payment, as long as they maintain majority ownership of that LLC. With the DSCR loan, we can close directly in the LLC at closing. And so the big difference between those two is that anonymity aspect of the DSCR loan that is not the case on conventional loans. Where if you think about it, when you close in your personal name, that's public record. You'll see who bought the property and then moved it into an LLC at a later date. So anybody can see that goes looking for it. On a DSCR loan, you can close directly in the LLC. There's no chain of title there where you can see who actually purchased it. And if you layer that LLC with a holding company, it makes it very, very difficult to find out who actually owns the property, which adds added protection for investors that are trying to keep their personal assets protected from any of their business assets. Right. So when you have new investors, are most of them buying in their personal name? Are they setting up LLCs? Or does it just depend on which loan product they decide to use? Depends on where they are on their journey. And most investors that are just starting out are usually using conventional financing unless they don't have documentable income. So if a lot of clients that are in between jobs or just have a lot of money, in that case, a lot of them are going straight to DSCR loans. But primarily people that are just starting out, let's say property zero through five are using conventional financing because the rates tend to be a little bit better. And then the big difference is that there's no prepayment penalties on conventional financing. Where on DSCR loans and any type of non-conventional investment property loans, there's prepayment penalty options that range anywhere from zero to five years. And the way that I like to explain this is, is this is a period of time where you're agreeing not to refinance, sell, or pay down more than 20% of the principal without having to pay an early payoff penalty. And the reason why this is on there, why you have these options is because this is all of the big investment banks on Wall Street that lend in this space. And they have a required rate of return already factored into lending this money. And so if you think, if you agree to keep the loan for five years, it's going to stretch that required rate of return over a longer period of time and you'll get the best rate. Alternatively, if you want the flexibility of refinancing or selling, or if you have a shorter timeline with the property, you want to make sure you shorten that up. And every year that you shorten up the prepayment penalty, it usually raises the rate by about an eighth to a quarter because it's compressing that required rate of return into a shorter period of time. Wow. I am learning so much. Yeah, it does.

It does. So you referenced it at the beginning of the episode that you're a personal investor and that that's something that you saw with your own family. So talk to me about, and I know that personally because you're looking at properties in our town of Tuscaloosa, but talk to me about your requirements or what we call your buy box and what you look for when you're doing personal investing. Yeah. And this has evolved over the years. At this point, what we are looking at, we're looking out by you. And then we are also looking out by us. I live down in Southern California and we have a property up in the Sierras that we're in the process of renovating. It's going to take about a year, year and a half, and we're looking for other opportunities up there actively. And then we are also looking in college towns, but primarily Tuscaloosa at this point, we've really narrowed it down. I know it's the number one college town in the nation and we've been down there a couple of times and it's incredible. So we are looking for multifamily, two to four units, and then also single family residences, right outside of the box. And I've talked extensively about this, but what I've found is that it's getting a little challenging with the three twos because there's a lot of competition. You guys are such a hot market down there. Properties move quickly and so we're also exploring doing three ones and then building, you know, looking at three ones and building a extra bathroom. So that way we could do college rentals that way. So we've really narrowed it down. We spent the last year, year and a half looking at different opportunities. And those are the two directions that we're heading right now. Very good. Very good. Well, you just referenced we're the number one college town in the country to invest in. Thank you, BiggerPockets for that designation. But any other advice for people, again, that are specifically looking in college towns? You actually just referenced one thing is that maybe you look at a property and then figure out how you can make modifications to both add equity and value and also make it more desirable as a rental. But any other thoughts or advice as a lender? Yeah. So one of the things that we've come across that is just when you're going to be able to actually rent it. So how, you know, where in the college year are you currently in the calendar year? How easy, you know, we've looked at recently where one of the college students moved out and there's going to be a little bit of a period of time before we're going to potentially be able to fill that room. Also, that one that we looked at last year that was in the box that looked like a great opportunity, but it just was going to it wasn't going to be cash flowing for an extended period of time because we needed to stabilize it and it needed some work. So those are the only things I would say as potential things to look at. And then I would say from a lending perspective, look at other alternatives. I mean, this is going to be the year of the arm, you know, adjustable rate mortgages, we're seeing adjustables really come down. We're doing a lot of DSCR, what are called 3010s, where it's a 30 year fixed with a 10 year interest only option that helps maximize cash flow to where it gives you an option to either make an interest only payment or make a principal and interest payment. So if your primary objective is to maximize cash flow, that interest only option is going to do it. So for a lot of our clients that are buying real estate that may be, you know, midlife or a little bit later that don't really care they're going to, you know, they want to maximize cash flow going into retirement and then the kids can deal with it. That interest only, yeah, I mean, that interest only program is going to check that box because you're not going to get a lower payment, but it comes at that trade off of not paying principal and you lose the amortization. So, you know, you're not going to, you know, if you were to pay, so you've got a 30 year fixed loan for the first 10 years, you have the option of making an interest only payment. If you were to make the interest only payment that full 10 years, your principal balance would be the exact same. So that's that trade off, but it maximizes cash flow. The other way to use this loan is to use it more as a cash flow management tool. And so for our investors that are buying multiple properties, you can think if you start 5, 10, 15, 20 plus properties, this program gives you the flexibility of managing your cash flow because it, you know, you can always make a principal and interest payment, but if you have a couple of large capital expenditures or a few tenants that move out and all of a sudden you're in a cash crunch, you know, if you have a traditional 30 year fixed mortgage, you're stuck making that payment and you can't make a partial payment without being late. But that interest only option, it gives you that flexibility if you need it and you get into a situation where you need to make a lower payment. So these are just some of the programs and strategies that we're using as rates are staying elevated. And who knows, they look, all signs are pointing towards they may be coming down, but I would plan that they would are going to stay elevated and hope for the best because there's a good argument on both sides. That's what I was just going to ask you because I know people ask me and I know they ask you. Everybody wants us to pull out our crystal ball and, you know, tell them if rates are going to come down this year. That's an ongoing theme. And so are there any trends that you see that maybe would give us some insights on where rates are going to go this year? And again, we won't hold you to it. It's a great question. And I, you know, nobody has a crystal ball. I follow a lot of economists, different economists with different opinions. I was on the on the market podcast yesterday with Dave

