The Final Chapter - Learning to Think Like an underwriter
As we have journeyed down this road of understanding the Fix and Flip mortgage we have stressed that all financing approvals are based on risk. It’s important to understand the logic behind the underwriter and how their decisions are calculated. It’s not as easy as having a simple checklist and when they check off a certain amount of items the deal is either approved or denied. If it was that simple everyone could be an underwriter and the whole process would be much simpler.
First, let’s look at what it takes to be an underwriter. What qualities must they possess, and what risk methods are used to protect the company and the investors, which is the main focus.
For any underwriter an analytical ability is paramount. They must be able to be a detective, and be able to draw conclusions based on the information provided to them to access the risk of a client, and finally decide if the client should be approved or declined. What you need to know is that an underwriter’s job is to help the lender approve as many deals as possible, which is the business purpose of the company. But they must also protect the company from loan defaults, which not only causes the company to lose money, and ruin investor relationships which can put the company out of business. The underwriter’s job and future employment are also based on their underwriting capabilities as well as their proficiency to approve deals that result in minimal foreclosure rates.
The underwriter must review all the documents and look for any inconsistencies or items that may raise red flags. Borrowers must understand that they should not hide any information or do anything during the process without first consenting with their loan consultant first. Part of the underwriting process is to do an inner body exploratory examination, which means that whatever it is, it will up usually at the end of the process resulting in a denial.
When underwriters see something that doesn’t look right, they will begin to ask for more items. Remember, underwriters handle hundreds of files each month, and they have seen everything. To be honest, there are very few things that slip through the cracks, so make sure that everything is buttoned up. The more questionable items in the application package, the more supporting items the underwriter will ask for, and the longer your file will sit. When that happens the possibilities of denial increase dramatically.
After the initial underwriting, the file the package is sent for final compliance review where another set of eyes reviews the information in order to stamp the final approval and send it to the closing department. This is a backup procedure to assure that the integrity of the file is ready for closing. This also keeps the underwriters on top of their game knowing that someone will be reviewing their work.
Underwriting the Borrower
When an underwriter reviews credit, they are not only looking at the score. They compare the information about your identity to the information on your application. They look and compare employment, housing history and then review your credit history, length of credit accounts, balances vs credit allowance, and any kind of inconsistencies. Tax liens, unpaid child support, and newer foreclosures are usually an automatic denial. For Fix and Flip mortgages, credit is reviewed, but the weight of the credit file is less persuasive than in other financing types, but it does play a role. Various lenders have various credit qualifications for their Fix and Flip programs, based on their risk factors and how aggressive they want to be.
Just a short note regarding credit. You should work on your credit if you have issues before you start applying for finance. The better your credit the better financing terms you will receive. Although credit is only a part of the approval process, rates rely heavily on the score and depth of your credit report, even with hard money and Fix and Flip mortgages. The difference in rate and payment will add to the profitability of the project which is what being in business is all about.
I also want to reiterate something, many think that no matter what happens that the lender gets the property so they are ok. This is not what lenders want. They are in the business of lending and not selling real estate, they want to get paid and that’s it. Many state laws require that during a foreclosure sale that the lender can only retrieve the mortgage balance plus fees charged for the process (Attorney, Late Fees, etc..) and any excess is the borrowers. The problem with this is that the borrower is never notified, and the money goes to the local government who holds it and as time goes by it moves up the governmental chain. They say they hold it forever, but who really believes that?
The underwriter reviews the borrower’s liquidity, which means the financial ability to complete the deal and the probability that they will be able to maintain the ongoing financial responsibility of the property. When we talk about the financial ability we are looking to see that the borrower has the money to complete the down payment, pay the closing costs and will have the ability to make, through employment income, the future payments, and complete the project. The money must be sourced, which simply means that the borrower is not borrowing the money to use for the downpayment and closing costs. The standard is that the money should be sourced (in the borrower’s possession) for 3 months. What this comes back to is the old theory that the borrower needs to have skin in the came. Something for them to lose, so that they just don’t simply walk away if things start to become difficult.
