In the past, a borrower was typically asked to provide a simple financial statement with a credit check, and that was the extent of the credit items required. Ah, the good old days. In today’s environment, lenders have upped their borrower documentation considerably requiring an extensive amount of information on the borrower.
I’m continually surprised by most borrowers who don’t know the necessary documentation they need to provide in order to get a lender interested in them. They could avoid many of their financing problems if they anticipated the financing road blocks before they happen. Shown below are seven of the more common examples of issues to watch out for:
1. Minimum Net Worth to Loan Ratio – Each lender has different requirements but they typically require the borrower’s net worth to be equal to the loan amount. Some require a borrower’s net worth to be as much as two times the proposed loan amount. Find out what your lender requires before signing the application.
2. Minimum Number of Months of Debt Service Required of Liquid Assets – Again each lender is different but they typically require liquid assets showing on the borrower’s balance sheet equal to 6 to 12 months of debt service. Find out what your lender requires before signing the application.
3. Complete the REO Schedule with all the Details Filled In – Many lenders are now creating a global cash flow spreadsheet on the borrower. They want to see if the prospective borrower is generating a positive cash flow or slowly draining himself of all his cash. Much of the detail required to determine his global cash flow comes from the real estate owned schedule. Prepare the REO schedule before you begin talking to lenders so that when they ask for it, it’s ready for them. If you need a copy of a REO schedule contact me and I’ll email you one.
4. Credit Rating & Explanations of 30 Day Late Payments – Run a credit report on yourself before you start looking for a lender. Find out your credit score. Most lenders require that your credit score be a minimum of 680. If yours is not that high, you better have a good explanation. Also you need to explain every payment that is 30 days late or more. Put it in writing before they ask.
5. Explain Past Tax Liens, Judgments, Litigation – have written explanations with back up documentation already prepared before you sign the application. Give the prospective lender your explanations and have him verify in advance of signing your application that your explanations are satisfactory and will not impact loan approval. Do it before you sign the application when you have the most negotiating power, not after when you have little or none.
6. Tax Returns, not just Schedule 1040s, signed and dated including all K-1s – Lenders want all of your federal tax returns, not parts of them. Typically, most borrowers forget to sign and date their tax returns and most times it takes two or three attempts to get all of their K-1s. To speed up the process get it done correctly the first time.
7. Thoroughly Read the Application and Ask Questions Prior to Signing the Application – It is imperative that you understand every clause in the loan application. Lenders become frustrated, and rightly so, when borrowers and their legal counsel voice issues at the closing table about lending requirements that were disclosed on the loan application. Negotiate any onerous lending requirement prior to signing the application.
One of the truest statements ever uttered about commercial real estate is, “Time kills deals.” A lengthy, drawn out loan underwriting process will at the very least move your deal to the bottom of the pile. It has the potential of killing the deal altogether. Many of these seven issues can be avoided if the borrower will be proactive and anticipate what the lender is going to require. A good borrower, a good mortgage broker should work towards making the lender’s process as easy as possible to avoid ever hearing the words, “I’m sorry to inform you, your loan has been turned down.”
Source: From the Analyst Chair: Anticipate the Road Blocks in Commercial Real Estate Finance by Metropolitan Capital Advisors Blog, September 4, 2012.