Underwriting: Traditional vs. Private Lending
What is underwriting? Simply put, underwriting is just another way of saying, “What are the risks of lending money to this borrower and what are the odds it will be repaid?
There are two primary methods of underwriting. The first is the traditional bank method which is weighted more towards the borrower’s ability to repay. The other method, usually used by private money lenders, is asset-based underwriting or using the value or after repair value of the property as a basis of mitigating risk.
Traditional bank loans have more paperwork and disclosures/affidavits but the interest rates are normally lower. On the flip side, the ability to underwrite and fund a private money loan quickly and efficiently is an advantage that will cost the borrower more. In addition, asset-based lending normally focuses on the after-repair value which is inherently riskier, thereby costing the borrower more in interest and fees.
Both types of underwriting are valuable tools in helping the lender determine the risks of extending credit to borrowers and which types of lending products will work the best for the borrower’s situation.
Traditional Mortgage Underwriting
Owner occupied, primary residence borrowers normally experience the traditional underwriting method through their bank or mortgage broker. Real estate investors most likely will not go through the same underwriting experience because banks and mortgage brokers typically will not lend money to real estate projects that require rehabbing and construction to get the property to retail condition for sale or refinance. These investors normally use private money lenders for help funding their projects. Either method, it is important for loan originators to help their borrower understand how the underwriting works and the process involved.
As a traditional residential mortgage originator, it is important that the borrower understand that the borrower’s finances, credit and ability to repay the loan are the most heavily weighted parts of the underwriting decision.
A good time to explain the underwriting process is when you are filling out a loan application with a borrower. The traditional underwriting process requires a lot of documentation, so it is important for borrowers to be aware upfront of what will be required from them as the loan application moves through the process.
Private Money Underwriting
Private money underwriting is much easier on the borrowers, especially if they don’t have perfect credit and financials. Also, underwriting can be completed much faster, which helps investors, especially with investment projects where the ability to close quickly can mean a deal or no deal. Underwriting for private loans is easy to deal with because the focus is primarily asset driven and requires very little paperwork to get the loan to funding.
The downside to this type of underwriting is that interest rates at banks and non-bank lending institutions tend to be more favorable than in the private money lending world. Private money and hard money lenders are not normally lending at the national or regional level. Most private lenders will have less than $1-5 million to deploy on a yearly basis and, for the most part, they will have their own required paperwork, underwriting process and risk assessment on a submitted deal. Geneva Lakes Funding has standardized the underwriting process, documents used and funding timelines with their private capital investors to ensure a smooth, consistent loan closing experience for its borrowers.
The appeal of private money is that access to funding and speed of closing happens very quickly. Many real estate investors and commercial brokers lean toward private money over traditional bank lending when working on loans to purchase investment properties because they want to close quickly and begin the work that will help them maximize their profit on the deal.
True private and hard money loans won’t require W2s, tax returns, bank statements or other documents related to the borrower’s financial situation like a bank requires, however. This is because, in many cases, the underwriter also is the lender that is ultimately financing the loan, so they want to make sure that the asset being purchased is the first line of protection against loss in the event the borrower does not pay. Geneva Lakes Funding conservatively underwrites loans to protect the capital investor and ensure that should a loan default, the asset has plenty of equity built in to recover the principal balance plus interest.
Both private funding and traditional institutional lending have their place in real estate investing. The underwriting process for these different types of lending differs greatly and shouldn’t be confused with the other. One major difference between the two financing paths, however, is that traditional mortgage lending focuses more on the borrower than the asset, while private money lending focuses on the asset itself when determining the risk assessment.
Geneva Lakes Funding specializes in direct-placement, private money lending to real estate investors for fix and flips, fix and holds and cash-out refinancing on non-owner occupied single family, multifamily and light commercial properties. If you would like us to have a look at your project, give us a call at (262) 222-6400 or email us at firstname.lastname@example.org