The bank statements will be reviewed for balance average, NSF’s and other discrepancies that may throw up red flags. Bank statements are a good indicator of how the borrower handles their finances, frequent low or negative balance can be a negative influence on a file, influencing the underwriter to look deeper for other negative indicators. These bank statements may be business or personal depending on the borrower. Experienced flippers may have an established business entity (recommended for liability purposes) and only business statements will be required, while others may be acting as a sole proprietorship and personal statements will be required. In high-risk situations and when the business entity is new and has limited experience the lender will require both,
When dealing with fix and flip financing, builder loans or any type of investment real estate mortgage is when experience comes into play. Experience means exactly that, what type of experience they have in real estate. Without any experience, the file will be scrubbed more thoroughly and will require more compensating factors, like a larger down payment, and probably will incur higher rates. The financial and credit stability of the borrower will be a stronger factor than usual when the experience is none or limited.
Underwriting the Property
The property or what is referred to as the asset is underwritten for value, stability, and freedom of encumbrances or claims. The appraisal is where the underwriter will start. The appraiser typically performs an inspection of the property, but before he/she does the inspection, they start by pulling the tax records and like properties in the immediate area. The one thing when evaluating properties is that the asking price of a property has no value on the property you are trying to value. The appraiser then goes and inspects the properties and does drive-bys of the like properties in order to take pictures of the comparables and then begins his comparative analysis. This where dollar credits are added and subtracted to estimate the value of the subject property. For example differences in square footage are price adjusted, lot size is adjusted, updates or lack thereof are adjusted, and so on to determine value. There is also other information like the stability and growth or decline of the neighborhood, demographic information, etc..
The appraisal provides information regarding value and stability. Pertaining to a Fix and Flip mortgage, the appraiser will provide an as is value, then they will utilize an estimate of work provided by the borrower’s contractor regarding the improvements to be made as well as the budget and based on that information will determine what the After Repair Value (ARV) will be. This will provide the lender the number to determine how much money they are willing to fund for repairs. I am sure you have seen the websites and marketing stating 100% of the renovation costs, and that can be true, but there must be some profit in there also. You can look at maximum repair funding up to 65-70% of the ARV.
The following information needed to clear the underwriting of the property is a title report. Definition of a title report is – the written analysis of the status of title to real property, including a property description, names of titleholders and how title is held (joint tenancy, etc.), tax rate, encumbrances (mortgages, liens, deeds of trusts, recorded judgments), and real property taxes due.
The title report shows the information needed to assure that there can be a smooth transfer of title. The title company will also provide the title insurance which protects the borrower and the lender from any existing or future claims on the property.
Scope of Work Review
The scope of work on the rehab (contractors estimate) is also reviewed to verify the estimates costs to make sure they are in line. Padding the bill to try to earn extra money can get the estimate rejected if someone gets too greedy. I have seen some ridiculous things come my way on these estimates, and it is best to catch these things early. The contractor must be licensed and insured. The borrower will also need to obtain a Builders Risk Policy from an Insurance company, it is important to find out the lenders requirements early in the process so that the borrower can work on getting what is needed.
- Loan Application*
- Copy of Current Credit Report
- Letter of Experience & Explanation*
- Investor Portfolio & Schedule of Real Estate Owned*
- Credit Card Authorization Form (Appraisal or BPO)*
- 3 months most recent Bank Statements- all pages w/ name & account # visible
- Copy of valid ID (Driver’s License or Passport)
- LLC / Corporation Documentation (If holding title in Entity) a. Articles of Organization/ Incorporation b. Operating Agreement/ Bylaws
- Insurance declaration page- ask lender about policy requirements
- If purchase transactions- provide fully executed, valid purchase contract
- If refinance transactions- provide payoff demand or mortgage statement
- If Property requires rehab- provide rehab bid/itemized list of work with associated costs
- If property is currently leased, provide…
- Executed lease agreement(s)
- Rent Roll and P&L Statement (If multi-unit)