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Investment Loans And The Mortgage Landscape
It’s my pleasure to welcome Shawn Huss to the show. Shawn has been in the mortgage business for years. He’s been ranked as one of the top 200 loan officers in the country for the past years. He’s personally originated over $1.8 billion in loans. He resides in Cincinnati, Ohio and he can lend pretty much all over the country. He’s one of our preferred mortgage lenders and mortgage brokers. Shawn, welcome to the show.
Thanks, Marco, for the introduction. I’m glad to be part of your show.
I’m happy you’re on. I’m doing a mortgage special. I’m going to have you and one of our other preferred and highly recommended lenders/mortgage brokers that we work with because we wanted to share with our audience some insight as to where the mortgage market is headed and what has changed with investment mortgage loans because that landscape does change. I know one thing with the lending space is that it’s dynamic and fluid. It’s not static. This is going to be helpful for a lot of people to understand what’s available today, where we’re going and how that’s going to impact them as real estate investors. Tell us a little bit more about yourself, what you do and the business that you’re in.
I work with Chemical Bank. We’re a very investor-friendly bank. We close anywhere from 50 to 60 transactions per month. How we work with investors all over the country, we follow Fannie Mae and Freddie Mac guidelines, which means you can do up to a total of ten finance properties per one person. When you recommend your clients and you’ve got two qualified borrowers with a married couple, sometimes we’ll suggest and educate them why it’s best to maybe split them into one by ten and the other by ten. We do this process as far as an educational process. The industry has changed a lot with investment lenders. I’ve been working with the investor community the last years. Some of the banks follow Fannie Mae guidelines, some of the banks follow Freddie Mac guidelines. That’s where people have seen differences with different banks over the past three or four years. They’ve pretty much in the last twelve months lined themselves up with each other. That’s why some banks will max out four, some banks will max out six.
With Chemical Bank, we don’t have any overlays. We don’t have any low minimums. A lot of banks will have a low minimum or they won’t lend for less than $75,000. As the investor will start looking at different price points at different levels of investment properties, they might find some of the $50,000, $60,000 range that are worked within their portfolio, then they go up to $150,000, $200,000 price point. Every situation is slightly different. What separates Chemical Bank in the investment community as far as making life a little easier is our processing, our underwriting and our closing all sits right outside my office. We have a little bit more control over the process than most other banks but otherwise, we’re committed to helping the investor community go. It’s a strong market right now. There are more buyers out there than there is of inventory, which is a great problem. We can get into talking about rates and different opportunities and things in that respects throughout this conversation.
I always like to start off with the most simplistic and basic questions. For those who didn’t understand the term you used, which is an overlay because we have a lot of sophisticated investors all across the country and the world. We also have a lot of newbies, people who are just getting started and they don’t understand some of the terminologies. An overlay is an additional set of guidelines or rules overtop of what Fannie Mae or Freddie Mac give you that are additional qualification criteria. Did I miss anything?
No, you hit it on the nose.
Here’s a basic question, Shawn, and this is for those people who are still struggling to understand the difference between a regular mortgage loan that you would get for your home and an investment loan. What an investor would use to buy, not a secondary home, but an investment property or a rental property, what is the main difference between these two things?
One is the rate. The rates on investment properties are higher. What that means is when you buy a single-family property, you can put as little as 15% down. You have mortgage insurance where homes are occupied the minimum down, you can do 3% or 5%. Most of the investors are going to put at least 20% down, which when the investor community, Fannie Mae or Freddie Mac will charge additional points for being an investment property. For instance, if it’s 20% down, they charge 3.375 points, which in my world, what we do is the investor community, a lot of them will choose to take a slightly higher rate of interest to try to not pay points to minimize their out of pocket. If you choose to put 25% down, the rates are about 3/8 of a percent cheaper than doing 20% down. If you get into the market of doing two to four families, the minimum down payment there is 25%. What happens is the rate tend to be about three quarters of a point to 1% higher than owner occupied properties.
With investment lending, we do have to document all the assets coming from the borrower or borrowers on the loan. Meaning you can’t do a gift, you can’t have another party give the down payment. Everything has to be sourced whether it’s a secured home equity line of credit, a loan for your 401(k) or your checking/savings account. That’s probably the biggest difference between owner-occupy investment. All assets must come from your own account if you don’t have them or somebody did provide them to you. You have to season them for 60 days not to have a bank question you where they came from. Basically, that’s a creative way to do that if somebody is helping you provide assets for down payment. Other than that, the process is very similar to owner-occupied.
