National Banks vs. Local Lenders vs. Hard Money Lenders
We help a lot of clients and new investors to get financing for their turnkey rental properties, rehab projects or construction loans. I have done all of these things personally and I’ve helped a lot of people do them as well. One of the questions that I get asked all the time is should I use a national lender or a local bank. There is no right answer but I will discuss both options below.
National banks are great for buying turnkey rental properties, and the reason why is they don’t touch anything that needs rehab or is not in livable condition. These national banks are banks like Wells Fargo, US Bank, Bank of the West, etc.. The reason why they don’t do loans on rehab projects or anything like that is because these are national banks, they typically lend on investment properties or give mortgages in all 50 states, and there’s no way that they could figure out all the different neighborhoods and cities and know a ton about them.
They focus on stuff that’s already been completed so that they can do appraisals, verify the value, and then they just look at your income and see if you can support that mortgage on your debt-to-income ratio. That’s how they come up with the mortgage for you and see if you’re approved or not.
These national banks are great for buying turnkey rental properties, not much else. If you don’t have a W2 income or solid W2 income job over the last two years, then you’re going to have to look at some different options because national banks are not going to work for you.
The other benefit of using these national banks is that it allows you to buy and diversify your rental property portfolio into multiple different states because they are national banks. For example if you use Wells Fargo you get a mortgage in Tennessee. Two months later you want to diversify and buy a house or duplex in Cleveland, you can still use Wells Fargo. You just need to provide them the last two months of your bank account and just a little bit of information, but they already have your whole personal record.
I do recommend many of my clients to national banks for that reason. Many of my investors and clients like to buy properties in different states, they like to diversify their portfolio and using the same national lender over and over makes that possible.
The other benefit of using them is they provide the best terms that I’ve seen. Many of these banks don’t have loan minimums, they charge very low amount of fees. They will just look and see if your W2 income supports that mortgage, and that’s how you’re approved, it’s nothing much about the property or the cash flow of the property.
The downside of using these national lenders is that they do a ton of research about you, maybe to a point where it becomes annoying. They’re going to ask you everything, all the dirt under your fingernails, everything you’ve done the last two years, ask you why you have these certain large deposits, they’re going to ask you a ton of different questions like that. It is a pain in the ass, but for that 5-6% interest rate on a 30-year amortization there’s nowhere else that you can get that. I’ve talked to many hard money lenders, local lenders, and nobody that I’ve seen is offering exactly what those national banks are offering with very low amount of fees. They’re a great solution for the turnkey rental properties if you have a W2 income and a solid job over the last two years. They’re a great resource to use especially for financing those turnkey rental properties.
The second group that I’d like to talk about is local lenders. Local lenders can be small commercial banks, like Bank of Memphis, Bank of Bartlett, Cleveland Bank, etc. There are going to be many of these little banks in the cities that you are investing in. They’re great for rehab projects and construction loans. The reason why is because these lenders are local they can actually go to the job site, they can go visit the property, they have post-renovation appraisers and do things like that to protect their investment.
The national banks on the other hand won’t even touch it, they’re not going to touch anything that needs a rehab. Only these local lenders are great for those rehab projects and construction loans. If you do use them for these loans you are going to have some fees. They’re going to be a little bit more expensive and a little bit more strict about the property but not so strict about you and your W2 income.
For example, I don’t have much W2 income because I run everything through my company, so when I went to a local lender it was very easy for me to get approved because the property was cash flow positive. I just showed them the financial statement for the property and that was it. They didn’t care that I didn’t make any W2 income over the last two years. It was all about the property and how much cash that property was producing.
The only other thing that these lenders look for it to make sure the income of the property will be able to pay for the debt service, this is called debt to income ratio. Typically they want a rate of 1.2 to 1.5. This means that they want the income to pay the debt, plus 20%, or plus 50%, if that makes sense.
It’s also important if you’re investing in a city where you live in to make a connection with those people at the bank. Trust me, it goes a long way. You can get stuff done that you never think would be possible, you can get rates that maybe you’ve never seen before. If you build that relationship with those people and maybe open a bank account with them and put in some money into a savings account with them so that they could use it. Doing so is really going to increase your chances of getting a great loan.
Hard money lenders
Many new investors go and look for hard money. Hard money is great for rehab projects, they’re great for construction loans, they do some turnkey rental property financing as well. Personally I’ve never really used hard money, I’ve never been a fan of hard money, and the reason why is it’s so expensive. Hard money lenders charge three points, and a 12% interest rate.
Hard money lenders are also going to do a ton of due diligence on you and the project. Especially if you’re doing a construction loan, they’re going to be very diligent, especially with some of the national hard money guys. They’re very diligent about your draws, about sending photos for verification, about doing all these kinds of things to verify that a draw should be paid out to a contractor. That’s because these hard money lenders are national guys and they’re not local. If you have a local construction loan, the guy from the bank is going to walk over to the property and make sure that the stuff was done and pay your draw for the construction. But if you’re using a hard money lender who’s a national lender then they’re not going to be able to verify that information. So you’re part of the verification process and it becomes an extreme headache, especially after paying three points and 12% interest rate.
Of course there are many other ways to raise money for your real estate investmensts. The two that I use the most are private money lenders and joint venture partners. You can find these people through networking. Go to meet-ups and network your ass off on biggerpockets.