Which Type of Lender Is Right for You?

Lenders come in all shapes and sizes. Investors often don’t have a solid understanding of the different types of lending entities, how they are structured, and the products they offer. As founder of a national commercial mortgage brokerage that works with most of the top private lenders serving the investment property lending market, I have experienced this firsthand.

Here is breakdown of how the various types of lending entities are structured to serve real estate investors, organized based on how they do business.

Hard Money Lenders

These lenders are generally local and can move quickly, but usually charge the highest rates and fees. However, they are equipped to make quick decisions and provide deal certainty. This is very valuable to investors who need to move quickly and don’t mind paying more for deal certainty and fast execution. They lend funds from investors or bank credit lines and the loans are short term (6-36 months is common). They specialize in fix & flip, construction, and bridge loan products. Some can handle a diverse set of property types, including land, single-family, multifamily, mixed-use and commercial real estate. Some hard money lenders have extended their products to include long-term rental loans and work generally as correspondent lenders for those products. For the long-term rental products, they lose some of their nimble nature as they are making loans that must be approved by the direct lender they are aligned with.

Correspondent Lenders

This is one of the fastest-growing areas of private lending for investment properties. Loan buyers have enabled these smaller correspondent lenders to represent themselves as the direct lender to borrowers. These lenders can be local, regional, or national. They are smaller lenders that generally have graduated from being a mortgage broker or hard money lender and aligned with the loan buyer or direct lender. They rely on their loan buyers or direct lenders to approve the loan prior to closing. This can cause some late negative surprises that disrupt a normally smooth closing. Their pricing is good but generally not as competitive as a direct lender. They generally do not service loans as they are sold immediately to the loan buyers.

Direct Private Lenders: They generally are medium or large in nature and can be local, regional, or national. These lenders have full underwriting decision-making authority. When an exception is required, many can make the decision in-house, versus needing to send it to the loan investor. They have short-term funding sources in place to hold short-term loans for a period of a few months to up to three years. They also can hold long-term loans for a few months prior to selling that loan to a loan buyer. Their pricing is generally the most competitive for both real estate investors and commercial mortgage brokers they serve.

Some direct lenders even do their own loan servicing. Lenders such as Silver Hill Funding and Constructive Loans have loan servicing companies that allow a borrower to stay with a consistent servicer throughout the life of the loan.

Agency Lenders

These lenders offer the Fannie Mae/Freddie Mac non-owner-occupied loan options. These rates are generally lower than those offered by Private Lenders but have some hurdles that need to be addressed to qualify. First, investors are allowed to have no more than 10 properties financed. Second, the loans require full review of personal income and debts to determine if you qualify. It is not based solely on the income of the property and may require a review of tax returns to determine qualification. Third, loans must be in the borrower’s personal names and not in a business entity (LLC, Corp, LP). This limits a borrower’s ability to protect their other assets. Agency loans can be a good option for those wishing to “house hack,” meaning living in one of the units, where private lenders will not allow that.

Non-QM (Qualified Mortgage) Lenders:

These lenders generally have a history in making agency mortgages (Fannie Mae/Freddie Mac). They have several programs for investors including full doc, bank statement, and now DSCR-based loans. They typically are a bit more robust and rigid with documentation and verification requirements. Many of these lenders specialize in one property per loan and do not offer blanket or portfolio loans as of the date of this article. Their pricing is good, but sometimes lag the private lending market in terms of underwriting guidelines such as maximum LTVs, pricing, property seasoning, etc.

Commercial Mortgage Brokers:

Brokers are not lenders; however, they serve an important role in the investment property lending space. Brokers generally have a broad range of products available and shop the market for the best overall options. For many direct lenders, brokers make up more than 50 percent of all the loans they originate. Brokers take on the sales, marketing, and some of the paperwork processes from the direct lender in exchange for wholesale pricing that then is marked up to a retail price and offered to the borrower. Many times, the pricing will be similar or slightly above what the lender would charge a borrower if they came directly to the lender. Brokers can quickly analyze the details of a loan request and rule out certain lenders and products. They speed up the shopping process and help borrowers avoid unknown bear traps in the lender’s guidelines and documentation processes, which could create negative surprises. Brokers can range from a one-person organization working in one local market to dozens of employees with a nationwide lending capability.

For context, there is one other participant that is not a lender that will be contacting you directly but is an important part of the loan origination food chain.

Loan Buyers or Aggregators:

Loan buyers acquire loans from the groups above and generally have relationships established with entities that can turn the loans into bonds (securitization) or other capital sources that will pay more for the loan than they paid to purchase it (spread).

Here are two questions to quickly size up any lender with whom you might be discussing a loan:

1. Are you an Agency Lender, Direct Private Lender or Mortgage Broker?
2. If Direct Private Lender, do you complete 100 percent of the underwriting and exception approvals in-house? (If no, this could be a sign they are really a correspondent lender.)

There is no right or wrong answer to either of these questions as there are pros and cons to each lender type. These answers will help you know the general capabilities of the lender on the other end of the phone and allow you to determine if you have the best fit in a financing partner.