Something you mentioned made me think of this. There’s a debate sometimes between investors about how much they should put down 20% or 25%, and that doesn’t make a whole lot of difference. It lowers the principal amount, which lowers the amount of debt service you have, so it increases your cashflow a little bit. Then it takes away 5% of your investable capital that you can put towards the next down payment on your next purchase. I’m curious to know if you have an opinion on that, if you have a suggestion when it comes to a strategy when you compare 20 to 25%. What do you think of that?
You nailed it on the head as your explanation. There are two types of investors out there. One is cashflow. They’ve got a ton of assets and they’re looking for cashflow because in both scenarios, you’re trying to grow your real estate portfolio for retirement. Every situation is different, you do have the investor that might not have all the assets. 20% and/or 15% every once in a while is a perfect scenario because it gets them started, gets them in the investment world. As far as rents go, what we can do is we can use 75% of whatever the house leases for and use that to offset the payments. Sometimes when you do with 15% or 20%, if that 75% is higher than the PITI on the payment, the principal interest tax insurance that creates additional income we can use for the next property. Sometimes that’s creative to do the 15% or 20% down route so you can keep that extra 5% in your pocket to give you a head start to buy property number two.
You’ve got the other investors who have enough assets who say, “25%, that gives me the best rate, the best cashflow. That’s where I want to continue to proceed.” As a reminder, each one person can only have a total of ten financed properties under the Fannie Mae, Freddie Mac guidelines before you started looking for alternatives. You nailed it on the head with the two different types of investor, one for cashflow and one is looking to preserve their cash for the next property, which is their next opportunity to create more cashflow.
When you are taking 75% of the rental income, I assume you’re talking about the gross income. For property rents for $1,000 a month, you’re taking $750 and that’s what you consider income towards the debt service. Is that correct?
That’s correct. When it’s a subject property because this is a misconception I hear a lot, “I have a lease on it so now I can finance it,” that’s not the case. Part of the appraisal process, they have a market rent comparable schedule that the appraiser performs. If the house is at lease as of yet, we will use the appraiser’s estimated rents. What that means is if it rents for $1,000, we will use 75% of that to offset the payments. If it’s a subject property, we will either use the lease or we’ll use the appraisal to come up with that number. It’s not required to be rented at time of application. Where it gets tricky is when you go buy a second house in order to offset the PITI. At that stage, there must be a lease on that to offset the payment on the first house. If it’s not a lease on the subject, we can either use the appraisal, if necessary, for help for qualification or to create additional income for qualification.
Let’s take a step back and look at the entire force here and get away from these numbers and tactics. Some people might think that they’re missed the boat on the low rates that we’ve seen for many years now. What would you say to these people?
They have not missed the boat. The investment community is stronger than ever right now, so mortgage rates are creeping up. We’re still sitting at 5% on owner occupied. Historically, the rates are still very low but we’ve been spoiled over the last years as far as where rates have gone. What’s happening in today’s world is as the rates are slightly going up, what we do see is we have less people purchasing. Meaning the Millennials are saying, “I don’t want to buy because I’ve seen the 3%. I’ve seen the 4%, so now we’re at 5%.” What’s happening is those Millennials are starting to rent. On the flip side, we have our investors who are building their real estate portfolio. As rates go up, rents are going up. Rates shouldn’t play a big factor whether you buy a rental property or not because as the rates go up, we’re seeing rents increase too. Now, we’re seeing more people that want to rent instead of own unfortunately. The investor community is stronger than ever at this point. I have not seen any slowdown for all of 2018 and I expect to see a stronger 2019.
If rates are going up and rents are keeping pace with that or they are going up as well, that covers the debt service. The rate increase ultimately becomes a moot point. It’s almost awash. It might be in favor of the investor if rates are being surpassed by the increase in rents on properties. The other thing too is I don’t have data to support this. My feeling is that if rates are going up and affordability is going down and fewer people, including Millennials, can qualify for housing, what does that do? It increases the size of the rental pool. That increased demand leads to a demand for more rental housing, whether it be apartments, single-family homes, duplexes, fourplexes. That’s a good position to be in for us as real estate investors because now there is a growing demand for the product that we put out there as investors.
What we’re seeing is there are more people educating themselves in the investor community, which I’m sure you’re seeing you have more clients coming to you. They’re seeing the positive cashflow, they’re building for retirement. The inventory is lower because there are more people coming out who are learning the philosophy, learning the process and the benefits that basically have been a rental portfolio is bringing to their income stream long-term.
One of the top questions some people are asking including clients of ours and the investors we work with, they’re saying, “Where are rates headed?” Some people don’t care about the answer to this question. They don’t even ask but for some people, it matters because they’re thinking that, “I have to get the lowest rate possible regardless of what I do.” They’re thinking that, “I’m getting a 30-year fixed rate mortgage. I’m going to keep this for a long period of time, potentially 30 years or more and never do a 1031 exchange.” For them, it’s important to lock in at the lowest possible rate. That begs the question, does that matter whether they’re getting five and three quarter, five and a half or five and a quarter? If you run the numbers, it makes a marginal difference. What’s your opinion on that? What are you seeing? You run numbers every day.
