3 Common Financing Mistakes
Which Can Cost You Big…Doh!
When taking on financing as a real estate investor, it is important to ask yourself this question: What am I actually trying to accomplish?
Obviously you want to get financing to acquire a property , but here’s the thing: financing decisions are often made without having all the facts. I have talked to many investors who (until they got too deep into the deal) didn’t fully understanding all the fees and terms accompanying the loan…they simply were unaware of all the financial implications involved and didn’t know to ask until they got approved and then had to make a decision of whether they wanted this financing with the fees involved (and due diligence time was running out) or gamble with the remaning time left to find other financing (which may have the same terms and fees).
The result is often a property which isn’t making the margins initially anticipated.
The right financing option varies for every deal and lending environment, but there are three common areas where people frequently make financing mistakes. Here are the common pitfalls and the best ways to avoid them so you can choose the best option.
1. Be aware of your real interest rate. Surprisingly often, people who think they know how to calculate interest rates often don’t.
For example, if you borrow money at 6%, the monthly rate breaks down to .05% using simple interest. In Canada, loans are calculated with semi-annual compounding which makes the actual rate or what is known as the effective rate as 6.09%. In the US, mortgages are compounded monthly. In this same example of a 6% interest rate, the US effective rate is 6.17%.
2. Pay attention to hidden fees. When taking out financing you must take into account origination fees. Many lenders charge origination fees of 3-4 percent, especially private lenders (which are more prevelant these days) which can be deducted from the loan amount. Depending on how quickly you pay that loan back, that fee can have a large impact on the true interest rate you’re paying.
When borrowing money, be aware of these other fees that accompany the financing: administrative fees, appraisal fees, due diligence fees and more. These fees can be hidden in the fine print, so comb through ALL the paperwork carefully before moving forward. If you don’t understand all of it, find someone who does!
3. Not having a ‘financing binder’. Banks or mortgage brokers can take up to two weeks or more to review a loan application and, if approved, potentially another 15–60 days to fund the loan depending on the type of loan. There are also more documents required by the borrower than ever before, so if you, the client, don’t have all the pertinant documentts ready and available, your ‘subject to’ time can be burning away as the mortgage broker keeps chasing you, the client, for all your paperwork to qualify you for the loan.
You will speed up the process and potentially get funding faster by having your financing binder ready and up to date.
The object is to get your income, debts, income tax returns, credit and net worth statement into an orderly fashion and clean up any messes affecting your chances of getting approved at the best rates BEFORE you start making offers an property and applying for financing . Anyone wanting to grow a portfolio must have this part of their business together, regardless of where you are starting financially.
Here’s what you need to have prepared and included in your Financing Binder:
- Pull your own credit. Go to Equifax.ca (score power) and Transunion.ca. They provide your credit score and a detailed history with your creditors. This allows you to repair any mistakes which can be pulling your score down. There is no negative impact on your credit score if you pull it a few times a year (which I recommend).
- Eliminate debt. High credit card balances, leases, loans or credit lines can impede the qualifying process. If you are struggling in this area, perhaps talk to a credit councillor or mortgage broker and get on a plan to eliminate or decrease your debt to manageable levels.
- Get your taxes current. Lenders tend to not advance mortgages to people who owe income tax. Why? Because the “tax-man” comes before everyone in the foreclosure food chain.
- Get your income documents. This means your last 3 pay stubs and a Letter of Employment (if you are salaried). If you are self-employed, 2 years of T1 Generals (Tax returns), 2 years NOAs, and proof of being self-employed like a copy of Business Registration or Articles of Incorporation. If you are paid by your own numbered company you will need your latest T4s. Also if you have rental income, you will need to include leases or economic rents through appraisals.
- Investment statements for any non- real estate investment such as RRSPs, TFSAs, stocks, mutual funds or insurance policies.
- Mortgage statements from all properties should include current balance, interest rate, monthly payment and maturity date.
- Property tax information. A current property tax statement and latest assessment for all properties.
- Net Worth Statement. You can download a template on-line which you can fill in all income; expenses, including all debts and who they are to. Include assets like properties, vehicles, jewellery, precious metals and art
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