loans

Prepare for a Closing

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We have purchased 16 properties directly (3 personal residences) and 2 properties indirectly (partner); we’ve sold 3 properties. All houses have been mortgaged because we choose to leverage our money rather than own them outright (at least at first). This post covers the closing process in terms of clearing the loan processing.

Your loan must pass through underwriters before being approved and issued. The underwriter is evaluating your financial statements to determine risk and credit worthiness. While you’re given a pre-approval based on your credit score and report, the underwriter is verifying there are no other risk factors in the details. I’ll probably never cease to be amazed at what an underwriter focuses on – sometimes they want every account’s statement and several explanations, and sometimes they want you to confirm you don’t own a property that you never did own while ignoring the accounts you do own.

While a deadline is rarely given, you should provide the paperwork within a couple of days. The longer you take to gather the required documents, the more you jeopardize being able to close on time (the timeframe is set within the purchase agreement).

The are several documents that are going to be requested every time that you can keep filed away or know to start gathering them when you make the offer (some need to be more current than having them filed away). Inevitably, there will be follow up requests from the underwriter, so it’s best to get these files to them as quickly as possible.

  • Most recent 2 years of tax returns
    • Usually we just hand over the PDF version of our tax returns. One time, we actually had to fill out a transcript request form on the IRS page.
  • Proof of income (e.g., W-2)
  • Most recent paystub(s) (e.g., cover 30 days)
  • Color copy of drivers licenses
  • Most recent 1 or 2 bank statements
    • At the beginning of our purchasing, we had to provide a statement for every account (e.g., retirement, investments, banks). Over time, the request has become more focused on showing the statements associated with the accounts that will be used for funds as closing. I don’t know if this is related to our credit worthiness, or if it’s simply how they’ve streamlined the process. Here’s an example that shows they only requested accounts that make up our closing funds.
  • Proof of paid earnest money deposit (EMD)
    • EMD is a deposit made along with the signed contract. It’s the buyer’s showing of good faith to purchase the home. There are different expectations on the amount of the EMD. Sometimes it’s 1% of the purchase price, sometimes it’s a flat rate. We’ve just followed our agent’s lead on the amount to put on there, and it’s usually $1000 or $2000. The EMD is held by your Realtor’s office and credited to the total due at closing. If the buyer breaches the contract, the buyer may forfeit this deposit to the seller (e.g., backing out of the purchase without invoking a clause within he contract, such as the home inspection clause).
    • Proof is usually given by showing the check image along with the bank statement from the account it cleared.
  • Insurance agent contact information
    • This isn’t always known at closing, but you’ll need to provide your agent’s information before closing so that escrow can be set up. If the property won’t be escrowed, then you’ll need to provide proof of an executed policy before closing.

When investment properties are involved, you’ll need to provide documentation associated with those properties. For instance, a mortgage statement may be sufficient if you have the taxes and insurance escrowed. If you don’t have it escrowed or don’t have a mortgage, then you need to provide the current tax statement and insurance declaration. You’ll also be asked whether the property is subject to an HOA, and, if it is, you’ll provide a statement or coupon book showing the payment schedule. Neither Mr. ODA nor I are patient when it comes to illogical requests. For example, we were asked to give mortgage statements for all of our properties, as well as tax documentation and insurance policies for every property. Well, if the property is escrowed, then I don’t have tax paperwork because it’s sent to the bank, nor should I have to prove that the taxes are paid since it’s managed by the bank. I eventually provided all the tax documents though – it just took a while.

There may be large deposits or withdrawals that you’re requested to explain. For instance, I had to sign a statement that the deposit in our account was from the sale of our house. While it can be tracked with paperwork, there are many instances where the underwriter wants the details explicitly stated, versus making assumptions. For the example below, I provided the corresponding withdrawal from our main checking account.

Our first home purchase was at the same time as our wedding (we closed on our house on July 15 and got married on August 4!). A NY wedding isn’t cheap, and we were attempting to pay 20% down on our DC suburb home ($$$), so there was a lot of money movement around this time. Since my parents were helping pay for the wedding, we had large cash deposits into our account that had to be explained. We also had several investment account liquidation transactions. The underwriter had a hard time following the flow of money, and it took me several, very detailed, emails to show how each liquidation entered our checking account. We also had to provide gift letters, which stated we were gifted these sums of money and there was no expectation of paying it back (thereby creating another liability). That’s probably been the hardest closing in terms of our financial status, to date.

