Advertiser Disclosure

Mortgage

Guide to Getting the Best Rate on Your Mortgage

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Guide to Getting the Best Rate on Your Mortgage

A house is the single largest asset that most Americans will ever buy. The median price of a home sold in the United States is up to $301,300, and the median household income of a homeowner is $60,000. This means that a house now costs more than five times the income of a typical homebuyer.

With prices so high, it’s more important than ever to find a great rate on your mortgage. Finding the lowest rate can save you tens of thousands of dollars over the lifetime of a loan. But finding the best rates on the loans with the right features can be a challenge. In this guide we’ll teach you how to find the best mortgage rates.

Finding the best rate on a mortgage

When it comes to buying a house, you don’t just need to house hunt; you need to shop for a mortgage. According to the Consumer Financial Protection Bureau (CFPB), just 53% of Americans shop for mortgages, but comparing lenders has a huge payoff. Saving 1% on your rate will save you tens of thousands of dollars over the life of your loan. Your mortgage can make or break the affordability of a house, and it’s up to you to find the best rates. These are the steps you can take to find the best rates.

Compare rates using the CFPB’s handy tool

The CFPB offers a tool that allows you to compare the prevailing interest rates on various types of loans. To use the tool, you need to know your credit score, the amount you intend to borrow, and how much money you have for a down payment.

By exploring the different options, you can determine the best rates in your state, and the most common rates.

screen shot 1

This tool will give you an idea of the rate landscape in your state. However, you still need to do work to get the best rates.

Next, find lenders that offer the lowest rates

Once you know the lowest interest rates, you can find the lenders offering those rates through search engine queries. Enter the following formula: “State Mortgage, X% Interest Rate, Loan Type.”

For example, “Alabama Mortgage, 3.75% Interest Rate, 30-Year Fixed Rate.”

The bank or credit union with the best rate should emerge near the top of the search rankings. You will find mortgage comparison websites that will help you connect with the banks. Mortgage comparison websites can be a helpful resource, but they require your contact information. If you use a comparison site, expect to receive phone calls or email solicitations.

Continue to cross-reference the rates from comparison sites with information from the CFPB. The rates on a mortgage comparison site should be as good as those on the CFPB’s site.

If a lender has already pre-approved you, they may be willing to match the lowest rate. Talk with your loan officer about the rate you saw on the CFPB’s website. Ask them to match the rate. If they will, the conversation saves you time and money.

Get pre-approved for a mortgage from multiple banks

Once you find the banks with the best rates, consider getting pre-approved for mortgage rates from a few different banks. A pre-approval means that a bank plans to give you a loan at a given rate. You will need to submit documentation to a loan officer to get pre-approved. Typical documentation includes W-2 forms, tax returns, credit reports, and evidence of assets.

The bank will review your documentation and give you a pre-approval letter. The letter explains how much you can borrow and at what rate. If you’re denied at this stage, you can find out why.

A pre-approval is not a contract. It is not subject to underwriting or an appraisal. Rates can change after you get a pre-approval. That’s why we recommend getting multiple pre-approvals if you can.

When you’re pre-approved, a bank will give you a letter that you can submit with offers on a home. Home sellers want to see a pre-approval letter because it means that you’re likely to have access to the financing to close a deal.

Once you have pre-approvals in hand, start shopping for houses. You can submit a bid and negotiate a price using your pre-approvals.

Request loan estimates from lenders

Once a seller accepts your bid, request loan estimates from all the banks that pre-approved you.

A loan estimate is a three-page document that contains an estimated interest rate, monthly payments, and closing costs for the specific loan. It explains everything you need to know about the loan if you choose to move forward.

Compare all the loan estimates before committing to a particular mortgage lender. Loan estimates allow you a true apples-to-apples comparison of interest rates.

A loan estimate isn’t a contract. The bank may deny the loan based on the home’s appraisal values or due to underwriting problems. But a loan estimate will allow you to make an informed decision.

Factors that influence your interest rate

Shopping for a mortgage isn’t the only way to find the best interest rate. You can influence the rate by controlling these factors.

Credit score

The better your credit history, the better your rate will be. In some cases, the difference can be a full percentage point or more. Fixing your credit score is one of the best ways to influence your mortgage rate. Depending on your credit history, you might be able to fix your credit score on your own within a few months.

