One of the most common challenges for new—and sometimes even for experienced—real estate investors is getting deals funded. When you’ve got a great deal and you’re having trouble finding the money you need to close it, you may be tempted to take a loan with terms and conditions that will work against you. There may be times when this is an acceptable strategy—and times when you should walk away from the loan, even if it means walking away from the deal.
When you see one or more of the following red flags, think carefully and explore all your options before you accept the loan.
Higher than normal fees. There are fees and costs associated with originating loans that are an acceptable part of the borrowing process. Watch for fees that are excessive or hidden. Do the arithmetic yourself to be sure everything adds up correctly.
Higher than normal interest rate. If you have less-than-perfect credit, you can expect to pay a slightly higher rate than someone with a top-notch credit rating—but it shouldn’t be exorbitant. Know what the going rates are; if the lender is asking for more than six percent above prime for a first mortgage loan, look elsewhere.
Prepayment penalties. Don’t put yourself in a position of losing a substantial amount of your profit through prepayment penalties if you want to refinance in a year or two or if you sell the property.
Extra services you don’t want or need. Some lenders will bundle things like life or disability insurance into your loan. Not only is this the most expensive way to get such coverage, if you don’t want or need it, you shouldn’t be forced to buy it.
The contract includes a binding mandatory arbitration clause. This means that you give up your rights to sue for any reason and instead agree to binding arbitration—which means you could lose your right to due process if a dispute arises.
Upfront fees. If the lender wants any money upfront, especially before you’ve been approved for the loan, be very cautious. Legitimate lenders make money by making loans—not by soliciting applications and collecting upfront fees.
Anything you don’t understand. Mortgage loans can be complicated, especially if you’re considering products such as an adjustable rate or interest-only loan, or one that might result in negative amortization. Be sure you’re clear on all the terms and that you know what the payment will be, how often it might change, how high it can possibly go, and what will happen if your payments are capped but the interest rate is not.
There may be times when it’s worth less-than-desirable loan terms to get your deal done. For example, you may be willing to pay a higher interest rate because you know the property will generate enough cash flow to cover the debt service. The key is to understand the terms of the loan along with the advantages and disadvantages, and make a decision that will allow you to build wealth and achieve financial success.