You may be requested to provide updated bank statements closer to the closing date, especially if there’s over a month between the initial documents given and the closing date. When you go into a closing, you’re told that it’s not a good idea to open new credit cards, make large purchases, or do anything along those lines that would affect your credit worthiness. They run a recheck of your credit before closing to ensure your credit card balances are about the same, and that there’s been no new credit opened in your name. Verification of more recent bank statements accomplishes the same.

We’ve had two closings delayed.

House 5‘s sale was about 6 weeks delayed due to the buyer’s lack of responsiveness. They didn’t respond to information requests quickly and struggled to provide the necessary documents to underwriting. Unfortunately, as the seller, our only ‘play’ is to take their EMD and walk away. If it’s bad enough, this is worth it. But it brings you back to square one. This was an off-market deal, which is enticing to see through rather than attempt to list and sell it. If we decide not to sell, we’re now looking at January or February before we had a renter; it could be even longer since we struggled in the summer to find someone for the house. Plus, the EMD doesn’t cover the lack of rent we experienced while under contract, where we expected to lose only one month of rental income, but it turned into 2.5 months. We had our Realtor (who was a dual agent, unfortunately for this matter) lean into the attorney on the buyer’s side after already being weeks beyond the contract’s closing date. By the time their delays were acknowledged, it was Christmas, which delayed closing into January, unfortunately.

Houses 12 and 13 were purchased together (and not yet discussed here). That closing was delayed a week, and it was completely the loan officer’s fault. We, the consumer, obviously get no restitution for their mishap. He didn’t order the appraisal timely and then had to put a rush on it, but it still didn’t come in on time. He created several errors in our paperwork (including the house number of one of the purchases). It got so bad that we just worked with the title agency, and she was awesome at getting all the documentation in order, even if it was a week later and Mr. ODA had to be my power of attorney!

Be prepared and be responsive. Understand that the bank is doing their due diligence and you want to be able to close on the loan and purchase that property. While there will be several requests for information, keep in mind that it’s over a short period of time and will soon be over.

Refinancing Investment Properties

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When we purchased the majority of our investment portfolio in 2016/2017, primary mortgages with excellent credit were sitting around 3.5% and investment property mortgages were about 4.5-5%. We thought these were amazing rates. Fast forward to a once-in-a-lifetime pandemic. A new baseline for low rates is created: We closed on our primary residence in November 2020 at 2.625% with nothing special about getting that rate.

Let’s go back to early pandemic days in the spring of 2020. Mr. ODA is always watching the market, but was particularly interested in the mortgage interest rates because we were coming up on the 61st month on our primary residence’s 5/1 ARM. Just a couple of months into the pandemic, we decided to move, so the ARM refinance (refi) became moot. But since rates were so low, he looked into refinancing our investment properties.

There are a few caveats. With the first company, we couldn’t refinance loans that had a balance less than $100k and be able to maximize the pricing structure they advertise so proudly ($0 closing costs). There was also an investment property fee, and took a long time for both of these to close.

As with the original loan, you’ll want to weigh the financial cost of refinancing against what the new rate will save you. When we looked at the variables, only 2 of our loans were worth pursuing a refinance.

In 2020, we refinanced House 9 from 4.875% to 3.625%. Our monthly payment went from $778.80 to $674.55.

The original loan amount on this property was $110k originated on 9/22/2017. We had paid it down to about $105,800 (shows how slowly the amortization schedule works for you in the early years), but with the closing costs rolling into the new loan (and cashing out $2,000), the balance became $111k. Eek, seems counterintuitive to refinance to a higher balance, but it’ll save us in the long run. We have greater cash flow each month with the lower mortgage payment, a larger percent of the monthly payment goes toward principal vs interest (amortization schedule again!), and we’ll save ourselves over $9k in interest over the life of the loan, if we make no additional principal payments.