When you’re shopping for a mortgage, pay your bills on time and keep your credit usage low. Try to use 10% or less of your total available credit. Don’t close old credit accounts or apply for new accounts when mortgage shopping. These actions promote a high credit score while you shop for a mortgage.

Down payment & PMI

In general a bigger down payment means a lower interest rate.

If you put down at least 5%, you will probably qualify for the lowest advertised rates. But don’t confuse the lowest interest rates with the lowest cost financing. Most banks require you to purchase private mortgage insurance (PMI) if you don’t put at least 20% down on a home. PMI adds about .5%-1% per month on your mortgage. You won’t be able to remove PMI until you’ve built up at least 20% equity in your home. You build equity when your home rises in value and when you pay down your mortgage.

If you have a down payment less than 5%, you’ll need to look at FHA loans or VA loans. VA loans don’t require PMI, but you will have to pay an upfront financing fee. This is a fee that doesn’t help you build equity, but VA loans have competitive rates for people who don’t have a down payment. Check the fee schedule for VA loans to see if the financing fee is worth it to you.

FHA loans require just a 3.5% down payment, but FHA loans have require mortgage insurance premiums (MIP). The MIP is an upfront fee (usually 1.75% of the total mortgage) and monthly interest rate hike of around .5%. You can’t get rid of MIP unless you get rid of your FHA loan.

Location

Buyers looking for a mortgage in a rural area may see higher rates compared to equally qualified buyers in nearby urban areas. Most lenders have less familiarity with lending in rural areas. This leads to higher rates. In rural settings, you may get the best rates from nearby banks and credit unions.

Rates also differ on a state-by-state basis. States that have laws that make foreclosure difficult tend to have higher mortgage rates than states with looser foreclosure laws. Likewise, states that require lenders to have a physical presence in the state raises interest rates.

Loan size

Interest rates on small mortgages (less than $50,000) tend to be higher than rates on typical mortgage sizes. Small mortgages are less profitable than other loans, and many banks won’t issue this size mortgage. Borrowers may need to work with local banks or credit unions or government lending programs to find a micro-mortgage.

At the other end of the spectrum, jumbo mortgages tend to track closely to conforming loan interest rates. Banks can’t sell jumbo loans in the secondary market, so they are riskier for the bank compared to other mortgages. Usually, banks compensate higher risk with higher interest rates. However, the rigorous underwriting on jumbo loans may drive many poor prospects out of the market.

Length of loan (Loan term)

Mortgages with shorter terms have lower rates than those with longer terms. A longer term represents more risk for the bank. Banks compensate their risk with higher interest rates. This doesn’t mean that a shorter term loan is always the right choice. Choose the loan term that fits your needs before you compare rates. That way you’ll get the best interest rate on the right mortgage for you.

Fixed or variable rates

Adjustable-rate mortgages put more risk onto borrowers. You’ll initially pay a lower interest rate if you take out an adjustable-rate mortgage, but the rate might increase.

When you’re considering an adjustable-rate, learn when and how the interest rate adjusts. Most loans adjust based on a set index. In a low interest rate environment, you can expect rates to increase, but you need to guess how much. Weigh whether the low rates now are worth a potential high rate in the future.

Conforming vs. FHA vs. VA vs. conventional

The company that backs your loan may seem unimportant, but it influences your rate.

Conforming loans (those that can be purchased by Fannie Mae or Freddie Mac, the largest purchasers of mortgage loans in the U.S.) tend to have the lowest interest rates. Despite their low interest rates, conforming loans are profitable for banks. Banks can easily sell conforming loans to Fannie Mae or Freddie Mac and reinvest the proceeds in making more loans. Conforming loans require at least a 5% down payment and good credit. For conforming loans, put 20% down to avoid paying PMI.

FHA loans have more lenient down payment and credit standards. They tend to be expensive for well-qualified buyers. However, an FHA loan may be the right option if you have a low down payment or a poor credit score. Only you can determine if the extra cost is worth it for you. VA loans are available to veterans, and they charge an upfront fee. However, they offer competitive rates for first-time homebuyers. If you can qualify for a VA loan, look into it as an option.

