The purpose of this letter is to explain how lenders decide the terms and conditions they offer borrowers and to discuss some of the differences in how various lenders do business.  This information, along with an understanding of your financial situation can help you to choose the appropriate lender/loan for your borrowing needs without wasting your time or money.

            There are three basic ways that most lenders compete for loans; Price/loan interest rate, service, or the willingness to do loans that other lenders will not.  Lenders that make the lowest cost loans for the strongest borrowers are generally called “A” lenders.  Lenders that consider slightly less qualified borrowers are called “B” lenders.  Those lenders that consider loans that the other lenders will not are usually referred to as “C” lenders.

            Lenders also often refer to the various loan requests that they see as A, B or C loans. “A” loans are the strongest deals and getting the best rates.  “B” loans are not as strong but still good loans and come with a slightly higher interest rate than “A” loans.  “C” are often loans with significant difficulties and generally have a significantly higher rate than “A” or “B” loans. 

“A” Lending  

            Most of the lenders that provide loans for the strongest of borrowers are large banks, mortgage backed securities and life insurance companies.  These lenders usually offer the best combination of interest rate and loan term that would be considered an “A” loan.

            There are some potential problems that can come with these loans. 

            The large banks typically want the borrowers who get their best loans to have other accounts and services with that bank.  It is not always in an individual’s best interest to have all their accounts at one institution. (I wrote a letter about keeping all your accounts at one bank some time ago, please let me know if you would like another copy.)

            Many of the loans that are provided by life insurance companies and through mortgage backed securities have prepayment penalties that guarantee the lender all of the profits (and sometimes all of the interest) in the event the loan is paid off early.

            Many “A” level lenders (especially the banks) invite borrowers to apply and then have their underwriters decide which loans that lender will consider.  Most “A” level lenders want to see a complete loan package prior to rendering a credit decision.  At that time the loan is presented to an underwriter for decision making.

            Since borrower’s want to get the best loan terms possible most “A” level lenders will always have a steady stream of potential borrowers. Sometimes this means that these lenders do not treat their potential borrowers as well as those borrowers would like to be treated.

            Unless a borrower has their loan package available quickly they may wait a while before getting a decision form an “A” lender.  Furthermore, anything but the best loans are declined.  A potential borrower can find themselves trying to find a loan thirty days after first applying.  I have seen people fall out of escrow for the purchase of a property as a result being declined for a loan and not having enough time to chase another loan.

            There are always strong borrowers looking for the best rates. For borrowers who meet the above conditions and are willing to deal with what it takes to get the lowest rate loans these are usually the best loans available.

“B” Lending

            Many very good loan requests do not offer the perfect combination of ownership and collateral. These loans still get done by many lenders including the larger banks, community banks and credit unions.

            The lenders that are willing to work on and close loans that might have a problem or two but that are otherwise good loans (B Lenders) can still provide good terms.  These lenders can also be more flexible regarding the borrowers timing and what documentation they can accept.  They also provide an answer more quickly and often have an easier loan process. 

            The difference in the loan might be some combination of an increase in rate and/or shorter term for the loan. One benefit to these loans is that prepayment penalties are usually not a severe as the “A” loans.

C Lending

            There are some loans that may have either significant or multiple problems. The lenders that make these loans are typically referred to as “C” lenders.  These loans are often for special use property and/or borrowers with a bad credit history or even properties where the cash flow necessary to pay back the loan has yet to be realized.

            There are typically good reasons to make the loan that can help mitigate the problems presented.  The interest rate for these loans are often one or two points higher than the rates for a “B” level loan and the loan rate is rarely fixed for longer than five years. 

            The lenders that make these loans usually specialize in making “C” level loans.  Some people call them Subprime lenders.  These lenders do not typically have many bank branches (if at all) but are often found through the internet or through a mortgage broker.

            The lenders that provide “C” quality loans have more borrowers looking for loans than they have capital available.  For “C” lenders the problem is usually that the deal presented to them has too many problems with it and is therefore not lendable.  These lenders are almost always busy and can be slow.

How to decide where your loan might place.

To judge the quality of a commercial real estate loan a lender looks a variety of factors.  The main factors are listed below.  The answers to these questions will help decide what type of loan that a borrower is presenting.

Investor loans

            In order to know if you qualify for the best investor loans ask yourself these questions.

1.Does the property have significant deferred maintenance?  If a borrower wants to get the best rate and the property does have significant deferred maintenance this will need to be cured either prior to the loan closing or as a result of the loan.

2.Does the property cash flow well enough to support the loan payment, provide a profit for the owner and cover any reasonably expected expenses?  Has the property provided this cash flow for at least twelve months?

3.Financially secure and responsible ownership.  This does not mean that the lenders need to see an extremely financially strong borrower. If the loan to value is low and the cash flow from the property is good, then a strong a lender just wants to make sure that the ownership has handled all their prior debts responsibly and that their financial position will not be a drag on the loan.

4.Lenders like to see a property that is appropriate for the area that it is in so that it is easier to sell in the event of a default.  When dealing with commercial property lenders want to see a property than can handle a wide variety of uses.

            If the property and the ownership meet the above criteria, then there is a good chance that the loan that you are requesting can go to the “A” lenders.  To the extent that your loan request falls short in any of these areas I would recommend a “B” level lender.

Owner/User loans

            In order to know what type of owner user loan that you qualify for you would ask these questions.

1.Does the business for that will occupy the property show enough historical income to satisfy the loan payments?  Furthermore, does the lender believe that the believe that the existing income will continue into the foreseeable future.

2.Does the borrower behave in a financially responsible manner?  Does the borrower live within his/her means?  Do they pay their bills on time?  Have they gone bankrupt and cost previous lenders money?

3.If the lender had to foreclose on the property being used for collateral will it be easy for the lender to sell the property and get their loan funds back.  Lenders like properties that can be purchased by a wide variety of buyers at the price that the lender would have to sell the property at.  They also like to avoid properties with too much deferred maintenance as it makes harder to sell these properties.

So how can a borrower get the best loan that he/she is qualified for without wasting time trying to get a loan that they are not qualified for:

1.Prior to submitting a loan get together as much of the loan package as possible.  This would include tax returns, financial statements and personal financial statements.

2.Consider the property that you are offering as collateral.  Is this a property that a lender would feel comfortable owning In the event of a default.

3.Look at your tax returns as the relate to the monthly cost of owning the real estate that you would like to purchase. *  The stronger the tax returns look as the relate to the cost of owning your property in question the better loan a borrower should be able to get.

4.If you are looking to finance a special use property a borrower would do well to find out what lenders other owners of similar properties use.

5.Consider using a commercial mortgage broker.  The money, time and heartache they can save you is usually worth more than their fee.