We refinanced through a “zero closing costs” type entity. However, there are stipulations to what counts as $0, and investment properties aren’t exactly that. We had to pay an ‘Investment Property Fee’ of $2,358.75. The company paid the closing costs (e.g., credit report fee, title fees, recording fees) worth $548.91. We paid our prepaids, but also received a lender credit of $300. Essentially, we paid a slightly higher rate than the market would offer because the company rolls its closing costs into that rate, akin to paying points or receiving lender points to shift your rate up and down.

Mr. ODA initiated the refinance through an application in the beginning of March. We were quickly informed that we wouldn’t even be assigned a loan officer for two weeks. At the end of those two weeks, we were told they still didn’t know if they could move forward with our refinance. A week later, Mr. ODA followed up, and they had approved us to move forward. We were patient through the process, but it wasn’t until mid-May that we finally closed (in a parking lot, under a tent = pandemic closing #1!).

We rent this property for $1,280 and pay a property manager 10% of that. Minus the $674 mortgage and we’re still sitting quite pretty. While we reset the payoff clock by 3 years by starting a new 30 year mortgage, the extra money working for us in future years will far outweigh the costs of refinance.

In January 2021, we refinanced House 7 from 5.05% to 3.375%. Our monthly payment went from $664.31 to $559.34.

Our loan balance was $85,616, and the closing costs of $3,108 were rolled into the new mortgage. We also cashed out $2,000, so our new loan amount was $91k. The $2,000 was the most that could be cashed out during the refinance; we chose to take the cash out because we could make that money work elsewhere (e.g., pay down a mortgage with a higher interest rate). Even with the higher loan amount, the interest rate is so much lower that we’ll save over $15k in interest.

An appraisal was required as part of the refinance, which is how we learned that the house that we purchased for for $110,500, is now appraised at $168,000!

So, we rent it for $1,200 and self manage but only have to pay a $559 mortgage now? HELLO cash flow!

This closing was done at our kitchen table in KY through a VA-based loan officer. Mr. ODA initiated this loan in November, and we closed in January. A notary came to our house to go through all the paperwork, but it was all wrong. I enjoyed the “we never make mistakes” type of response from the Title company, and I pointed out that their paperwork did not match the lender’s paperwork that we had sitting at the table. Since the closing was at 6 pm, it was after hours for everyone and we couldn’t get an answer quickly, so we sent the notary home. We spoke with the loan officer an hour or so later and pointed how how each closing document had different numbers on it, and she went to work fixing it.

Theoretically, every investment property we own could’ve benefited from a refinance. And we would have with the “zero closing cost” company over time without their own pandemic policies getting in the way. If the loan amount was less than $100k, they would make you pay the closing costs AND would arbitrarily add 0.375% to the advertised rate. BUT, they wouldn’t let you pull equity out as cash to get the loan back up to $100k. So, that crushed our dreams a bit.

With options limited to “traditional” lenders’ pricing structures, we had to evaluate our future goals for the property and where the loan balances and rates already stood. Not to mention, there’s the time and complexity that comes with refinancing while hoping rates continue to stay low.

The lender we normally use has closing costs around $3k. This means that with the extra principal proportion and smaller monthly payment resulting from a refi, we need to balance against $3k to determine how long it will take to break even. Properties with small balances and properties with decent rates (mid 4%) would take longer to break even. Since we pay down our mortgages relatively systematically to achieve greater portfolio cash flow, some of our 30 year loans won’t be around for 30 years. And what if we wanted to sell the property to ‘1031’ to a different one? Our portfolio also has 15 and 20 year loans with great rates that wouldn’t be beneficial for us to pay to lower that rate.

There are a lot of moving parts when deciding whether or not to refi, and its very rarely free, especially with rental properties. But if the numbers work, it should be a no-brainer to pull the trigger and make it happen. Your future self will thank you!

Mortgage Evaluations

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Rate Sheet Options from your Lender

When reaching out to a loan officer, there are a lot of options to choose from. I’m hoping to break down the decision-making here. I’ll share how we ended up with several different options, too.