Conventional loans can’t be purchased by Fannie Mae or Freddie Mac. They require more shopping around to find the best rates. Not every lender issues conventional loans. If you qualify, the rates should be competitive with rates on conforming loans.

If you’re taking out a jumbo mortgage, you need to qualify for conventional underwriting. Likewise, condo buyers may need to qualify for a conventional loan. Fannie Mae and Freddie Mac will not purchase a mortgage if the property is part of an association that has more than 50% renter occupants.

Buying points

Many lenders offer to let borrowers buy “discount points” off of a mortgage. This means that you pay a set fee in exchange for the lender to lower your rate. In some circumstances buying discount points makes sense. Divide the cost of the point by the change in your monthly payment. This will tell you the number of months it takes for the prepayment to pay off (in terms of savings). If you expect to stay in the house significantly longer than the payoff period, go ahead and purchase the points. Otherwise, pay the higher interest.

Closing costs

An advertised interest rate doesn’t account for your total cost to borrow money. Most banks make their real money by charging closing fees. Banks might charge loan origination fees, recording fees, title inspection fees, underwriting fees, and application fees.

All the financing charges will be disclosed on a loan estimate. The loan estimate will also provide you with an annual percentage rate (APR), which expresses the total cost of borrowing money including the financing fees.

Special programs

Cities and states often issue special interest rates on loans for homebuyers who meet certain criteria. For example, Raleigh, N.C., subsidizes a $20,000 down payment loan for low-income, first-time homebuyers in distressed neighborhoods. Check your city, county, and state websites to see if you qualify for special rate programs. These programs often have favorable borrowing terms in addition to great rates.

Accelerating payments

Some borrowers cut their total interest costs by accelerating their mortgage payoff. If you make a half mortgage payment every two weeks, you’ll make an extra mortgage payment every year. This cuts a 30-year mortgage down to 23 years.

Making extra payments early in the life of your loan will help you achieve 20% equity faster. This will allow you to drop PMI payments or refinance at a lower rate.

Determining a budget for your loan

Finding a great rate on a loan that you can’t pay back is a sure way to destroy your credit. Before you apply for a loan, establish a realistic budget for your monthly mortgage payment. Avoid borrowing more than you can comfortably pay back.

When banks approve you for a mortgage, they will lend based on your current debt-to-income ratio without considering your other costs of living. Lenders have some limits, but you need to establish your own limits. Most of the time, lenders will not extend mortgage loans to borrowers whose monthly debt liabilities eat up more than 43% of their gross monthly income.

To understand debt-to-income ratio, consider this example. A person with a $60,000 annual income and a $500 monthly car payment applies for a mortgage.

A bank will allow them to carry a debt load up to $2,150 per month (($60,000/12)*43%). The bank subtracts the $500 from the maximum allowed debt load and determines that this person can afford $1,650 in house payments each month.

The bank in this example determines that $1,650 a month is an affordable budget.

No matter how large a loan you can get, you need to be a savvy consumer. The Consumer Financial Protection Bureau recommends that your entire housing payment (including taxes, insurance, and association dues) should take up no more than 28% of your gross income.

The CFPB’s advice may seem too strict, but you need to determine your non-mortgage-related cost of living before committing to a new loan. Calculate costs like income taxes, transit expenses, and child care or education costs. If you pay alimony or for out-of-pocket health care, consider those costs too. Plus, you’ll need to factor in the costs of home maintenance. Experts recommend setting aside 1%-3% of your home’s purchase price for maintenance and upgrades.

A 43% debt-to-income ratio may be manageable for people who expect a significant salary bump in the near future. But for many, such a high ratio could get you into credit trouble.

If you’re seriously shopping for houses, use Zillow’s advanced affordability calculator to determine how much mortgage makes sense for you. You can also learn if buying makes financial sense by using the Rent vs. Buy Calculator from realtor.com.

Before you start shopping for houses, determine how a mortgage will fit into your budget. Don’t succumb to pressures to overextend your budget. A burdensome mortgage has the power to turn a dream house into a nightmare. You can avoid the nightmare by planning ahead.

