Why Lower Rates May Cost You More

When you apply for a real estate loan, the thing that most people look at is the interest rate. After reading this article, you’ll learn that the rate isn’t the only thing that matters when it comes to the overall cost of the loan.

Are Advertised Rates Actually Cheaper?

The more time I spend in the lending industry, the more I get surprised at the requirements and regulations that lenders go through to get a deal funded.

Sometimes, the pressure causes them to create promotions that make a loan seem great, only to have them change the terms on their clients last minute before closing.

Here are some of the ways that lenders advertise cheaper rates that actually make you pay more in the end!

High Origination and Processing Fees

Some organizations will quote a low-interest rate but will charge abnormally high origination and processing fees. I’ve seen origination fees north of 5% with extra fees for appraisal and processing per property funded.

Your typical origination and processing should be 2% or less of your loan amount. If it’s higher than that amount, you may be getting a loan with extra fees padded just to make the rate look lower.

What’s the point of saving a few tenths of a percent on your rate if you’re spending a few thousand more on fees?

Extra Prepayment Penalty Requirements

One of the levers that lenders can pull is to increase the number of years of a prepayment penalty on a loan. The standard for a long term non-QM loan is 3 years. If you want a lower rate, you can opt-in for a 5-year prepayment penalty instead of the 3-year standard. Likewise, if you want less prepayment penalty, then you can get it with a higher interest rate on your loan.

Some loan originators are sneaky and will immediately quote a lower interest rate for you and assume that you’re ok with getting a 5-year prepayment penalty on your loan. Make sure you know what you’re signing up for.

Higher DSCR requirements

One of the main qualifications of getting a long term loan is the DSCR requirements. This means that the net operating income of the building must be greater than or equal to the monthly PITIA payments (principal, interest, taxes, insurance, and association dues).

Some lenders may truly have a lower interest rate but may require you to have 1.25x DSCR requirement instead of standard 1.1x DSCR requirement. This is a safer investment for the lender because the property sustains itself better at 1.25x DSCR.

If your property can meet these higher DSCR requirements, it’s likely that any lender can give you a discount on the rate anyway.

Required LLC Formation

Another way that lenders can reduce your rate is by forcing you to create an LLC to place the property into. This makes it easier to foreclose on your property if you default on the loan in the future.

But by forcing you to create an LLC, you’ll have to pay extra costs for the LLC formation, have to pay an additional yearly tax for it ($800 in California), and will have to pay transfer taxes to move the property into the LLC in the first place! These costs add up and may not be worth the few tents of a percent that you’ll save by originating a loan with that lender.

Quoting A Higher Loan Amount

In general, higher LTV loans are more expensive than lower LTV ones, and some lenders charge extra for having a loan amount below $100,000.

Some lenders will intentionally misquote potential borrowers by claiming they’re getting a larger loan at 60% LTV on a property to bypass the $100,000 threshold, even though the property may only be worth $110,000. They’ll present the borrower with the lower rate to get them to continue the process.

However, during the appraisal process, the lender will go back to the borrower to let them know that the LTV is higher than expected and won’t be able to do the deal at that rate and will increase the rate at the last moment.

Make sure that you’re actually getting a quote for a loan that will actually close! The worst thing you can do is get your rate locked on a property, pay for the processing fees and either have to accept their new terms or forfeit your fees.

Get A Solid Quote

When you’re looking to finance a rental property, make sure you know what you’re actually getting. There’s more to a loan than just the yearly interest rate. By understanding what you’re getting and appropriately comparing them against each other, you’ll be able to get the best loan for you at the best rates.

If you’re looking to purchase a rental property or refinance with a long term loan, feel free to schedule a call with me today!

Contact me if you want to learn more about hard money lending and how we can help you finance your next real estate investment.