Finding and negotiating with a bank
It is daunting dealing with a bank for a rental mortgage. Who should you go with? And what can you negotiate? After all, they do this all the time. This is your first time. Guess who has the upper hand?
There's good news and bad news.
The good news is there's a gazillion mortgage providers out there. And they're hungry for your business (especially if you're organized and have good credit).
The bad news is there's not that many things that are actually up for negotiation. Side note: we are talking about apartments or houses with one to four residential units here. If there are five separate units or more , or if there's a storefront you're in commercial residential territory. That's a different game.
Let's cover two things:
- Mortgage parameters you need to decide
- Things you can negotiate
Mortgage parameters you can decide
If you've ever bought a car, you first decide on what model and trim level. You don't start negotiating until you've decided if you want the leather seats and heated steering wheel or something else. Same with mortgages. There's 30 year fixed, 15 year fixed, 5/1 ARM, hybrid ARMs, VA loans...you get the idea. 90% of residential mortgages are 30 year fixed rate. 6% are 15 year fixed rate. The rest make up 4%.
The chances are you're going with a 30 or 15 year fixed. With good reason too. It's predictable. With a 30 year fixed mortgage you know your monthly mortgage payment - to the cent - into the 2050's! I challenge you to find a more predictable part of your life. Predictability matters. It gives you peace of mind.
Your default mortgage term should be to choose a 30 year fixed mortgage. It provides you stability, especially as you get started in real estate investing.
There are two other decisions you need to make. How much down payment is and how many points you're going to buy.
Banks like a nice juicy down payment. They look at "LTV" or loan-to-value. If you're buying a property for $200K and your down payment is $80K, the bank's loan-to-value is $120K divided by $200K or 60%. There's less risk to the bank than if the LTV is 75%. They more money you've put in, the more skin in the game you have. And the lower your mortgage payments the better your cashflow. And the better your cashflow, the more stable your rental business.
Banks usually like a minimum of 25% down payment (you put in $1 for every $3 the bank lends you). The more you put down, the lower your mortgage rate and the better your cashflow. But the lower your returns (ROE).
The only other decision (not negotiation) is if you want 'points'. Points are you option to buy a lower rate. Your rate for a 30 year mortgage is determined by the bank you choose and your credit score. That's it. If you go to Local Bank and you have a credit score of 722, the bank will tell you what the mortgage rate is and how much points cost you.
Here's a real example I had recently. I could get a 15 year mortgage for 2.75%. Or - from the same bank - I could get a 2.50% rate and pay 0.68 points.
Should I do it? (For all you amortization officianados, yes I'm simplifying this by "straightlining" the interest payments). If I wanted a $100,000 loan, I could pay $2,750 interest in year one, two, three etc. Or I could pay the bank 0.68% x $100,000 up front ($680) and then pay just $2,500 in years one, two, three etc.
The rough mental math is "I save $250 interest cost a year if I pay a one off fee of $680. So by the end of year three I've saved $750 in interest payment and it cost my $680. Year four onwards I'm saving $250 each year".
To repeat: this is a massively simplified example. But good enough to make a decision.
You need to decide the type and term of your mortgage, how much you will put down, and how many points you will buy. These are decisions, not negotiations.
Things you can negotiate
You can negotiate some of the closing costs.
Closing costs are a buffet of different items. The costs don't vary that much bank to bank. They're usually in the $3,000 to $7,000 range. I counted a total of ten different fees on my last mortgage. The two largest were "processing fee" and "appraisal fee". The first was over $1,000. The second was $915. Ouch.
Some of these fees you have to get through the bank or lender. Others you can shop around for. There's lots of views on these fees. My simple take:
Ask to get your appraisal fee waived. Ask if the lender will offer other rebates. Do this before you start the mortgage application process. You lose negotiating leverage once you've started the application.
How to get a good rate for you
"For you" is important. Your rate is dependent on your credit rating, the loan amount, and the loan-to-value ratio, the points you buy (or don't) and some other factors.
Here's the simple process and steps you need to do. You'll need 90 minutes start to finish. Links to all these are at the bottom.
- Sign up for a free credit monitoring service or get your free annual credit report. Know your score from all three credit monitoring agencies if possible.
- Find two national banks/lenders using online "aggregators". Find a mortgage advisor in your state with 10+ years experience. The banks' websites will have a mortgage advisor's direct phone number.
- Google two local savings banks in your state. Find the person (or people) who deal with mortgages. The banks' websites will have a mortgage advisor's direct phone number.
- Google two local mortgage brokers in your state. Brokers are like the online aggregators, but old school. Brokers have relationships with a number of lenders. Again, the brokers' websites will have a mortgage advisor's direct phone number.
Find a representative who has years of experience. The person you're talking to is the sales person. They want to get the deal done so they get their commission. Mortgage advisors with years under their belts know how to get deals through their underwriting team. No-one wants to be examined by a doctor who just graduated. Same goes for mortgage advisors.
Your script for each of the six phone calls you need to make. "Hi, my name is [X]. I'm looking to get a mortgage for a rental property with [X] units in [X] town/city. The property price is [X]. Ideally I'd like an LTV of [X%] by putting down [X]. For a credit score of [X], what is your 30 year fixed rate today? And roughly what are your closing costs with any rebates or offers? I'm not looking for firm numbers, but want to get a good idea. I've got all my paperwork in order and ready to go for an application."
Ask about points later. It adds to much complexity at this stage.
A small side bar. If you're going to hold the property in an LLC (more on this in another post), you need to tell the lender up front. Some lenders won't do it. Others charge a premium on a non-LLC rate.
Free credit monitoring services
Free Credit Monitoring | Credit Sesame
Formal credit report
Online lending "aggregators"