Determining loan features you want

In addition to establishing a budget, you need to understand how to find the right features on a mortgage. A great rate on a bad mortgage could spell financial ruin. When you’re shopping for loans, ask yourself these questions:

How long will you stay in the home?

Some buyers purchase houses with the intention of staying just a few years. Someone who plans to sell in a few years might consider a lower interest rate adjustable mortgage. However, an adjustable-rate mortgage is risky for someone who intends to live in a home long term.

How risky is your financial situation?

Do you and your partner have two steady jobs and a large cash cushion? In such a stable situation, you might feel comfortable putting 20% down. You might also feel good locking into a 15-year mortgage to save on interest.

People with less stable income and finances might feel more comfortable with a smaller down payment and a longer payoff period. This will mean paying PMI and higher financing costs, but they can be worth it for peace of mind.

Do you expect to have better cash flow in the future?

If you think that you’ll have more accessible cash flow in the future, you can borrow near the higher end of your limits today. An interest-only loan will allow you to get into a house with lower payments now and higher payments in the future. Of course, you need to be realistic about your future expectations. Your future income may be more modest than you hope, or you may face high costs in the future. An interest-only loan could leave you trapped in a house if housing prices decline.

Even if you expect a higher income, borrowing near the top end of your budget could keep you “house poor.” If the raise doesn’t pan out, you’ll be stuck in a house that you can’t comfortably afford.

Do you have access to other sources of financing?

Alternative sources of financing like a home equity line of credit make a loan with a balloon payment more viable. Alternative financing means that you’ll have options if your original mortgage payoff plan falls through.

Anyone considering a balloon payment loan should have a solid lead on alternative financing before they take out the loan.

How much cash do you have for a down payment?

You can purchase a house with almost no money down. For example, the Federal Housing Association (FHA) offers “$100 Down” home financing on select HUD homes, or down payments as low as 3.5% for FHA-backed loans. Veterans can purchase homes using $0 down VA loans.

On the other hand, if you have more money to put down, you may qualify for a conventional mortgage or a mortgage backed by Fannie Mae or Freddie Mac. The more cash you have, the more options you have for loan types.

Do you have compelling uses for cash outside of a home down payment?

Putting a large amount of money down on your home locks up the cash. You can access home equity through a home equity line of credit, but that introduces a new element of risk. Even if you have a large amount of cash, you may not want to use it to fund a down payment. For example, you may want to hold cash for an emergency fund, to start a business, or to fund some other purchase.

If you have a compelling reason to hold onto cash, you may intentionally narrow your mortgage search to low down-payment options.

How quickly do you want to pay off your house?

A paid-off home might be your top financial priority. In that case, you might want to look for options with a short payoff period. For example, you might prioritize the forced savings of a 15-year mortgage. You might even aim to payoff a 5/1 ARM before the first rate adjustment if you have sufficient cash.

How important is the monthly payment?

A lot of people prioritize a low monthly payment above any other factor. You can achieve a low payment by avoiding fees (like PMI), finding the lowest possible interest rate, and extending the terms of the loan. Even more important than those factors is borrowing an amount that you can easily afford under most circumstances.

Common mortgage terms

Sometimes the most difficult part about shopping for a mortgage is understanding the terms that lenders use. Below we’ve defined a few of the most common mortgage terms that you should know before you sign a loan.

