We’ve now discussed the importance of credit, and capacity- but do you have collateral? Here we explore the importance of collateral during the underwriting process.
What if a borrower doesn’t pay their mortgage? Collateral mainly refers to the down payment or total equity. However, the type of property, value, the use of property and everything related to these aspects are also factored into collateral. Property type can be classified in the following order of risk from lowest to highest: single family homes, duplex, townhouse, low rise condo, high rise condo, triplex, four-pled, and condotels. Occupancy is also considered part of collateral. Owner occupied and second homes have the least amount of defaults, while investment properties have higher occurrences of default. Please note that value is also considered in this equation.
It is important to realize that price, cost and value are the three different characteristics of a home.
- Price is the dollar amount that a seller agrees to sell a house to another party for.
- Cost is the dollar amount needed to build the home including labor and materials.
- Value, which is usually the most important characteristic, is the dollar amount that is supported by recent sales of properties with similar characteristics.
Under fair market circumstances, when the seller is not in distress and the housing market is not under volatile conditions, price and value should be comparable. If the home needs to be foreclosed upon, the lender must be able to sell the property to recoup the losses.
The comparative analysis of the collateral is known as Loan-To-Value (LTV). LTV is a ratio of the loan amount to the value of the property. In addition, the Combined Loan-To -Value (CLTV) is the sum of all liens against the property divided by the value. Naturally, the higher LTV’s and CLTV’s increase the risk of the loan.
You need to know that you, as an investor, can buy multiple properties. However, in order to leverage the bank’s money they will require you put down 20% to 25% on each investment deal when you do a conventional purchase. I’ll show you later how to buy without putting money down, so it hurts me to even type this previous sentence. If for some reason the bank is able to allow you to put less than the 20% down then you must remember to calculate in private mortgage insurance (or PMI) which is tacked on to the monthly mortgage payment in order to cover the loan should you default on it.
Another point to make is that when you are financing house number 5 and higher, you have no choice but to put 25% or more down on an investment purchase. On an investment refinance of house number 5 or more, the maximum loan is 70% of the value or less.
Unsure about the underwriting process? Contact our experts today at Starting Point Real Estate. We want to learn from you, too! Let’s take this friendship to Facebook, Twitter, Pinterest, and Google+.