During the height of the mortgage boom, it seemed all you needed to get a mortgage was a pulse. Now that banks have tightened their lending rules considerably, many people find it impossible to get a traditional mortgage.
One of those people is Amber, a Credit.com reader who wrote us recently. Her “credit score is not good enough to go through a bank or small lender,” Amber wrote in a recent comment to our blog.
Through a chain of personal connections, however, Amber’s husband met a man who says he can help.
“This guy says he works with investors and can find a home,” Amber writes. “The investor will finance it and will have the home in my name.”
But before she gives her downpayment, Amber has a few questions. “Is this possible,” she asks. “What are the pros and cons?”
Yes, it is possible, answers Curtis Novy, a mortgage and real estate analyst with Corporate Mortgage Advisors. Seeing an opportunity to make money, many private investors are getting into the mortgage business, he says.
“We are seeing more private lenders who are filling the gap, taking the place of conventional lenders and banks who are just too timid to lend money,” says Novy, who is among those organizing private investors to fund commercial property loans.
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But Amber is right to be nervous. “It could be a scam,” Novy says.
How can Amber tell if these private “investors” are legit? How can she avoid getting conned? Novy has a few tips:
This is a trick. Don’t fall for it. Never give anybody any money until you get — and read! — the actual loan document.
“Upfront payment is just asking for trouble,” says Novy.
2. Apply for a bank loan anyway. Are you sure you can’t qualify? Even if you’re worried about your low credit score, it doesn’t hurt to apply for a loan from an actual bank, or maybe even two or three. They may offer you a loan with a higher interest rate than what they give people with sterling credit scores. But the costs may be roughly equal to those associated with a private loan, since private lenders will surely do the same.
“I would get a second opinion,” Novy says.
3. Know what to expect. If it’s private citizens putting their own money on the line, chances are they won’t be willing to loan you 100% of the home’s value. And they won’t give you a super-low interest rate.
Because Amber has poor credit, and because a private loan is by its nature more risky than one that’s underwritten by a bank, a real investor will find ways to lower that risk. That means Amber will have to pay a significantly bigger downpayment, often between 20 and 40 percent of the home’s value, he says. And expect an interest rate significantly higher than 5 percent.
“A private lender needs a good cushion,” says Novy. “They want to be more careful” than a bank.
If the loan offer is too generous, beware. If the lenders offer to give you nearly 100 percent of the home’s value, and/or give you a low interest rate, he says, that could easily be a scam.
4. Hire a lawyer. At most, it’ll cost a few hundred dollars to hire a local attorney who specializes in real estate to read the loan document and make sure that everything is legit. That’s nothing compared to the thousands you stand to lose if it actually is a scam, or the long-term damage that scammers can do to your credit if they take your new house using an underhanded clause in the contract.
“Absolutely, pay an attorney to look over the documents,” he says.
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5. Research the people involved. Is the mortgage being put together by a broker? It’s not required, but if there is a broker involved, that person must be licensed by your state, and also by the National Mortgage Licensing System & Registry. Check to make sure that he or she is a licensed broker in good standing. Also, if the investors have a company name, ask your local Better Business Bureau whether it has received any complaints about them.
6. Never give the downpayment to the lender directly. Real lenders don’t want the downpayment check written to them. Instead, that check should be written out to a trust, which holds the money in a secure place until you authorize actual payment. This trust is maintained by a lawyer who is independent of both sides. That way the lender knows you have the money to make the downpayment, but you have power to make sure they uphold their end of the deal before they get paid.
7. Beware the balloon payment. A “balloon payment” is a one-time, lump-sum payment, usually costing tens of thousands of dollars, that comes sometime during the life of the mortgage. Its purpose is to keep the monthly payments low and preserve your monthly cash flow. If your private mortgage contains a balloon payment that comes three to five years after signing, that may be okay, as long as you know it’s coming, and have a plan either to pay it or refinance the loan before it hits.
But if the balloon payment is scheduled to come within six to twelve months of buying the home, beware. If you don’t have $20,000 right now to put toward your downpayment, what makes you think you’ll have it six months? This could be a backdoor way for the “investors” to steal your house.
“You want to be very careful and not lose the property,” says Novy. “And that does happen.”
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Image: David Goehring, via Flickr