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Bank Lending – What Do All Those Terms Mean?

Maybe you have decided to buy a rental property or invest passively in a rental property. A major hurdle in any real estate investment is the loan. There are a number of considerations when choosing a loan type including your investment goals, hold periods, and the market. This article will many of the terms you will see from lenders. Even if you are choosing to invest passively in a syndication, you should still get educated on the types of loans as part of your due diligence to asses upside and more important downside or risk.
Amortization – Amortization is the process of paying off debt with regular payments made over time. The fixed payments cover both the principal and the interest on the account, with the interest charges becoming smaller and smaller over the payment schedule.
Application Fee - An application fee is an added cost associated with submitting an application for consideration.
Balloon Payment - A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity. The final payment is called a balloon payment because of its large size.
Brokerage Fee - A brokerage fee is a fee charged by a broker to execute transactions or provide specialized services.
Ceiling Rate - An interest rate ceiling, also known as an interest rate "cap," is the maximum interest rate that a lender can charge a borrower when negotiating a loan.
Conventional - Conventional mortgages are permanent loans offered by traditional banks and lending institutions with terms of 15 to 30 years. They can be used to finance multifamily properties between two and four units. Conventional mortgages are conforming because they adhere to Fannie Mae's qualifications and maximum loan amounts.
Debt Service - Refers to payments in respect of both principal and interest. Scheduled debt service is the set of payments, including principal and interest, that is required to be made through the life of the debt.
Delegated - When a loan is delegated, that essentially means your lender is underwriting the loan in-house, as opposed to submitting the loan to an outside underwriting party. Since no two loans are alike, this enables your lender to customize the terms. It also means the loan closes faster, which is great for everyone involved.
DSCR (Debt Service Coverage Ration) - The ratio of operating income available to debt servicing for interest, principal and lease payments. NOI/Principal + Interest.
Floor Rate - Agreed-upon rate in the lower range of rates associated with a floating rate loan product. Interest rate floors are utilized in derivative contracts and loan agreements. This is in contrast to an interest rate cap.
Guarantor - An individual who promises to pay a borrower's debt in the event that the borrower defaults on their loan obligation.
Hybrid - ARM that offers a fixed rate for a predetermined period and then an adjustable rate for the rest of the loan term.
Index – A benchmark interest rate that reflects general market conditions and the margin is a number set by your lender when you apply for your loan. The index and margin are added together to become your interest rate.
Interest Only - Loan in which the borrower is required to pay only the interest on the loan for a certain period.
Interest Rate - The amount a lender charges and is a percentage of the amount loaned (Principal).
Interest Rate Cap - An interest rate cap is a limit on how high an interest rate can rise on variable rate debt. Interest rate caps are commonly used in variable-rate mortgages and specifically adjustable-rate mortgage (ARM) loans.
Key Principals - The individuals that controls and that control and manage the borrower. Usually carries required net worth and liquidity for the loan.
Pre-payment Penalty - A fee that some lenders charge if you pay off all or part of your mortgage early.
Loan Amount – Amount of loan financed by the lender.
LTC - Loan-to-cost compares the financing amount of a commercial real estate project to its cost.
LTV - Loan-to-value ratio is a number lenders use to determine how much risk they're taking on with a secured loan. It measures the relationship between the loan amount and the market value of the asset securing the loan.
Non-recourse - Loans that secured by the real estate itself vs the borrower’s assets.
Origination Fee - What the lender charges the borrower for making the mortgage loan.
Purpose – What the funds will be used for (acquisition, refinance, or construction). The purpose and use will determine risk for the lender and impact the interest rate.
Rate Lock - Interest rate won't change between the offer and closing, as long as you close within the specified time frame and there are no changes to your application.
Recourse - Secured debt that lets lenders recoup defaulted loan balances by seizing both the loan collateral and, when necessary, the borrower's other assets.
Step-down Prepayment Penalty – A predetermined, sliding scale of penalties based on the principal balance of the loan at the time of prepayment and the amount of time which has passed since the loan was closed or the rate was last reset.
Spread - The profit the bank obtains by lending you the money when you have a variable-rate or mixed mortgage.
Term – Duration of the loan.
Third Party Reports - Lenders typically rely on third-party reports to confirm that the property is in good condition and to identify any necessary spending, both up front and ongoing (Appraisals, environmental, & inspection).
Yield Maintenance - A sort of prepayment penalty that allows the lender to attain the same yield as if the borrower made all scheduled interest payments up until the maturity date. This applies when paying off the loan early.
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