Finding the right financing

by Enza Venuto & Dalia Barsoum20 Aug 2012

After having made the decision to climb a mountain, it is not enough to just show up with gear and guidebooks. You’ve got to be physically prepared to go the distance, as there aren’t any quick exits from the side of a mountain. You’ll want to spend an appropriate amount of time and energy on getting your body’s physical systems ready for the demands that climbing puts on you.

That mountain is not unlike the proverbial mountain people face when looking at real estate investing. If you are on a wealth building journey with real estate, you need to master one or more investment strategies as well as financing strategies. You also need the right trainers by your side.

It is essential investors master the ins and outs of financing and get the right advice with regard to that topic, in order to reach your investment goals.

This guide will help you do just that. Covering in great details conventional financing – which pertains to getting approved for a loan with all of the rules and limits surrounding that process – and creative financing – which pertains to strategies that you can use to legitimately overcome some of those rules and limits...


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Conventional Financing
Conventional financing is about getting approved for a loan and doing so formally by submitting a mortgage application directly to the lender or through your mortgage broker.

A lender is any institution or individual who loans money to borrowers.  Lenders are generally categorized by the following categories: “A,” “B” and Private. An “A” lender typically looks for income proof and is picky about the caliber of credit they deal with (620+) and offers the most competitive rates for applicants meeting those criteria. A “B” lender typically deals with applications that do not fit the “A” lending criteria.  Private lenders are in most cases, lenders of last resort and their criteria are most flexible but their rates are the highest.

Lenders are not equal. They differ in terms of:
•    The geographic focus of where they lend: Some lenders are not willing to lend in cities or towns where property value fluctuates or the local economic fundamentals are weak (i.e. lack of job growth, infrastructure expansion)
•    The property types they lend against: Some lenders shy away from lending towards student/rooming houses or rental properties all together. Some lenders specialize in residential while others in specialize in commercial properties.
•    The number of rental properties one can own: Some lenders will finance a maximum of 2 rental properties per individual/entity. Others are willing to go with 5 in total with that particular lender or per individual while some may not have a limit.
•    The criteria they use to evaluate the strength of a particular application: Each lender has its own qualification ratios for evaluating applications. Some lenders accept higher investor debt load than others and some will consider the strength of the property over the applicant’s. Some deal with minimum credit score requirements while others does not.  For example : “A” lenders want to see a credit score of 620+ minimum with a solid credit report and don’t want to see your total monthly debt obligations (including your mortgage payments) exceed 44% of your income. B lenders on the other hand can work with credit scores below 620 and are comfortable with your debt obligations being at 50 per cent of your total income.
•    Product offering:  Lenders differ in the client segments they focus on. For example, some have good products for the self-employed or clients with challenged credit while others don’t. They also differ in terms of the extent of support documentation required from the client to close the deal.
•    Down payment requirement:  Applications who meet the tight lending criteria of “A” lenders can purchase a primary residence with zero per cent to five per cent. On an investment property, the minimum is 20 per cent.  The minimum down payment requirement with a “B” lender is 10 per cent. It can be higher depending on the property and the credit.
•    Allowing second mortgages:  “B” lenders are generally opened to the idea of having the client arrange a second mortgage on the purchased property (typically up to 90 per cent of the value – between the 1st and the 2nd mortgages). “A” lenders however are very strict with respect to this policy and majority do not allow a second position if the “A” lender holds the 1st mortgage against the property
•    How they factor in rental income: Lenders differ in how they look at rental income. They differ in what they factor, how they factor is, the degree its factored and their perceived risk of a rental property.  With regard to what they factor: lenders won’t factor in income from a non-legal suite even if it is rented.  How rental income is factored also depends on the lender: some add rental income to total income while others use it to offset expenses for the property. The degree of how much income is factored can range from 50 per cent to 100 per cent and some lenders add a rate premium for buyers purchasing a rental property.

•     The structure under which they finance the deal: Some lenders won’t finance deals that are setup under a corporate structure (if the Corporation is the primary applicant on the application).  Simply because they perceive it as a higher risk deal due to the effort/costs associated with dealing with multiple parties if a foreclosure has to take place.   

Mortgage Brokers

A mortgage broker in Canada is a professional trained to represent you, the borrower, in obtaining financing from a variety of lending sources. In most provinces, mortgage brokers are required to be licensed.  Brokers have access to several sources of lenders including Chartered Banks, Trust Companies, Credit Unions and private lenders.

Lenders change their lending guidelines and qualification criteria on a regular basis. That is why it is important that you have a long term relationship with a lending advisor who is keeping up with the market and lending guidelines changes and who would know where to place your deal to ensure it will be approved given your unique situation.
Mortgage Insurers
We have three mortgage Insurers in Canada: the Canadian Housing and Mortgage Corporation (CHMC) – governed by the government, Genworth and AIG (private insurers) which funds are governed by shareholders of private funds.

Mortgage insurance protects the lender if you (the borrower) default on your mortgage loan.  If a borrower stops paying on a mortgage, the insurance company ensures that the lender will be paid in full. Lenders pick insurance providers for their borrowers, but the borrowers have to foot the bill. Usually, they do so in monthly installments but some lenders offer programs whereby the borrower pays the entire insurance premium in a lump sum.

As a borrower you pay for a mortgage insurance premium if you put less than 20 per cent down of the appraised value for purchasing your primary residence or second home. The cost varies depending on the size of the down payment and the loan but typically amounts to about half of one per cent of the loan.

If a lender’s practice is to insure all of their mortgages, then regardless of your down payment, both the lender and the insurer have to review and approve your application when you submit a deal in.  We have come across situations where an insured lender initially approved an application but their insurer declined it, resulting in an overall decline.  

With respect to investment properties, the minimum you need to put down under the conventional lending rules is 20 per cent.

Having said that, some insured lenders may require you to put it in more and if you are below their minimum requirement, you will be charged an insurance premium.

An appraisal is the process of determining the value of the property for lending purposes. A lender may see that a property is only worth $100,000 although its market value or the price you paid for it is $150,000.

Discrepancies between the appraised value and the price you pay for purchasing a property mean that you either have to put more money down, negotiate your price down or submit your application to another lender or insurer.

Some lenders rely on system valuation whereby the value of the property is determined based on the local area market solds and norms while other lenders will send someone to physically appraise your property.

Conventional financing requires not only a deep knowledge of the insurers and lenders lending guidelines and products but also a skill in structuring the deal and knowing where to send the application.

As the CEO of your real estate investment business, you need to know the context of conventional financing and what does/doesn’t work. With this knowledge you will work better with your lenders and mortgage broker and with an understanding of what lenders look for, you will be able to plan better and increase your chances of approval.

Looking for more in-depth information and analysis to help your clients succeed and allow you to grow your mortgage business? Subscribe to Canadian Real Estate Wealth magazine now!

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