Background: Our advisor made inquiries with a number of our lenders about establishing a Multifamily Equity Line of Credit shortly after closing escrow on a commercial building. To begin with, very few lenders will offer this loan product. Of the few that will offer it, every single lender required a Full Documentation approach for a MELOC. The lenders view a 2nd position as greater risk, so therefore they require greater documentation and verification for this type of loan product. In addition, they will enforce a stricter Debt Coverage Ratio of 1.20 or higher, which means that the property may not qualify for a $100,000 line of credit. (Keep in mind we are using a 1.15 DCR on the 1st mortgage, which maximizes loan dollars for the client.)
MELOC vs. 2nd Mortgage: Since the MELOC is not a feasible scenario, an alternative would be a 2nd mortgage from a private lender. The biggest advantage is that a private lender will fund $100,000 without requiring a full verification of the borrower’s financial condition. Private lenders are asset-based lenders so they focus on the unused equity in a property. However, they will generally limit their exposure to 65% of the property value.
Despite the fact that we can probably obtain a $100,000 2nd mortgage on the property from a private lender, there are some disadvantages to this scenario:
The client would be charged a 4-point loan origination fee on the $100,000 loan request plus a 12% interest rate. Even though the payments are interest-only, this is still $1,000/month vs. $665.30/month that the client would be paying on that same $100,000 if they were to have a $900,000 loan at 7% interest rate. These higher payments would have reduced the investors overall cash flow from the property.
The higher debt service ultimately would reduce the annual cash flow from the property by $4,016. In our cash flow analysis, we expect nearly $18,000 positive cash flow in the first year of operation. However, placing a 2nd mortgage on the property will cost $4,000 in loan origination fees. Furthermore, the higher interest rate will further reduce the expected cash flow. So instead of making $18,000 our advisor forecasted that the client would make less than $10,000 during the 1st year of operation.
Most private lenders issue short-term notes. In this case, the lender will probably issue a 2nd mortgage due in 3 years. This meant that our client would need to refinance the property or find another way to pay-off the note. Having said that, the maturity is negotiable, and we can probably negotiate a 3-year term with 1-year extension, or even a note with a longer term, e.g., 5 years.
Within the page of the link below our Advisor created a chart that shows the difference in payments between a $900,000 loan at 7% interest rate vs. an $800,000 1st mortgage at 7% and $100,000 2nd mortgage at 12%.Payment Options