Wall Street and lenders should be on high alert since the passage of the 2022 Inflation Reduction Act (IRA), with an earmark of $46.5 billion for enforcement activity. The question on everyone’s mind given the allocation of funds to the Internal Revenue Service is: “Will IRS audit rates increase?” The answer is “yes,” but how will that impact private lending?
Over the last few months, we’ve all watched closely as Federal Reserve actions to control inflation have affected the housing market. Increased interest rates have slowed housing sales, and homes on the market are much less affordable than they were just three to six months ago.
As a result, housing affordability has been reported as the worst in 37 years. The challenged market has caused a deceleration in home values, leaving homeowners and real estate investors in limbo about the best timing for considering a sale or refinance for cash out. The good news for some investors is that rental demands are still at an all-time high due to the already existing housing shortages.
Direct and Indirect Impacts
Real estate investors are seeing both the direct and the indirect impacts of these market shifts, notably decreased profit margins, less cash available from refinancing, and tightened lending criteria on both short-term and long-term loans. Investors are challenged with balancing cash liquidity options (i.e., selling or refinancing with decelerating values equals less cash out) or refinancing and continuing to rent with higher monthly payments. The flip side is rental rates are increasing across the board, making those higher monthly payments possible.
The fact remains, however, that lenders and investors cannot forget that stated income (e.g., non-income verified) loans contributed to the real estate crash and financial crisis of 2007-2008. The tightening lending criteria and underwriting guidelines are there for a purpose: to protect both lender and borrower.
The implications of these new rules may hit you as an investor, so it is best to be on alert and prepare as you consider your next real estate investment. New IRS auditors hired to improve the tax monitoring system will seek enforcement if you are delinquent or commit fraud in paying your taxes, which could result in a lien on your owned properties and any properties that you subsequently purchase. Anecdotally, we have seen an increase in REIs who have become used to non-income verified loans and have been slower to pay taxes, and some have not filed taxes at all.
Check the Boxes
As of the last report in 2018, only 32% of self-employed borrowers underreport on their taxes, and a whopping 36% choose not to file at all. You will need to be able to provide filed tax returns and show income/cash flow consistent with those returns in order to be approved for a real estate investment loan. Below is a checklist of what you should keep in mind:
- Stated income is still a very popular path, but lenders will be much more conservative with the items listed below. Some lenders who require tax returns, proof of income, or cash flow will offer more aggressive terms. Ultimately, most lenders are not as worried about your reported income as they are that you filed.
- Credit score will always be the most important indicator of whether you can afford your next real estate investment. You can be sure lenders will be stricter on minimum FICO scores and outstanding delinquencies.
- Many lenders will argue that the second most crucial requirement besides credit score is experience. Lenders want to see that you have invested successfully before. Lenders who offer loans for those without experience may require proof of income or cashflow and more equity in the transaction (i.e., lower ARV/LTVs).
- Lenders want skin in the game. Most lenders will increase what you will need for your down payment or required cash at closing and other reserve requirements.
- LTV, or ARV, will continue to be reduced. Ultimately, lenders are hedging or anticipating decreased values in the market, requiring more cash at closing to protect them more.
When choosing a private lender, weigh your options. Look for a partner who keeps your success balanced with their own and has the flexibility to tailor a product that is right for you. Find the lender that can help you navigate the post-IRA, inflationary environment we are currently experiencing.
Susan Naftulin founded RFG with partner Jeffery Goldberg in 2009. In addition to serving as president of RFG, Naftulin serves on the American Association of Private Lenders’ Ethics Advisory Committee, where she continuously upholds the real estate industry’s values and supports professional conduct in private lending.
Prior to becoming president of RFG, Naftulin held several senior management positions in the mortgage industry, including general counsel, managing attorney, chief operating officer, and senior vice president for both privately and publicly held mortgage lenders. Before entering the mortgage industry, Naftulin was a creditors’ rights attorney with the Philadelphia law firm of Fox Rothschild LLP.