ForeclosuresMass - ForeclosuresMass Monthly - Feature Article - Conventional Financing for Less Than Stellar Credit (December 2007)

You don't have to be going through a foreclosure to know the Massachusetts real estate market has drastically changed within the last six months. Thanks to the sub-prime meltdown, lenders such as New Century have filed for bankruptcy, Countrywide had to modify $16 billion in loans, and foreclosures continue to rise across the state as adjustable rate mortgages reset.

It's definitely a buyers market, but for real estate investors seeking financing, the days of easy money are long gone. However, you can still get solid financing, and great deals, even if you have less than stellar credit. What follows is basic information about how the lending process has changed and how you can use a combination of conventional and seller monies to finance that next deal.

Banks look at three things when you apply for loan: capacity or income to make payments, collateral (the property you're buying), and your credit score. Lenders call these "the three C's" and as an investor, you need to understand them, too. Let's look at each one in detail.

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Capacity: This is simply your ability to pay the loan. Banks look at your income, assets, and debts. For conventional fully documented (full docs) loans, lenders look at your W2s, pay stubs, bank statements, 401K statements, etc.

In the go-go sub-prime days, unscrupulous lenders would say, "Hell yes, we can qualify you for a loan up to 65% of your income! Not a problem!" They did this by running what is called a "no doc" loan. This means the bank didn't document your income or assets and instead based your income information on industry Websites such as salary.com.

The problem was the loan was based on 65% of your gross income, not your net income. If you made $5000 a month, you need to automatically take off a third for taxes. Now you're taking home, or netting, $3500, but your mortgage payment, based on your gross income, is $3000, and you have $1500 a month in expenses, not including your debt. How do you pay for that? You don't, which is why foreclosures have skyrocketed.

Keep yourself from financial ruin by running your numbers before you go loan shopping. To determine how much loan you can afford, know the difference between your gross income and net income, and factor in your expenses, including debt payments, too. For investment properties, you need to include the expenses associated with the property such as property taxes, maintenance, vacancies, etc.

When you know your numbers, you won't fall prey to lenders or realtors trying to sell you more loan or house than you can afford.

Collateral: This is simply the value of the property. Don't let a lender base the loan amount on the assessed value of the property since most properties are now selling below their assessed values. Instead, make sure you know the market value or After Repair Value (ARV) of the property you're considering. One way to do this is through networking with local Realtors - a truly invaluable asset in today's ever-changing real estate marketplace.

Credit score: In the go-go market, anyone could get a loan. Now banks have shut off the spigot for sub-prime borrowers and have made it really tough for "alternate borrowers" to get financing.

Let's face it, the hot market produced some really unscrupulous mortgage brokers, which is why so many of them have gone out of business and foreclosures are rising.

When shopping for loans, ask your network for recommendations. Check out the company or broker before a face-to-face meeting: How long have they been in business? Do they have any complaints registered against them? Research the Internet for local or national news stories that mention the lender or broker. Keep abreast of financial news by reading publications such at the Wall Street Journal or Mortgage News Daily.

When you meet the lender or broker and he or she makes you feel nervous or uncomfortable due to a hard sell, walk away. Don't let anyone push you into something you can't afford.

Because it's a buyers market, you have lots of really motivated sellers. It's also a great time to get into the market as a long-term "buy and hold" investor because so many former homeowners are now renting.

If you don't qualify for a prime conventional mortgage, consider combining one of these "creative" seller-financing strategies with your conventional mortgage. Instead of asking for a reduced price on a property, for example, ask the seller to provide $5K in closing cost credits which will help lower your interest rate.

The seller may also be interested in doing a buy-back mortgage or second mortgage - which means you don't have to put as much money down. The transaction is quite simple actually. In most instances, a seller will receive proceeds from the sale of their home (minus any fees or expenses such as a broker's commission, mortgage payoff, etc.) which they will generally use toward the purchase of a new home, with the balance going toward debt consolidation, retirement, and future investments.

However, with today's highly volatile equity market, most consumers are reverting back to the old-fashioned methods of generating income, such as CDs and savings accounts with their local banks -- not very equitable endeavors.

Instead, they could loan a part of their proceeds or equity to help you buy their property. In return, they secure better-than-average returns - completely negotiable between you and the seller - while keeping a percentage interest in the property. So, if a CD earns them 4-5%, a second mortgage may earn them 7-8%. You do the math - you both benefit without either losing the asset.

Or, consider seller financing where the seller gives back a 5 - 10% mortgage at a slighter higher than market rate. For example, if the market rate is 6.4%, the seller can give you a mortgage at 7%.

Although you may not have excellent credit, you can still get into the market. To ensure the best deal, understand the lending process and how banks look at you, find a lender you trust, and let sellers help you with financing. Then sit tight and let your property appreciate over the next three to five years - and improve your credit worthiness, too.

Jeffrey Chalmers is the President of Real Solutions LLC, a one-stop real estate service. For more information, visit the Real Solutions website at www.ClicknCompare.com You can also call Jeffrey at (781) 646-8430 x901 or email him at jchalmers@clickncompare.com