  • Interest Rate – The amount charged by a lender for a borrower to use the loaned money. This is expressed as a percentage of the total loan amount.
  • APR – The annual percentage rate is the total amount that it costs to borrow money from a lender expressed as a percentage. The APR factors in closing costs and other financing fees.
  • Amortization Schedule – A table that shows how much of each payment goes to the principal loan balance versus the interest portion of the loan.
  • Term – A set period of time over which a fixed loan payment will be due (often 15 or 30 years).
  • Fixed-Rate Mortgage – A mortgage where the interest rate stays the same for the entire term of the loan.
  • Adjustable-Rate Mortgage – A mortgage where the interest rate changes based on factors outlined in the loan agreement. Often, the adjustment is tied to a certain publicly available interest rate like the Federal Exchange Rate. Adjustable-rate mortgages are considered riskier than fixed-rate mortgages due to the potential volatility of payments. Adjustable-rate mortgages (ARMS) include:
    • 1-Year ARM – A mortgage where the interest rate adjusts up to once per year for the life of a loan.
    • 10/1 ARM – A mortgage where the interest rate is fixed for ten years and then increases up to once per year for the remaining life of the loan.
    • 5/1 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every year for the life of the loan.
    • 5/5 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every five years for the life of the loan.
    • 5/25 ARM – Also known as the five-year balloon mortgage. A 5/25 loan is a subprime loan with a fixed rate for the first five years of the loan. If a borrower meets certain standards (usually a record of on-time payments), they will receive the right to refinance the remaining 25 years on an adjustable-rate mortgage. Otherwise, the bank requires a “balloon” or remaining balance payment after five years.
    • 3/1 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once per year for the life of the loan.
    • 3/3 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once every three years for the life of the loan.
    • Two-Step Mortgage – A mortgage that offers a fixed interest rate for a fixed period of time (usually 5 or 7 years). After the fixed period, the rate adjusts to current market rates. Often, the borrower can choose either a fixed rate or an adjustable rate during the second step.
  • Interest-Only Mortgage – A mortgage where a borrower pays only the interest on a loan for a fixed period (usually 5-7 years).
  • PMI – Private mortgage insurance is a product that protects a bank if you default on your mortgage. Lenders often require borrowers with less than 20% equity to purchase PMI.
  • Jumbo Mortgage – A mortgage that is larger than the standards for a “conforming loan” set by government-backed agencies. In most parts of the U.S. a jumbo loan must be larger than $417,000. In some of the highest cost of living areas, a jumbo is in excess of $625,000.
  • Fannie Mae – The Federal National Mortgage Association is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Freddie Mac – The Federal Home Loan Mortgage Corporation is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Conforming Loan – A mortgage that meets the funding criteria of Fannie Mae and Freddie Mac. The most stringent criteria is the loan size.
  • FHA Loan – A loan guaranteed by the Federal Housing Administration. Qualifying standards are not as stringent, but the fees are higher. In addition to a monthly premium (similar to PMI), borrowers pay a “borrowing” premium when they take out the loan.
  • VA Loan – A mortgage guaranteed by the Department of Veterans Affairs. Veterans can purchase houses with a $0 down payment when using a VA loan, provided the veteran meets other lending criteria.
  • Conventional Mortgage – A mortgage that is not guaranteed by any of the federal funding agencies. Certain homes or condominiums will only qualify for a conventional mortgage financing option.
  • Down Payment – The initial payment that a homebuyer supplies when purchasing a home with a mortgage.
  • Balloon Mortgage – A mortgage where a borrower pays fixed payments for a period of time (usually 5 or 7 years) after which the balance of the loan is due. This is considered a high-risk loan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Hannah Rounds
Hannah Rounds |

Hannah Rounds is a writer at MagnifyMoney. You can email Hannah here

TAGS: , ,

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply

Advertiser Disclosure

Mortgage

Commercial Mortgage Refinancing: How Does It Work?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

iStock

In business, there are many reasons why you may want — or need — to look into commercial mortgage refinancing. Maybe your credit score has vastly improved over the last few years and you’re hoping to score a better interest rate, or maybe you’re trying to avoid making a large balloon payment at the end of your current loan term. Regardless of your reasons for wanting to consider a new loan, the process can seem daunting. However, it doesn’t have to be. This guide will walk you through the ins and outs of refinancing a commercial mortgage so that you can make the financing decisions that will work best for you and your business.

Why refinance a commercial loan?

Lower interest rates

The first reason why you may want to refinance a commercial mortgage is to take advantage of lower interest rates. Interest rates are still at relative lows, historically, and if your financial situation has improved since the last time you were approved for a loan, you could be a candidate to take advantage of those lower rates.

Increased cash flow

The main benefit of those lower interest rates is that you’ll have a decreased monthly payment. That lower payment means increased savings, which can be a source of greater cash flow.

On the other hand, you also have the option of doing a cash-out refinance, in which you borrow more money than you currently owe. The excess comes to you as tax-free funds to be used however you wish. Usually, people use this method to undertake big projects like making improvements to the property or funding an expansion.

