Learn How To Start Investing In Real Estate
Learn How To Start Investing In Real Estate

5 Reasons Not To Use A Conventional Mortgage Loan

Written by JD Esajian

A conventional mortgage loan is the bread and butter of real estate financing. This traditional home loan option remains wildly popular in today’s marketplace because it customarily provides great rates, lower costs, and home buying flexibility. Because it’s tailored to meet the needs of traditional homebuyers, a conventional mortgage loan is perfect for those with the financial means and credit score to do so.

On the other hand, a conventional mortgage loan is the antithesis of what real estate investors desire. Slow and stringent, this loan program is not always the best bet. Not to mention, a conventional mortgage loan requires a substantial credit score (700+) and down payment (typically 20-30 percent of the loan); not something every investor has. Depending on their business plan and exit strategy, which will differ drastically from property to property, each transaction will be geared towards costs, speed and profit margins. While a conventional mortgage loan is the right choice for many people, it won’t always facilitate the demands of an investor.

The following outlines five reasons not to use a conventional mortgage loan:

5 Reasons Not To Use A Conventional Mortgage Loan

Speed: The tempo of a conventional mortgage loan can be very long and drawn-out. Speed of implementation, or lack thereof, can be a problem for many investors, as the availability of funds can sometimes be the difference between closing on a deal and losing one.

For those looking to take advantage of speed and efficiency in real estate financing, an all-cash offer is the way to go. Offering cash can provide significant advantages over a conventional mortgage loan, including the removal of PMI, the likelihood of deals falling through, and even serve as a bargaining chip in negotiation process.

Underwriting: Another thorn in the side for investors when obtaining a conventional mortgage loan is the approval process, otherwise known as the underwriting. This is when mortgage lenders will examine a borrower’s credit, income, employment and other qualifying factors to determine whether or not their loan application is approved. This process can take days, weeks or even months depending on the lender and their qualifying standards.

Condition Of The Property: Investing in real estate consists of seeing the potential in a property when others don’t. However, the problem for investors can sometimes be convincing lenders.

During the underwriting process of a conventional mortgage loan, before a lender offers terms, the property will need to be evaluated by an appraiser. This examination will include a collection of basic information, like square footage, number of rooms, age and condition, to determine the value of a property, as well as any potential repairs that need to be made. In addition, the appraiser will designate the property in one of two ways: “As-is” or “subject-to.” Homes labeled “subject-to” will be much more difficult to finance due to lenders assuming the risk for the repairs. All things considered, a conventional mortgage loan could hinder an investment opportunity.

No Down Payment: When purchasing a home, conventional wisdom says putting down 20 percent or more is the way to go. From a homebuyer’s perspective, a large down payment will help to improve their interest rate, which in return, will lead to long-term cost savings. As an investor, however, the benefits don’t add up. Instead of shelling out large amounts of money to obtain a conventional mortgage loan, investors typically look to other lenders to meet their needs.

Advantage Over The Competition: Believe it or not, purposefully neglecting to utilize a conventional mortgage loan can prove to be a huge advantage for investors. While others are forced to sit and wait for mortgage approval, investors that utilize alternative financing options have the upper hand. Along with speed of funding, nothing entices a seller more than a cash offer, especially at the negotiation table.

Mortgage options

Alternative Options To A Conventional Mortgage Loan

In real estate, the cost of money isn’t what counts the most — it’s the availability of said funds. Rather than being governed by traditional lenders like a conventional mortgage loan, many real estate investors choose to go through other funding methods to acquire their investments. These financing methods are generally geared towards the needs of investors. The following breaks down some alternative financing options for investors:

Private Money Lenders: Rather than going through the hassle of securing a traditional mortgage loan, investors have the ability to instead choose a private money lender. Funded by an individual instead of a bank, a private money lender will provide the hard cash to purchase real estate properties in exchange for a specific payback period. Oftentimes, this period will last anywhere from six months to a year, with terms of the deal established upfront. Benefits include: speed of purchase, asset-based lending, control and profitability, shorter terms, and guarantee of capital.

Hard Money Lender: A hard money lender is comprised of companies that specialize in short-term real estate-backed loans. Because their qualifying standards do not conform to bank standards, hard money lenders will typically charge higher interest rates, with term lengths ranging from six months up to two or three years, depending on the type and size of real estate project. In most cases, the size of the loan will be determined by the “After Repair Value” (ARV).

Also, hard money lenders will not finance an entire deal, but rather a percentage of the purchase price or the ARV. This will generally range from 50 to 70 percent. In addition, hard money lenders will also charge fees on top of the interest rate of the loan.

Real estate financing offers a slew of options for homebuyers and investors alike. A conventional mortgage loan, on the other hand, offers the homebuyer a better deal — not the investor. While each has its own advantages, unconventional financing methods like private and hard money lending remains the heart and soul real estate investing.