We are going to see rates creep up again. The federal government is going to raise prime lending rate probably one more time before the end of the year. Prediction is going to raise in another three to four times in 2019. That typically does not mean mortgage rates. That’s the prime lending rate, which is more geared towards short time rates. We do see a little upward pressure on rates but as the rates creep up, rents are going up as well. It is important to get the cheapest payment. It is important to be smart at the time. To answer your question, there is upward pressure on rates. For people who are on the fence, this is the time you want to start getting into the game and getting serious because they might be up a quarter percent in 2019. Nobody has the answer to this question because there are a lot of different factors that go into today’s economy that can adjust that. It didn’t say even if they go up a quarter of a percent and you’re getting a real estate transaction that’s cashflow for you, which makes sense, which that will be your job to show the numbers. I don’t see it slowing down at all going into 2019.
It’s important to not be shortsighted and miss out on an opportunity for a quarter percent, a quarter point and miss out on the opportunities that are in front of you for the years to come in terms of cashflows and equity growth. We’re talking tens of thousands, hundreds of thousands of dollars added to your net worth. In terms of returns, you don’t want to miss out on an opportunity. People were investing real estate when interest rates were as high as 18% back in the ’80s and they made it work. They figured out a way to make it work. We are at historically low rates of interest right now.
We’re both on the same page. The opportunities are out there and it’s not right driven. It’s opportunity-driven in the market and that there are more renters out there than homeowners unfortunately at this stage. When I say unfortunately, that’s not a bad thing. It’s just where the economy is now.
The 30-year fixed rate mortgage, the benchmark was right around 4.1% a year ago. It was somewhere around over 5%. It’s gone up a percent over the course of the last twelve months. I know you don’t have a crystal ball and neither do I, but if you were to prognosticate and look at what we’re going to be seeing a year from now, do you have a prediction on that?
I’m not sure. We’ll see them in the mid fives in 2019. The housing market is going to be extremely strong in 2019. Anything can change out at any time.
It’s tough to predict, but I have not heard anybody including yourself, say anything that would suggest that anybody stop or even slow down investing in real estate and building their portfolio. If you look at the other options out there in other asset classes, including the stock market, which I have mixed feelings about. I still am a firm believer, as I’m sure you are too, that investment real estate is by far the best investment and asset class that anybody can get involved in.
An important part about getting into the real estate is setting yourself up with the right partners such as a lender like yourself, where the people who are going to help coach you to get you to where you need to be in five years, ten years, fifteen years as far as net wealth and building your portfolio.
I remember before the 2006, 2007 credit crunch and what ultimately led to the great recession of 2008. There were a lot of mystical loan products, stated loans, NINJA loans, no income, no asset, no job loans. There were a lot of creative loan products and credit was very easy to get. We’re in a different world now, but are you seeing stated income products coming back out? Do you foresee that to be a trend? What kind of changes are you seeing outside of the conventional traditional type of loan product?
I don’t see much of the state income, state loan products. We are seeing some of Alt-A lender. When I say Alt-A, some of the subprime where you get a little bit more creative with financing. In today’s world, a 20% down investment property, they compare that to a 95% owner-occupied property. When I say compare the risk level for 20% down, the normal person such as yourself and myself would say, “20%, that’s a ton of money.” In the investment community, that’s the minimum down payment, equate that to a 95% down owner-occupied. Sometimes as a banking institution, they look at us and if something happens to that property, maybe something with the roof, the heater, it’s a matter of, “Do I fix it or not?” Plus, the owner is not residing at that property. As a bank, that’s why they see it a little bit riskier, which is probably part of the reason Fannie Mae, Freddie Mac charge slightly higher rates for the investment community.
What’s funny about that statement, Shawn, when people say that, I don’t agree with the idea, I don’t agree with the premise. The reason is this, and maybe we’re saying the same thing here. I personally believe that real estate investors are a lower risk to lenders like the Fannie Mae and Freddie Mac because they come at this from a business perspective. It’s not a home to them, it’s a business. They need to finance their investments and produce positive cashflow. They know that they can’t miss their payments. They jeopardize their investment. It’s a non-emotional transaction. They look at it rationally and objectively and that’s not necessarily the case with homeowners. There have been so many homeowners to the tune of probably millions of people that have walked away from their homes who said, “Yes, take it back to the bank.”