Better loan terms

Another reason why someone might consider refinancing is to create an opportunity to negotiate more favorable loan terms. This could mean moving from an adjustable-rate mortgage (ARM) to a more stable fixed-rate option or simply tailoring the length of the loan to meet your current needs.

Avoiding balloon payments

Additionally, refinancing your loan could be a way to avoid having to make a sizable balloon payment — a larger-than-usual one-time payment at the end of the loan’s term. Mortgages with balloon payments generally come with lower, sometimes interest-only, payments over the life of the loan. However, when the balance of the loan becomes due, it could amount to thousands of dollars. If you don’t have that amount of cash on hand, refinancing will allow you to extend your repayment window.

What are the borrower requirements to refinance?

In order to get approved for a commercial mortgage, you’ll need to meet certain borrower requirements. Though the exact specifications will vary by lending institution, here’s a general overview of what you can expect:

Repayment ability

First and foremost, lenders want see that you have the ability to actually repay the loan. Typically, this is determined by something called a Debt Service Coverage Ratio (DSCR). It’s found by dividing your business’s net operating income by annual loan payments. In this case, it’s best to shoot for a ratio of 1.2 or more.

Management

Ideally, your business will have a strong management history in order to prove its longevity. For this reason, most lenders limit themselves to businesses that have been operating for two years or more. You may also be asked to show a resume or business plan detailing your experience and future projections.

Equity

In this case, equity refers to the stake that the owner has in the property. In some instances in which the property generates enough income on its own, it can serve as its own collateral. In others, the borrower must put up personal collateral of his or her own.

Credit history

Finally, lenders want to be sure that you have a history of paying off existing debts, so they’ll check your credit score. Be aware that both your business and personal scores may be evaluated.

How does a commercial refinance differ from a home loan refinance?

“Lenders look at this type of loan differently,” said James Hoopes, a senior vice president at NorthMarq Capital in Minneapolis, Minnesota.

“With home loans, your personal credit decides whether or not you get the loan. Here, the amount of income the property produces from its tenants is just as — if not more — important than your credit score.”

In addition to differences in qualifying requirements, Hoopes pointed out that there are huge differences in the way residential and commercial loans get paid off.

“Residential loans tend to amortize over the life of the loan,” he explained, “meaning that the homeowners will have usually paid off the loan in full by the end of the term.”

“Commercial loans, on the other hand, tend to have an amortization period that’s longer than the loan term, which means that borrowers can find themselves facing a large payment when the loan comes due.”

Above all, Hoopes cautions borrowers to think carefully before refinancing their commercial loans. These types of loans come with high penalties that aren’t seen when refinancing traditional home loans.

Types of commercial loans

These days, there are a few distinct types of commercial loans that you can choose from. Be sure to research each one before applying so that you know which type of financing is best for your business.

SBA 7(a) loans

The SBA 7(a) loan is the most common type of small-business loan. The loan is popular because it’s backed by the U.S. Small Business Administration (SBA) and is geared toward serving businesses that might otherwise be turned down by banks. These loans come with a limit of $5 million, and the SBA agrees to back up to 85% of loans up to $150,000 and 75% of those above that amount.

CDC/SBA 504 loans

Another government-backed loan, the CDC/SBA 504 loan is different from the SBA 7(a) loan in the way it’s structured. For this, the SBA will provide 40% of the total project costs, while a Certified Development Company (CDC) will provide an additional 50%, and your down payment will account for the final 10%. Due to its structure, there is no limit on how much you can borrow for CDC/SBA 504 loans; however, the maximum amount that the SBA will provide is $5 million.

Private loans

Private loans are offered by a bank or mortgage company. Traditionally, these loans offer competitively low interest rates. In exchange, however, they typically come with higher qualifying standards in terms of acceptable credit scores and operating histories.

How can you find a lender?

Ideally, you’ll already have a lender in place from the last time you applied for a mortgage. However, if that’s not the case, don’t hesitate to do your own research. Ask your industry contacts who they use for financing, use the SBA website’s free lender match service and read online reviews.

The commercial loan refinancing process

“The first step to refinancing a commercial loan is figuring out what kind of loan you need,” advised Hoopes of NorthMarq Capital. This means taking a close look at why you want to refinance, whether it’s to secure a lower interest rate or to fund renovations via a cash-out option.