Basically, it boils down to: 

  • Put enough down to avoid paying Private Mortgage Insurance (PMI)
  • Don’t pay more than 20% unless there’s a decent incentive. 
  • Don’t pick a loan term shorter than 30 years unless there’s a decent incentive. 
  • Carefully evaluate any Adjustable Rate Mortgages (ARMs).

PMI

I broke down PMI in a previous post: PMI – Private Mortgage Insurance. We suggest doing whatever you can to meet the requirements to avoid paying this. The cost of PMI can be a couple hundred dollars per month, which is money that can be put towards the principal balance of your loan or other bills, rather than in the bank’s pockets. There are also hoops to jump through to remove PMI early, which may include paying for another appraisal on the house ($400-$700!).

LOAN TERMS

A conventional loan will likely require 20% to avoid paying PMI. There are some loan options out there that may allow a smaller down payment without a ‘penalty’ (e.g., PMI, higher interest rate), but 20% is the standard, and is usually required when purchasing an investment property.

There may be an option to put down more than 20% or you may think you can afford to pay a higher mortgage each month, so you’re interested in a shorter loan term. Unless there’s an incentive (e.g., lower interest rate, better closing costs), stick with the bare minimum to get the loan.

If there is an incentive, you’ll need analyze the math and your goals to determine if committing extra money to a higher down payment or a larger monthly payment is worth it. If you have extra cash each month, you can pay more towards your principal rather than pigeon holing yourself into a higher monthly payment. Plus, if you have more cash liquid, you may be able to purchase another rental property, which will increase your monthly cash flow.

While we evaluate the loan terms on every house purchase, I’ll share the details of the two most “unconventional” options we chose. Two things to note: 1) lenders add a ‘surcharge’ to the rate for it being an investment property, typically around 0.75%, which means the rates aren’t going to be the great, super-low, rates being advertised; and 2) the term “point” means a fee of 1% of the loan amount.

HOUSE #2

For House #2 (purchased in 2016), we were informed that if we put 20% down instead of 25%, the rate would increase 0.25% on average. If we assume a 30 year conventional loan, 20% down at 4.125% equates to about $69,700 paid in interest (assuming no additional principal payments); 25% down at 3.875% equates to about $60,800 paid in interest. By putting an additional $5,850 as part of our down payment, we saved about $9,000 in interest over the life of the loan.

Once we determined that we’ll put 25% down, we then had to figure out the appropriate loan length. On this particular offer, 30 year amortization wasn’t an option for us because we would have had to pay a point to get a competitive rate. We chose a 20 year amortization because the house already came with a well qualified tenant, we didn’t expect a lot of maintenance and repair costs due to the house’s age, and we didn’t have an immediate need for a higher monthly cash flow based on our place in life at the time.

While our long term goal was to have rental property cash flow replace our W2 income, this house was early in our purchasing. At the time, we were focused more on paying off House #1 (higher rate and a balloon payment after 5 years). Frankly, we didn’t truly understand the power of real estate investing at this time, and didn’t know how much it would accelerate the timeline for us to meet our goals. By decreasing our loan length, we increased our monthly payment, but also lowered the total interest paid over the loan’s life by over $22k. Since more of our monthly payment is going towards principal reduction than had it been a 30 year amortization, this loan isn’t on our priority list to pay off early.

HOUSE #3

For House #3, we evaluated the rate sheet for the loan term, interest rate, and down payment percentage again. This house was purchased a few months after House #2, so those rate decisions were fresh on our minds. We were quoted several options: 1) 20% down at 4.25% for 20 or 30 years, 2) 25% down at 3.75% for 20 or 30 years, or 3) 25% down at 3.25% with 0.5% points for 15 years.

As you can see, there’s no incentive to pick the 20-year term because it’s the same rate as a 30-year term. If we have additional cash, we can make a principal-only payments against the 30-year term rather than unnecessarily tying up our money.

At first, we thought paying points was an absolute ‘no.’ However, points aren’t a bad thing. Paying down your rate up front can save you an appreciable amount in interest. Plus, points are tax deductible.

