This article was originally published by Uncapped Mortgage
Buying a home is an exciting milestone, but it can be overwhelming and emotionally draining especially when you’re faced with a wide array of financing options. As with most things, preparation is key. It is important to take the time to research the basics of financing a property as this will save you a significant amount of time and money. Getting loan pre-approval in advance is a smart move, too, as you will be able to know for certain the price range you are moving around in.
In recent years, homebuyers are given another way to qualify for financing other than their personal income: asset-based lending. It has taken the real estate investment battlefield by storm, giving homebuyers and real estate investors opportunities to participate in the up-and-running real estate market today.
What is asset-based lending?
As the term suggests, these are loans based on assets, generally accounts receivable, equipment, inventory, or property, used as collateral. Lenders advance funds based on an agreed percentage of the asset’s value. If the loan is not repaid, the asset is taken as collateral for the unpaid debt. Following this logic, a mortgage is an asset-based loan. However, the phrase “asset-based loan” is more commonly used in describing lending to businesses and large companies.
How does it work in real estate?
When you apply for mortgage, you will be asked about your assets, particularly your liquid assets, as sellers want to determine whether you have the capacity to pay for the down payment, closing costs, and the monthly mortgage payments.
Your assets are basically the things you own. Generally, application forms have assets divided into two categories: liquid and non-liquid. Liquid assets are those either held in cash or can easily be converted to cash such as savings and checking accounts, life insurance policies with a cash value, and stocks, bonds, and other securities. Non-liquid assets are valuable possessions that are harder to convert to cash such as real estate, cars, businesses owned by the applicant, and assets in retirement plans.
Asset-based loans are commonly used by real estate buyers for the following reasons:
The availability of liquid assets. The borrower has liquid assets, say, money in the bank. The lender then evaluates the asset by dividing the value by a certain number of months. The derived amount will be put into the income section of the mortgage application.
The need to augment the monthly income. Individuals whose monthly income does not qualify them for a home loan can make use of an asset-based loan. It is commonly used in conjunction with a borrower’s W-2 or salary information.
The desire to continue making their money work for them. There are those who have the ability to pay the property in full but wants their money to continue working for them, such as in a stock market. They can qualify for an asset-based loan for they can pay the loan in full.
On the other hand, there are those who take out asset-based loans using real estate as collateral. In this process, a borrower submits all the necessary documentation on the property they wish to use as collateral. The lender then performs a cash flow analysis to determine whether the property is a viable asset. The net cash flow of the property is valued by factoring in its projected rental income, as well as other expenses such as maintenance, insurance, and property taxes. The amount of loan can go as high as 65% of the derived value. Like most asset-based loans, loan term can range from one to five years. As for the rates, expect asset-based lending rates to be between 8% and 11% interest, which will depend on property type, location, lender, value ratio, and other factors. Lenders that accept real estate as collateral for asset-based loans understand that the borrower probably has a mortgage on their property to begin with; so they are willing to take a second position after the mortgage lender and still approve financing for up to 65% loan-to-value.
Why choose an asset-backed loan?
Investors can benefit from asset-based real estate financing, especially those who are looking to leverage cash flows across other real estate properties and maximize the proceeds of the loan. One glaring advantage is its being asset-based, rather than credit-based, which means that even borrowers who have less-than-stellar credit score and revenue history have a chance to qualify for it. The process is a lot faster, too, as lenders are more particular with the asset than the borrower, hence requiring relatively fewer requirements.
Asset-based lending creates opportunities for real estate investors whether in applying for a home loan or using their own property as collateral. It gives a chance to those who have been turned down by traditional lenders due to insufficient income or carrying too much mortgage debt.