The next step is to shop around. “Talk to different lenders in your area to get a sense of what they can offer you. Ask about interest rates, fees and other terms until you find the best proposal for you,” he continued.

From there, it’s all about gathering the right documentation and filling out an application. Every lending institution will have different application requirements. However, in general, you should expect to need the following: a property description, a rent roll, proof of income (profit/loss or revenue/expense statements showing several years of operating history) and the borrower’s resume and financial statements.

“After that, you can enter what’s known as the underwriting period,” Hoopes said. “During this time, the lender will order an appraisal and other third-party reports to determine if you’re eligible to receive the loan.”

“Once the loan has been approved, the lender will issue a loan commitment and, at that point, it’s just a matter of preparing the legal documents for closing,” he concluded.

Fees and closing costs

Not surprisingly, fees can vary from lender to lender, as well; however, two common fees that you should watch out for are prepayment penalties and and a guaranty fee. Prepayment penalties can be hefty and result from paying off your existing mortgage early with your new loan.

For their part, only SBA loans are subject to the guaranty fee. This fee is charged to the lender but is passed along to you for the security of having a government-backed loan. Only the amount of the loan that’s backed by the SBA is taxed, rather than the loan’s face value.

Luckily, closing costs are a bit more predictable. “As a rule of thumb, for loans under $10 million, I would estimate 2% of the loan amount for both closing costs and lender fees, not including legal fees,” Hoopes said. “But they can move up from there.”

The bottom line

At first glance, commercial mortgage refinancing can seem like an overwhelming process, but it doesn’t have to be. With a little bit of research, planning and forethought, you should be able to find a commercial loan that serves your and your business’s needs.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Tara Mastroeni
Tara Mastroeni |

Tara Mastroeni is a writer at MagnifyMoney. You can email Tara here

TAGS:

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply

Advertiser Disclosure

Mortgage

What You Should Know About VA Construction Loans

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

iStock

Ready to build your dream home? If you’re an active-duty service member or veteran of the U.S. Armed Forces, you may not realize that the Veterans Administration (VA) backs construction loans to help offset the costs of turning that house in your head into a reality.

Jesse Gonzalez, broker of record at North Bay Capital in Santa Rosa, California, and member of the Veterans Association of Real Estate Professionals (VAREP), said these loans are relatively new and not well-known, even among active-duty service members. “There are not a lot of mortgage professionals doing these,” Gonzalez said. “My competition is sparse in this area because most mortgage professionals simply don’t understand it.”

But experts like Gonzalez say a VA construction loan is a fantastic resource for folks who want to build a home. Unlike conventional construction loans, VA construction loans offer a host of special benefits — from the possibility of 100% financing without a down payment to locked-in interest rates that won’t change over the years of the loan.

So, what do you need to know to take advantage of this resource? Do you need a special credit score or an approved contractor to build your new home? Let’s take a look at what you might need to do to get some help from the VA to build that house.

Qualifications for a VA construction loan

Much like VA loans designed to purchase an existing home, VA construction loans carry a number of eligibility criteria that lenders will look for before offering you this special type of mortgage.

Before you call a private lender (more on that later), take a look at some of the qualifications you’ll likely need to get one of these loans:

  • Loans are open to veterans, active-duty military or eligible surviving spouses of members of the Armed Forces. You can check your eligibility on the VA’s website.
  • Lenders require a Certificate of Eligibility (COE), a special form issued by the government to prove you’re eligible for a VA-backed loan.
    Homes must be built by a licensed contractor (building it yourself or with relatives is typically not allowed).
  • Homes must be built as a primary residence and occupied within 60 days of completion (exceptions are made for business units built on properties primarily intended for residential use).
  • A minimum credit score of 620 is typically required, although some exceptions can be made.

Minimum property requirements for VA construction loans

Even if you and your home plans fit the bill for a VA construction loan, you should be prepared to jump through a number of hoops once you actually start construction.

Although the VA doesn’t put restrictions on the overall design of the house — whether you build a cute bungalow or a sprawling McMansion is up to you — if you’re going to build with a VA-backed loan footing the bill, your property will have to meet several requirements regarding usage, utilities and the like.