Now for the breakdown of each options. Let’s say the house purchase was $110,000 (because it wasn’t an exact number, and it’ll just be easier to use a ‘clean’ number like this). Microsoft Excel has an amortization template where you can plug in the loan terms and see the entire amortization schedule. 

Option 1: 20% down payment equates to a loan amount of $88,000; the annual interest rate is 4.25%; the loan is for 30 years, with 12 payments per year. If we make no additional payments, this totals about $67,800 worth of interest paid over the life of the loan.

Option 2: 25% down payment equates to a loan amount of $82,500 at 3.75%. If we make no additional payments, this totals $55k worth of interest paid over the life of the loan. This requires an additional $5,500 brought to the closing table, but saves almost $13k in interest. It also decreases our monthly principal and interest payment (i.e., not including escrow) from Option 1 by $50.

Option 3: 25% down payment, 3.25% interest, and 15 years (instead of 30 years) equates to just under $22k paid in interest. To obtain the 3.25% rate, it required “half a point.” If a point is 1% of the loan amount, that would be 1% of $82,500. This rate only required 0.5%, so that meant paying $412.50 as part of closing costs along with the additional $5,500 of down payment required for 25%. However, the shorter loan length means that monthly payment is increased (between Option 2 and Option 3, the difference is $197.63).

For about $6k, we pay a higher monthly payment, but we also save a significant amount of interest over the life of the loan. The short loan term of 15 years means this one is also not on our radar to pay off while we focus on paying down other, higher interest and higher balanced, mortgages. In this case, the benefits of the big picture math outweighed the increase in monthly payment.

We are five years in on this mortgage and are already seeing significant reduction in the outstanding principal due to the amortization schedule becoming favorable more quickly. In 10 short years more, our house will be fully paid for, through rent collection, without a single dollar of extra principal payments from our other financials. What a great feeling.

ADJUSTABLE RATE MORTGAGES (ARMs)

An adjustable rate mortgage can be beneficial depending on the terms and how long you expect to own the house. For us, we expect to hold our investment properties for a long time, so it wasn’t worth the risk of an ARM. Many times lenders won’t even offer an ARM on an investment. However, when we purchased our DC suburb home, we knew we didn’t expect to be there for more than 5 years, so we chose a 5 year ARM.

After a positive experience with that decision, we also chose an ARM on our second primary residence. We chose a 5 year ARM, even though we expected to be there longer than 5 years. We figured we would either accept the new rate, if there was one, at the end of the 5th year, or we would refinance when necessary. As a result, Mr. ODA monitored rates and refinance options over the last year or so. Unexpectedly, we sold that house 3.5 months shy of the end of the initial ARM term so we didn’t have to do anything.

I break down all the details of an ARM and our decision making in a recent post.

SUMMARY

When I reach out to my lender to ask what the rates of the day are and begin the process of locking a rate on a new loan, I ask for options. These options are in the form of a “rate sheet.” When you ‘lock’ a rate, you’re actually locking the ‘rate sheet,’ not the individual decisions of loan length and percent down. For every house, we evaluate the rate savings that can come from doing something less “conventional” than a 30-year fixed at 20% down mortgage. Our decision is based on what’s best for our goals and our cash in-hand.

As shown above, in our early decisions, we favored shorter loan terms for rate savings. but since House #3’s purchase, we noticed how much more we cared about low monthly payments and low down payments to allow us to buy more properties along the way. Every investment property loan since House #3 has been the ‘standard’ 30-year fixed at 20% down. Because of this perspective shift, we were able to buy six properties in 2017, which gives us about $2,000 in monthly cash flow that we can then use to pay down mortgages.

401k/TSP Loans

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Working for the Federal government, our 401k is called the Thrift Savings Plan (TSP). We max out our contributions each year. As a means of bridging down payment gaps, we utilized a little-known option – the TSP loan.

Per TSP.gov, “When you take a loan, you borrow from your contributions to your TSP account. Your loan amount can’t exceed the amount of your own contributions and earnings from those contributions. Also, you cannot borrow from contributions or earnings you get from your agency or service.” There are two loan options: general purpose and real estate. There are different requirements to meet for each type of loan.

