One of the most common challenges for new, and sometimes even seasoned, real estate investors is obtaining financing for transactions. When you have a great deal and are having trouble finding the money you need to close it, you may be tempted to take out a loan with terms and conditions that will hurt you. There may be times when this is an acceptable strategy and times when you need to back out of the loan, even if it means walking out on the deal.
When you see one or more of the following red flags, think carefully and explore all of your options before accepting the loan.
Higher rates than normal. There are fees and costs associated with originating loans that are an acceptable part of the loan process. Beware of fees that are excessive or hidden. Do the math yourself to make sure everything adds up correctly.
Interest rate higher than normal. If you have less than perfect credit, you can expect to pay a slightly higher rate than someone with a top-tier credit rating, but it shouldn’t be exorbitant. Know what the current rates are; If the lender is asking for more than six percent above the prime price for a first home loan, look elsewhere.
Prepayment penalties. Don’t put yourself in a position of losing a substantial amount of your profits through prepayment penalties if you want to refinance in a year or two or if you sell the property.
Additional services that you do not want or need. Some lenders will include things like life or disability insurance in your loan. Not only is it the most expensive way to get such coverage, but if you don’t want or need it, you shouldn’t be forced to buy it.
The contract includes a binding mandatory arbitration clause. This means you give up your rights to sue for any reason and instead agree to binding arbitration, which means you could lose your right to due process if a dispute arises.
Upfront Fees. If the lender wants money up front, especially before you’ve been approved for the loan, be very careful. Legitimate lenders make money by making loans, not requiring applications, and charging up-front fees.
Anything you don’t understand. Home loans can be complicated, especially if you’re considering products like an adjustable-rate or interest-only loan, or one that could result in negative amortization. Make sure you’re clear on all the terms and what the payment will be, how often it can change, how high it can go, and what will happen if your payments are capped but your interest rate isn’t.
There may be times when the loan terms are worth less than desirable to close the deal. For example, you may be willing to pay a higher interest rate because you know the property will generate enough cash flow to cover debt service. The key is to understand the terms of the loan along with the pros and cons, and make a decision that will allow you to build wealth and achieve financial success.