Myers, Bigger Pockets, and we had a long conversation about this. I mean, my feeling is we're probably going to stay somewhere between a primary residence, a five and a half to six and a half range for the foreseeable future unless something changes. And the things that we're looking at are weakness in the job market, which up until today, it looked like there was some pretty big cracks. And now we just got a BLS number this morning that came out much larger than expected. And so we'll see where that goes from here. Inflation is easing. I mean, we've seen a lot of movement downward on inflation. We've got another reading coming out on Friday. We'll see what happens with that. My feeling is in this and I tend to be a little optimistic because the industry that we're in, I think we're not going to see rates fall off a cliff anytime soon unless something comes out of left field. But I do think given and I have to preface this because I've stepped in it before talking about this politics aside, I don't care what side of the political fence anybody's sitting on. But as investors, we need to be able to have conversations about this because we don't want to miss the opportunities that are ahead of us. If you look at the current administration, whether you love them or hate them, look at what they're putting out because this is the most mortgage rate and real estate friendly administration we've had in a very long time. And they are prioritizing, unfreezing the housing market, lowering interest rates. And if you watch what they've been saying and doing, like the big reason why rates have come down here, they've come down about a point or so over the last 12 months. It's because they've been focusing on what's called the mortgage spread, which is the difference between the 10 year and the 30 year fixed. And that has tightened significantly. And Scott Besson, our treasury secretary, was talking about it in Q1 of last year. And just the fact that they were even talking about that and they knew what that was, I mean, just goes to show how they are prioritizing this and understanding how important this is to the American public. So with that being said, that was the big winner of last year. That's a big reason why that inflation coming down, why we saw rates come down the way that they did. I still don't think there's a lot of room for them to come down too much further. I mean, I think if we can get down convincingly into the mid to high fives and the media gets behind it, we're going to see a lot of momentum and a lot of homebuyers jump back into the market. But it's still going to cost, we still need a number of things to occur before we get to that point. And you heard recently they came out, they want to start buying mortgage-backed securities again, you know, $200 billion worth of mortgage-backed securities. It'll move the needle, but it's not going to move the needle as significantly as people hope, because you've got to think that unless they

go back to a period of time where they're doing quantitative easing, QE, quantitative easing again, like we saw during COVID, we're probably not going to see that downward momentum to the levels that people are hoping for, like down in the fours or even the threes. And personally, I'm hoping that we never see rates that low again, because it's caused so many unintended consequences and just had so many issues that I don't think the administration is going to start a round of quantitative easing again without something occurring significantly. And really, it comes down to the new Fed chair that's coming in, Kevin Warsh. I'm not sure if you've caught it, but he had a CNBC interview here last year, that's long before he was up for Fed chair. And it was good and bad about it, because we're going back into a period of time, kind of like the Greenspan era, where they're going to be looking forward-looking. And we've spent the last five plus years looking in the rearview mirror. And that's why it seems like the Fed's constantly behind the curve and always trying to catch up. So we're watching a sea change at the Fed, and it's going to be interesting once he gets into office in May and then beyond what ends up occurring. But at the end of the day, we've got an election year here, and there's going to be a lot of momentum and a lot of pressure to bring down rates leading into November. Right. I have learned so much. Is there anything that we haven't talked about that you think it's important for investors to know, real estate investors, and college towns or anywhere? Yeah. So a few things. I mean, no matter where you are in your investment journey, ask a ton of questions. I mean, there are no stupid questions, whether you're working with us or anybody else in my industry, make sure you go into that, you know, every conversation with the, you know, no stupid questions mindset, because that's the best way for us to know how to help you and where you are in your journey. And then, you know, looking at the pre-approval process, don't wait until you found a property to get pre-approved. So many times clients will, oh, I found a property, and then we find out we've got about a month or two's worth of planning that we need to do to either get a credit score up or whatever it may be. So the earlier you can get pre-approved, the better. And then also running your pro forma and your deal analysis with two rows of glasses. I mean, I've seen a lot of that over the last few years. And a lot of investors that, especially a couple of years, two, three years ago, they have ended up in challenging situations because they have moved forward on deals where they only work if rates come down. And when they did, did not come down as fast as we'd all like, they got stuck in a challenging position. So you may want to make sure you're running it best case, worst case, because this is my feeling on where rates are headed. I could be wrong. And if inflation starts taking off and, you know, things start going the opposite direction, we start heading back into a trajectory like we saw in the 70s, all bets are off. And, you know, these, you know, you just want to make sure you're not stuck in a deal that's losing money for an extended period of time. So run it conservatively and you can always run it best case. You know, I like the rosy glasses too, but you just want to make sure you're not backing yourself into a corner. That's great advice. So with that, Jeff, thank you so much for being with us at the end of this podcast, we will make sure to include Jeff's contact information. So if anybody wants to reach out to him, they can be sure to subscribe. And I am Vikki Grodner, the college real estate coach.