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   ARTICLE   |   From Scotsman Guide Residential Edition   |   January 2017

An Unexpected Duet

You can increase profitability by banding together with private lenders

An Unexpected Duet

Originators today are desperately trying to recover the market share they lost after the mortgage crisis of 2008. At a time when conventional lending is being squeezed by QM, ATR, TRID, LE, CD, HMDA and every other regulatory acronym in the book, however, many industry professionals feel like they are extremely limited in what they can offer their clients.

Creative funding through private lending, however, can tackle unique scenarios that typically fall outside traditional bank lending, offering much-needed solutions for investors that are banged up by previous foreclosures or bankruptcies. While limited options in today’s market are keeping residential lending tight, private lending is opening up and letting loose.

To put it plainly and simply, mortgage originators can make a ton of money in today’s marketplace by connecting real estate investors with private-lending financing. Yet this idea still comes as a surprise to many industry professionals who are often hurting for business, even when asked if they have ever considered expanding into the world of private lending.

So why should you consider private lending? Because it continues to succeed despite the new rules and regulations, and the originators who tap into this financing option can take advantage of a new profitable stream of income, while providing their clients better lending options.

Where to start

In general, private lenders are typically more flexible than big banks, giving you more funding options for your borrowers, but it is important to find a reputable private lender long before a client needs one. The key to success is to first establish a relationship with a private lender. This can be a real game changer.

It also is important to understand that private lender’s specialty and familiarize yourself with the lender’s products and processes. No lending scenario is ever the same, and as a mortgage originator you act as the liaison between the lender and your client. Private lending provides myriad options to create innovative financing solutions, so you need to figure out which products are most beneficial for your borrowers.

Say you want to focus on investors that own a mix of properties and are just looking to add to their long-term portfolio, for example. Or, you want to work with investors that want to buy properties to fix and flip them in the short term. These borrowers will need different lending programs.

Next, you need to know how to qualify your borrower: Some clients may have a lot of cash on hand, while others have very little, but have great equity. Different scenarios can work depending on the lender. It’s all about working with that borrower to find the right solution for a private loan.

Private lenders are typically more flexible than big banks, giving you more funding options for your borrowers. 

The bottom line is you need to understand a lender’s niche beforehand. Only then can you work with your borrowers to find the right solutions and guide them through the origination process.

Private-lending advantages

Private lending excels in two areas: speed and flexibility. Many private lenders pride themselves in being able to close a loan in two weeks or less. This ability to close quickly provides borrowers with a clear business advantage and affords them a competitive edge based on speed.

A traditional loan can take anywhere from 60 to 90 days to close, and if you have a borrower trying to purchase a property from auction or working against other deadlines, that won’t cut it. Speed of closing in private lending — which in some cases can be as little as a few days — gives your borrowers a greater sense of security early in the loan process.

Private lenders also establish their own lending criteria and common-sense underwriting guidelines, making them more flexible than traditional financing. With private lending, no one in Washington is setting rates or dictating the box your borrower needs to fit inside to be approved. Private lenders use their own money, so they set the loan criteria. The lenders are the ones taking all of the risk, so if they don’t get paid, that’s their problem, not the taxpayers’ problem.

When traditional lenders can’t provide a solution, private lenders have more room for negotiating and can come up with creative answers. They evaluate the current asset and look at the big picture, such as cash reserves, properties for cross collateral, the value of the improved property, etc., instead of just focusing on the borrower’s credit and background.

In some cases, you may have borrowers that check off all the right boxes to qualify for traditional financing, but their property doesn’t meet the tests. Borrowers can receive private funding on distressed, non-owner-occupied properties, properties in need of extensive rehab or even new construction.

Take a borrower who owns a rental property with a great deal of equity, who doesn’t have enough cash to purchase another investment property, for example. A private lender can consider putting a mortgage on that existing property to pull out some cash. The borrower could then put that money toward the purchase of the new investment property. It is creative solutions like this that private lenders can provide all the time.

How compensation works

Private lenders typically offer referral programs specifically for originators and brokers. The amount of compensation earned depends on the referring originator’s level of involvement and the loan scenario. Some prefer to have minimal involvement, while others like to stay more heavily involved throughout the process. It’s just that simple.

Private loans will not work for everyone, but they can be a financial game-changer for self-employed borrowers or those with poor credit.

Originators new to the process who are looking to get a feel for private lending, or those who have booming residential business and don’t have time to deal with private loans, may want to just make a straight referral and hand off their borrowers to a private lender. Once the deal closes, these hands-off originators will earn a point on the loan balance. A check will be cut for them right at the closing.

Those originators who want to remain actively involved will need to control the deal. The originator acts as liaison between the lender and borrower and will collect documents, put the loan package together and guide the borrower through to closing. In this instance, the originators can expect to split the points at closing with the private lender.

Most private lenders also guarantee broker protection, which just means the lender pays the broker fee. Both lender origination fees and the fees that are earned by the referring originator are disclosed on the commitment letter up front. These fees should never come as a surprise to the borrower.

Broker fees are memorialized on the HUD-1 Settlement Statement for most private lending transactions on residential properties, as well as in a transaction-specific agreement. There is no ambiguity. Whatever fee is stated in those documents is what the originator will receive, and a check is sent directly to the originator at closing.

Qualifying borrowers

Private loans will not work for everyone, but they can be a financial game-changer for self-employed borrowers or those with poor credit. Although private lenders focus mainly on the asset, they will evaluate the borrower. If the deal makes sense, however, it will get done. It usually comes down to income, credit and equity.

A borrower could have a 600 FICO credit score, for example, but if that borrower owns several fully leased rental properties free and clear and shows solid cash reserves, that is a deal a private lender would do all day long. When a borrower has two out of the three criteria — income, credit, equity — a private lender will typically do that deal. It only becomes a problem if the borrower only has one.

One of the first questions your borrowers will need to answer is how they plan to pay back the private lender. Most loans are short-term — usually six to 24 months — so a lender is going to want to know the borrower’s exit strategy.

Experience and background also are important. Private lenders want to be sure the borrowers know what they are doing. As entertaining as late night HGTV shows are, they don’t provide real-world experience for fix-and-flips.

Existing leases also can factor into qualifying for a loan because they show good, solid income upfront. These are more common when you have a borrower that is looking to buy a multifamily property or small apartment complex.

•  •  •

Residential mortgage originators have a unique opportunity to grow and expand their business through a creative funding source that is less dependent on interest rates and less restricted by regulation. So rather than disregard private lending as cumbersome, complex or out of reach, originators should embrace the chance to expand their business in today’s tight market. There is money to be made by offering more than just traditional forms of bank financing, especially in the world of residential real estate investing.


 


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