First, here are some items to consider in the decision-making. While these rules pertain specifically to the 401k program provided to Federal employees, TSP, your employer’s 401k service provider should have a similar program for taking a loan from your account and rules associated with paying that loan back.

  • You have to begin making loan payments immediately after your draw down. A general purpose loan must be repaid within 5 years, and a primary residence real estate loan must be repaid within 30 years but you have control over the amount of each payment, as long as the amortization keeps the repayment within the required period. 
  • You pay interest on the loan, which is set at the ‘G Fund’ rate. According to the TSP website, the interest rate is 0.875% as of 1/17/2021. This interest payment is paid into your TSP account.
  • There is a loan fee of $50. 
  • You must be currently employed by the government to take the loan, since repayment is processed through payroll deductions, and if separating from the government you must repay the loan in full within 60 days of separation.

The common talking point working against using a 401k loan is that you need to weigh the loss of compound growth on the balance of your TSP against what the loan will gain you. Many financial talking heads will warn you of using your retirement account for immediate, frivolous purchases. But, used appropriately and strategically, Mr. and Mrs. ODA fully believe that 401k loans can open up financial doors much earlier than through more “traditional” means. 

Our first loan was for our primary residence. While Mr. ODA was an excellent saver through college, he expected to buy a house for about half the cost of what a very basic house goes for in Northern Virginia. Our opportunity cost was private mortgage insurance (PMI); did we want to pay PMI (an added cost that a bank adds to your monthly loan payment to mitigate the risk if you don’t bring a 20% down payment to the house purchase) or take out TSP loans to make up the difference for our down payment? Taking out a loan was ‘out of the box’ and seemed controversial. However, paying PMI indefinitely and being subject to the bank’s decision on when PMI could be removed was more concerning. PMI is building the bank’s “pockets,” while the interest on a TSP loan is going back to your TSP account. 

We decided to each take a residential loan from our accounts. I took a $15,000 loan and Mr. ODA took a $25,000 loan. By taking a TSP loan, we were losing out on the earnings of the accrued balance, but the repayment to ourselves of the G-fund rate was a reasonable trade off. Plus, we could put any extra money towards the loan at any time, thereby increasing our TSP balances faster. 

My loan draw was 7/2/2012, and I had it paid off by 3/17/2015. We could have stretched the payment over the full 30 years to fully leverage our money, but at the time, owning rental properties wasn’t on our immediate radar. However, two incentives to pay a TSP loan off faster than a allowed amortization are 1) that you can only have one loan of each kind at a time, and 2) you can’t request a new loan within 60 days after you paid off a TSP loan. Then there’s that opportunity cost; we wanted to get our money back into our tax incentivized account as quickly as possible to get it working for us again. 

Since our experience was positive for these two loans, we kept this option on the table for future transactions. In 2016 and 2017, we purchased 9 rental properties using regular savings from our high savings rate lifestyle and the equity we were able to cash in from the sale of our first primary home. To cover the down payment of the last few purchases, Mr. ODA and I each took a general purpose loan of $50,000, which is the maximum amount for such type of loan. The loan rate at that time was 2.25%, which was a great lending rate back in 2017. We paid my loan off first, fairly aggressively using the cash flow from the rental properties we purchased, knowing that since I would be separating from the government once we had kids it had to be paid sooner than later. Mr. ODA has adjusted the repayment amount per pay check several times since 2017 to meet our cash flow needs. The loan was issued on 9/1/2017 and currently has a balance of $12,370. 

When looking at the opportunity cost comparison for the rental property purchases, we determined that the 4 ways we make money in real estate investing outweighed the likely (and what actually turned out to be very lucrative) gains of the stock market.

  1. Cash Flow – Profit from rent after all expenses are paid.
  2. Principal Pay Down – The amount the tenant essentially pays out of your mortgage payment that goes directly to the equity of the house.
  3. Appreciation – The increasing of property value based on the market.
  4. Tax Advantages – Being able to utilize the tax code in an advantageous fashion as a business owner. 

By carefully evaluating each property to ensure we had near-guarantees of all 4 of these methods working, we thought that the benefits of owning more rentals outweighed the loss of share ownership in our TSP accounts.