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Equity Line of Credit

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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%.

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