Lending Guidelines – 6 Things Banks Are Looking For to Finance Your Deals
It’s no secret that the financial meltdown of the last several years has caused major changes in lending. This has affected every aspect of business from the lack of available credit to banks’ increased lending scrutiny. Acquiring financing for your real estate investments has also become more challenging. Only a few years ago, if you had a real estate investment that cash flowed and looked good in the financial analysis, it was easy to get financing. Not anymore.
The good old days of loosely flowing capital have come to an end. New financial regulations by congress and the financial industry such as the Dodd-Frank act have made getting financing for your real estate investments much harder. This isn’t to tell you that you can’t get financing, you can. It’s to let you know what it now takes so you’ll be prepared when you get your next opportunity under contract, and can get it closed and put money in your pocket.
Keep in mind: if you don’t meet all of these lending guidelines, you can still get deals done. However, it might require a little more work on your part or a sponsor. If you aren’t familiar with a sponsor, they are the person who will be signing the loan documents and the one whose financial statement and experience will be scrutinized by the lending institution. Often times, the sponsor will be the person who found the deal. But when you might not qualify individually, you can take on a partner (sponsor) to help you get the deal done.
6 things banks are looking for before financing your next real estate investment:
- Financial Analysis of the Investment/Investment Plan – The first thing the lending institution is going to look at is the property that you are trying to get financed. To be prepared, you need to make sure you have the financial analysis of the investment prepared. It’s good to also present them with your plan for the property and budget for the operations.
- Debt Coverage Ratio (DCR) – One of the financial calculations the lending institution is going to look at is its Debt Coverage Ratio, which is simply the ratio of the income of the property compared to the loan payments or debt service. They want to make sure the investment provides positive cash flow so you won’t have to put money in each month to cover the loan payments. Normally, they are looking for a DCR of at least 1.25, meaning that the income of the investment property will cover the loan payments at least one and a quarter times. This tells them that the cash flow is positive and their loan is protected by the income the property generates.
- Net Worth – Lenders are increasingly looking at how strong the sponsor of the investment is financially. On most loans under $5,000,000 in size, lenders are looking for a sponsor with a net worth at least equal to the loan amount. This means if you are trying to get a $500,000 loan, they want to make sure you have a net worth of at least $500,000.
- Liquidity – This one can be a little more fluid (no pun intended) and can vary from lending institution to lender, but normally banks require you to have at least 10% liquidity on your financial statement at closing. So, what does that mean? It means that they want you to have cash (or assets that can be easily converted to cash) available on top of the amount they require as a down payment. This will allow you to handle temporary downturns in the performance of your property while ensuring that you can still make your loan payments.When they say 10% liquidity, it means that the extra amount they require you to have in liquid assets (easily available money such as that in a bank account or brokerage account) needs to be equal to 10% of the loan amount. So, if you have a $1,000,000 loan, the lender will also want you to have at least 10% or $100,000 available in liquid funds somewhere on your financial statement at closing. Sometimes you’ll also hear lenders give you their liquidity requirements as a function of time. If they say they require “6 months of liquidity,” they are saying they require you to have liquidity equal to six months of loan payments.
- Experience – This one is fairly basic. Most lenders want to know that you, or someone on your team, have experience in real estate investing. Don’t be surprised if you get asked to provide a resume or other information on your background. If you are new to real estate, you can easily overcome this by forming great relationships with lenders or partnering with more experienced investors when getting started.
- Global Cash Flow – This is a new requirement that you’re going to be hearing about more and more. Global cash flow refers to your global financial picture. Lenders are now not just qualifying the single property they are loaning on. They also want to know about all of your other financial commitments and income to make sure there isn’t another investment in your portfolio that is losing cash flow that might jeopardize the stability of their loan on your new investment. Overall, lenders are looking for a global cash flow that is at least positive across your portfolio. You can read more about Global Cash Flow in our article here.
The global financial meltdown has affected almost everyone including the real estate investor. It has resulted in tougher lending guidelines, making it harder to get financing on everything. To make sure your attempt to get financing for your next real estate investment is a success, you need to be prepared to meet the most common lending guidelines. By being prepared, you’ll be able to walk into the office of your lender with confidence instead of finding out at the last minute you are going to need to present them with additional documentation. It will also put you at a big advantage over your competition when you bid on your next big opportunity.
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