Second Position Loan on SFR Stated/Stated Just Funded

Before moving forward with Hard Money Commercial underwrting, I wanted to go over a concrete loan that I funded. From time to time, I will go over real loan cases to move from theory to practice. This loan was funded as a second position, stated income, stated assets loan, interest only with no prepay.


This loan was complicated for a number of reasons:
- Owner Occupied
- No Prepayment Penalty
- Loan Amount
- Loan Position
- Use of Funds
- Employment Status

At the same time they were couple of positives:
- Credit
- Loan To Value



Working with the Mortgage Broker and helping him understand all the potential challenges became very important. Fortunatly, we were able to communicate effectively and enough equity was available in the property to make the transaction possible. Challenges that we addressed:


Employment: One of the two borrower was self-employed for a short period of time. While we don't verify income we want to be confortable.

Use of Funds / Proceeds: Funds would be used to finance the above referred business. The combination of both new business and need for operating cash more challenging to approve.

Loan Position: A second position is not bad, but in this trouble lending times, every aspect of loan becomes important. A first position is always better than a second. However, the borrower was not interested in a new first since they had a loan with a fixed interest rate bellow 6%.

Loan Amount: The loan amount needed was higher than the loan amount of the loan in first position. We would have preferred doing a new first loan, but borrower had a great rate for his first.

Prepayment Penalties: In Hard Money lending prepayment penalties are, in numerous cases, part of a loan. They help provide investors and funds guarantied returns. In this case the borrower wanted to have the flexibility to refinance in 6 months as their financial position will be changing.

Occupancy Status: in some cases it can be an issue due to maximum APR authorized by law. When loan amounts are small and/or interest rates are high then we run on the maximum APR allowed by the law. In addition, we need to be carefull on the number of maximum points that can be charge as they will be included in the APR. As a second position in this case we had to charge a higher rate

Compensating factors wer the LTV after all we ended up making a loan at a 60% LTV. Who would not want to do it? Credit was reasonable for a Hard Money lender, mid 600s.

Commercial Valuation The Golden Ratio DSCR

Understanding how to value commercial properties is always a challenge. Not only the valuation process will be based on the income that a property generates or should be generating, but also on local and regional factors such as employment and the overall economy. Today, one more factor will be of consequence the availability of credit. Income is the primary decision making factor, all of the other ones are secondary even credit(to a certain extent).

Income is important, because a commercial property is an investment. Investments need to generate return that are performing to a minimum level. Every investment type will have a different expected return the more risky the investement the higher the expected return should be. For example buying a stock in coke will have a lower return than buying a strock in technology start up. The same applies to buying and selling Non Owner Occupied and Commercial properties.

The DSCR or Debt Service Coverage Ratio establish the relationship between income and debt on the property. The higher the DSCR the higher is the level of income in relation to the debt that needs to be serviced.

Debt Service Coverage Ratio = Net Operating Income / Debt Service

• Net Operating income = Gross Income - Vacancies - Expenses
• Debt Service = Monthly/Yearly loan payments

DSCR >1 Highly desired in most of the country provide best credit

DSCR = 1 Not as attractive but limited number of financing available

DSCR <>Very limited options

What loan at What cost?

Loans and lending are continuing to be a topic of interest. As the economy slow down providing the best financing possible to borrower is crucial. Until recently numerous borrower thought that they had an understanding of lending. As it appears, numerous mistakes were made. Today as real estate professionals we have the obligation to provide more valuable financial information and advice to our clients. Telling clients that they are getting the best rate does not really address anything and provide very little information.

As your can imagine, as a Hard Money Lender I get he usual your rates are too high from a number of people. This type of comments reflects a foundamental miss understanding of what an interest rate is. A rate represent a risk the higher the potential risk, the higher the rate. It is clear that subprime lenders provided financing solutions at rates that were clearly to low. If they had provided loans at rate that reflected the risks, most likely we would not be in the mess we are in today.

Understanding the intentions of your clients will allow you to help them understand what option they have. Once you are able to establish what your clients need, then your can help them understand the different options and costs associated with each options. I am a firm believer that discussing costs and options is the right approach. Our clients should understand that every loan has a cost, that different types of lenders will offer different products.

Basics of Commercial Loans

Commercial loans come in all shape and forms. However, you could identify three main categories:

1. A Paper Commercial - This is standard commercial lending. To qualify for such a loan a borrower needs to show all documents. Banks will verify property income based on leases and taxes (2years). Profit and lost statement will be required as well as income and expenses statement. Assets will be verified and credit score will be part of the lending decision.
2. Stated Income Loans - This categorie of commercial lending has been developed recently. The primary difficutlty with these loans for most banks that provide these types of financing is to establish the value. The value of a commercial property is normaly established by the income it generates. If income can not be verified then establishing values and LTVs is more difficult. Bank providing these types of financing will command higher rates due to higher risks.
3. Hard Money Commercial Loans - This is a little different than Hard Money Residential. Commercial Hard Money is for borrowers or properties that have issues. It does not mean Stated / Stated or no documentation etc... Valuation will be a concern as everything else listed above, however, a Hard Money lender will be much more flexible looking at the documents, credit, reserves, occupancy, leases etc... In addition, loan terms will also be more adaptable.

Hard Money Commercial lenders offer usualy more flexibility than banks and will lend on properties that bank will not consider lending on. Combining a number of these different factors will make a borrower get a Hard Money loan.

Commercial Hard Money Loans

Commercial real estate transactions are a great way for a number of real estate professionals to diversify their offering and business. Like the residential industry, commercial real estate is being affected by the residential credit crisis. However, a number of options exist for commercial borrowers who need some financing flexibility.

It is important to understand why a current or a potential owner of a commercial property would use a Hard Money / Equity lender:

• No Prepayment penalties: most commercial loans and even some Hard Money ones, have hefty prepayment penalties. In some cases, they have a lock out period and a prepay up to 10 years.
• Underwriting Flexibility: Hard Money lenders will need as much documents as possible, however, they don't require a perfect situation. An under leased building or low credit borrowers are acceptable situations.
• Faster Funding: While banks, even once a loan approved, can take some times to deliver funds, hard money lenders are in genearl a little faster.
• Flexible Loan Terms: This is really important hard money lenders are able to customize loan terms to reflect a borrower's need.
• Payment Structure: Interest only will be the standard loan payment.
• Loan Position: A Hard Money lender is able to offer first and second position loans.

Commercial Borrowers / Corporation do not have the same motivations as residential borrowers. In addition, methodologies, loan documentations and properties valuations are not done the same way as in residential transactions. If as a real estate professional you have not done a commercial transaction, contact a lender or go to a training and read this Blog to learn some of the basics.