For many years our company has had to wear 2 hats, one is our borrower hat and the other’s our investor hat. Since we stand in between a borrower in need of funds and an investor looking to invest their money we need to always remember that we must serve the needs of both parties. It is a challenge to balance the needs of both parties in the quest to satisfy the needs of both parties.
In this Blog Post we want to focus on the needs of our investors and what needs to done to provide a safe trust deed investment. The overriding determinant for a safe investment had always been and will always be equity. Equity is the borrowers’ interest in the property. Basically the difference between loan and lien balances recorded against the property and the market value of the property. A Borrower who has a lot of equity in their property just seen to sleep better at night, and the same goes for an investor who as loans on a property that has a lot of equity. Basically it’s safe to say that equity is a good thing for both borrowers and investors alike.
In the old days equity could be used as the one determinant in deciding to fund a loan. But in today’s world there are many laws and regulations that the state of California has passed into law that has done away with relying on equity as the only determinate.
There have been many analogies relating the mortgage business to a 3 legged stool. One leg being the property the second leg being credit and the 3rd leg being income. It is a very good analogy since a 3 legged stool will stand with only 2 legs and neither can a trust deed investment. Equity provides a cushion so the investor has a protected equity position in the property. Income provides the investor proof of the borrowers’ ability to pay and credit provides the borrowers willingness to pay. When you have all 3 you have a great trust deed investment.
Let’s take a look at the 3 components that goes into a safe trust deed investment.
When a borrower contacts our company to get a loan on their property one of the first things we look at is equity. If there is not sufficient equity right up front we reluctantly have to notify the borrower that we will be able to proceed forward in providing them a loan. There would be no need to check the borrower’s credit or verify their income if the main ingredient known as equity is missing. That’s how important equity is when reviewing a loan request.
The process of determining equity is as follows:
Since most of the loans our company arranges are first trust deeds our example here is based on a first trust deed.
The amount of money the borrowers request is determined.
Next the value of the property is calculated by way of a formal appraisal of the property.
Then a calculation is made where the value of the property is divided into the loan amount to calculate a percentage. That percentage represents a ratio of the loan amount relative to the market value.
Let’s look at an example:
Loan amount: $100,000.00
Market value: $200,000.00
LTV (Loan to Value) 50%
This would be a very safe trust deed investment.
If the loan amount was increased to $150,000.00 then the LTV would be: 75%
The LTV is calculated in the following way $150,000 divided by $200,000.00= 75%.
This would not be a safe trust deed investment sine it exceeds the industry standard of 65% LVT to insure a safe trust deed investment.
An additional calculation must be done to determine if the proposed loan amount is sufficiently large enough to pay off any and all liens recorded against the property and provide the borrower the necessary amount of funds requested.
When a borrower contacts our company or Bank of America the need to confirm income is required. We don’t live by the same standards that the big banks are required by both state and federal regulatory agencies. Our company must also live by both state and Federal requirements but not to the same standard.
Must banks will not approve a loan to a borrower that exceeds 40% of the monthly income. Our company will look at a borrower’s income that goes as high as 60% on the borrower’s monthly income. We also have the ability to review bank statements or even allow the borrower to state their income in some instances.
When reviewing a borrower’s income our company must determine that the borrower has sufficient income to make the monthly mortgage payment to our investor.
We always pull a credit report for every borrower who applies for a mortgage with our company. The payment history for all accounts of the borrower are reviewed to determine willingness to pay. Close attention is paid to any and all mortgage are reviewed to make an assessment into possible future willingness to make monthly mortgage payments.
After assessing all 3 factors, equity, income and credit a determination is make as to the appropriate interest rate that will satisfy the ability of the borrower and the investment returns of the investor. All hard money loans are not alike. Every loan has their unique attributes and associated risks that need to be attended to when our company negotiates a loan with the borrower ad a trust deed with our investor.