Some of the major things to be aware of include

  • Usage — VA loans are intended to help people with housing, so it’s no surprise the VA construction loan requires the primary use be residential. Up to four units are allowed on certain properties, depending on size. Business units are allowed, provided they don’t “impair the residential character of the property,” according to VA rules, or exceed 25% of the gross floor area.
  • Living space — The size of the living space must accommodate living, sleeping, cooking and dining space.
  • Utilities — Water, sewer, gas and electricity must be available for the unit (or units, if there are multiple). Homes must have a means for safe sewage disposal, and connection to public sewerage is required, if it’s feasible.

Steps to getting a VA construction loan

If you’re interested in applying for a VA construction loan, a private lender may be able to help you, and some of the process will be similar to that of a conventional loan application.

  1. Certificate of Eligibility. This step is required only for VA-backed loans, not conventional loans, but it’s a must! To apply, you can fill out an online application, send in your documents by mail, or ask a lender for help.
  2. Prequalification. This is the first step of any loan process, and it will include a credit check as well as the need to provide the COE, income documents, and possibly proof of other assets. You may also be asked to undergo the following:
    1. Builder registration. This is a review of your chosen contractor to ensure it’s reputable and up to the task.
    2. Deal calculation. This number crunching will be done by the lender as he or she figures out a total loan amount that includes any closing costs, seller or building concessions, interest and more.
  3. Underwriting. This is step two of the process. Your lender will submit the loan for review. As with conventional loans, the underwriter will look at your income, credit, assets and construction plans. Information to verify your debt-to-income (DTI) ratio may also be requested by some lenders. In the case of a VA construction loan, the underwriter also will look to see that your builder is approved by the VA.
  4. Closing. VA construction loans allow for something called a “one-time close.” While traditional building loans usually require the borrower take out and refinance a construction loan as a permanent home loan once construction is complete, VA borrowers get to skip that second step. Instead, there’s a single closing, at which time the borrower and lender sign all necessary paperwork and money is handed over so that construction can begin. The builder will use the money to build, but payback of the loan won’t begin until construction is complete.

Pros of a VA construction loan

Why would you want to get a VA construction loan, if you’re eligible, when you could just buy an existing home?

According to Evan Wade, co-founder and partner of Philadelphia Mortgage Brokers in Philadelphia and member of the Association of Independent Mortgage Experts (AIME), VA construction loans are especially popular in areas with limited housing inventory.

“The VA does not wish to restrict the type of homes a veteran is able to buy,” Wade explained. “If a veteran wishes to construct a brand new house while still being able to utilize their hard-earned benefits, they should definitely be able to do so.”

The benefits don’t stop there. A construction loan could allow the freedom to design a home that truly suits your and your family’s needs, instead of making do with a home that’s simply “almost right.” Here are some other benefits for which you might qualify with a VA construction loan:

  • Lower interest rates
  • Skipping a down payment
  • Avoiding Private Mortgage Insurance (PMI), which typically is not required

Cons of a VA construction loan

There are, of course, some aspects of a VA construction loan that might not make it a perfect fit. Before you approach a lender, you might want to take the following into consideration:

  • VA construction loans require builders be approved by the VA. That means you can’t build your home yourself or use friends and family helpers to cut construction costs.
  • Some building styles are banned under this construction loan, such as a tiny house.
  • Not all lenders, even lenders who offer VA loans, provide VA construction loans.

Where can you find a VA construction loan?

It can be tough to find a lender who is versed in VA construction loans; however, they are out there. Asking friends or family who are also in the military world for word-of-mouth recommendations can be a great way to find the perfect lender who can walk you through the process.

VAREP also offers a “find a member” option on its website to assist in locating military-friendly mortgage professionals located around the U.S.

Before you borrow

When it comes to building a home, the VA construction loan is a valuable option for would-be homeowners who qualify. If you’re not sure one is right for you, you might also want to consider a traditional construction loan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Jeanne Sager
Jeanne Sager |

Jeanne Sager is a writer at MagnifyMoney. You can email Jeanne here

TAGS:

Compare Mortgage Loan Offers for Free

Home Purchase Quotes

Home Refinance Quotes

(It only takes 3 minutes!)

NMLS #1136 Terms & Conditions Apply