First Capital Trust Deeds recently closed on a $125,000 private money cash-out refinance on a single family residential investment property on a very nice street in Los Angeles. The borrower was referred by another mortgage broker who could not get them approved for a conventional loan despite perfect credit and 20+ years of self-employment.
The primary reason for the Fannie Mae denial was that the borrower’s adjusted gross income (AGI) reported on their income taxes was too low due to large expenses incurred over the past two years purchasing new machinery for their business.
In addition to the new equipment purchases driving down the AGI, the borrower owned a few other rental properties which gave them additional tax deductions from mortgage interest, property taxes, and depreciation.
From an income tax liability standpoint, the borrower was doing great by reducing the amount owed to Uncle Sam while reinvesting in their business and owning investment properties. What’s not to like?
From Fannie Mae’s perspective, there was a lot not to like. Despite great credit and 20+ years of self-employment and more than sufficient liquidity, they were unqualified to borrow from Fannie Mae because they exceeded the maximum debt-to-income (DTI) ratio of 43%.
If you haven’t been following the mortgage market over the past six years, you might not be aware that this has become pretty common theme for self-employed borrowers who also own real estate investment properties.
Government-backed loans (Fannie/Freddie/FHA) are 90% of all new mortgages issued and conventional loans are geared toward owner occupied loans for W-2 employees. Investment property financing is just an ancillary product they offer, but it’s not their focus. Long-term data shows that owner occupied loans perform better than investment property loans.
The self-employed borrower, who often falls into what we call “A-Paper Fallout” category because of their tax deductions from capital expenditures, business expenses, and investment properties, is really limited to either squeaking into a conventional loan by having two consecutive years with high AGI, getting a loan from a portfolio bank or credit union, or falling down to private money, like our borrower here in Los Angeles.
Fortunately, private money lenders have responded with lower-priced loan programs geared toward strong borrowers like our client in Los Angeles.
Private Money Financing Terms:
- $125,000 (38% LTV – $325,000 Value)
- 8.00% Interest-Only
- 36-Month Term (Balloon Payment due)
- 1 Year Prepayment Penalty