We’ve done an analysis of my personal book of business compared to the company’s book of business. What we have found out is the investor community average credit score is higher than a bank’s normal portfolio. Their default rate is lower than the average of a bank’s portfolio. What we’re seeing is investors are stronger buyers and they are stronger borrowers. The banks do like that situation. I talked to investors all the time once Fannie Mae and Freddie Mac are going to open the door to go from ten to twenty. We’re out there helping the economy by buying distressed properties and making them rentals and things in that respect. I 100% agree with the analysis that you just said.
That question about going from ten to twenty or whatever that number may be, that question has been on the table for over a year. I’ve been hearing this for a long time. I’ve even talked to one of the top analysts with the Federal Reserve about that even though they don’t directly control it, but they do a lot of market research. They’re in the political circles to make that happen. Even he has been in conversations about it, but it just hasn’t happened. I have a friend who does a lot of research on housing and the housing market and investment. One of the things he mentioned to me is that the average credit score on a loan for investment purposes now is 720. You compare that to the average credit score of investors buying properties back in ‘04, ‘05, even until ‘06 it was a lot lower.
It was in the low to mid-600 range. We’re dealing with a different type of investor and a different demographic now. The risk is a lot lower. That underscores the point that investment loans are a safer bet for lenders. I don’t see a reason why they shouldn’t increase it from ten to twenty or more. Let’s hope they do. Let’s wind this up with giving people an idea or a snapshot of what they’re looking at in terms of an investment loan products. What would you say is the rate spread? What would be a low, a high? Can investors purchase in an LLC or do they still have to purchase in their own personal name and then transfer title?
Pretty much as far as where rates are now, let’s go to the easy part. The rates, assuming an excellent credit score, which is 740 or higher. You’re looking at 30-year fixed rate by around 6.0, that would be with no points. At that stage, we can look at buying points to buy a lower rate of interest. For those out there are points of percentage of your loan amount that you’re borrowing to purchase a lower payment. If you’re looking at 25% down, you’re looking at rates at around 5.625. This is on a 30-year fixed, that’s with no points and you have the opportunity to buy the rate’s lower. These rates change each and every day with the market.
A lot of investors will ask us if they can purchase in or through their LLC. Our general answer to that is you have to close in your name and then transfer title. I wanted to hear from you if there are any other options out there.
There are other options. The LLC is advised real estate investors for many reasons. One is asset protection, pretty much an LLC is a corporation. Technically, when you’re buying a Fannie Mae, Freddie Mac residential type lending, you cannot put it in the name of the LLC. What that means is if you were to purchase a property in your own personal name a little bit later in the process, after you close, you transfer in the name of your LLC, you’re technically violating the due-on-sale clause in that mortgage. That due-on-sale clause in the mortgage is the same for every lender. Pretty much when you get residential financing, the mortgage is signed as a Fannie Mae document. There’s a due-on-sale clause, which means that if the lender finds out that you transferred the title without permission, they could call the loan due or force you to put the title back in your own personal name. Fannie Mae has come out and said if the borrower person in their own name, and they would like to put it in the name of an LLC, they are going to start allowing this, but the LLC has to match the person on the mortgage.
This process has to happen after the closing. What would happen is if you have one borrower on the loan, you have to have a single member LLC. You would probably be granted permission from the lender to put it in the LLC as long as the parties on the note match the LLC. The two other avenues I’ve seen, perhaps a protection or a trust, you’re allowed to do a trust and that you can do that from day one. You don’t have to worry about transferring title after the closing by utilization of a trust. Your third avenue for asset protection is working with your insurance agent and looking into an umbrella policy and protect it through your insurance agents. Those are the three methods I’ve seen for asset protection for investors on the streets.
I want to mention that those three things are not in isolation. They usually work together, any combination with each other because asset protection is like layers of an onion. They work synergistically together. I will point out that we’ve probably done two or three episodes specifically on asset protection. If that’s something you need to learn more about, you want to get on a much deeper level. I would go back to those episodes and read the asset protection stuff. What else do you want to add? We’ve surveyed the landscape here and we have an idea of where mortgage rates are. What loan products are out there and possibly where we’re going. There’s no question that it’s still a great opportunity to buy with these still historically low interest rates. What parting thoughts do you want to give?
The industry is super strong. There’s a lot of information as far as the lending aspect of investment lending. If anybody has questions or concerns for me directly, I’ll go and give you my website that has my name, cell phone, email. You can email me anytime. I’m very responsive. I’ve got a team of four or five people that work with me as well, but I pretty much will be who you deal with up front. You can reach me directly at www.ShawnHuss.com. That will take you straight to my Chemical Bank website. It has all my contact information. Please don’t hesitate to shoot me an email, give me a call. I definitely would love to be your partner in growing your real estate portfolio.
Shawn, this has been great. I appreciate the perspective and input. I look forward to talking to you again soon.
Thanks for having me on your show.
Thank you, Shawn.
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