5 Terms You're Too Shy to Ask About

[River Sava]

Hey Everyone – I’ve been interning this summer at a private lender in the real estate space and have put together some of the tricky concepts that are commonly used. Thought I’d share five that I’ve come to understand, and hopefully this helps everyone out there when dealing with finding a loans and getting comfortable with the jargon. (It's like learning a new language at first!)

1. "30-Year Fixed" for a Loan

Important to understand what the "Fixed" in this term refers to - it is the interest rate, NOT the monthly payment. This is important because there are lots of loans with interest-only options that may not run the full term.

Meaning = the interest rate may be fixed, but some of the term may have interest-only payments and some of the term has amortizing (principal plus interest payments). So even if the rate is fixed, the monthly payment may change, and change dramatically!

2. "DSCR"

It is important to note that the DSCR metric calculation formula is different in commercial vs. residential

Commercial Real Estate DSCR = Net Operating Income / Debt Service

Investment Residential "non-QM" DSCR = Rent Revenue / PITIA (principal+interest+tax+insurance+HOA)

Important to understand, especially for CRE investors that are exploring SFR space

3. "7-Year ARM"

People may throw around the term "7-Year ARM" or "7-year paper". Most people I'd wager think this would mean a 7-year loan, where the debt matures after 7 years. However, this is not true - the term is going to be 30 years, same as "30-year fixed" loans above!

The "7" in the 7-Year ARM or "7/1 ARM" refers to the portion of the term of the loan that is fixed rate. So, it is likely going to be a 30-year loan, just the interest rate is FIXED for the first 7 years, and then floats based on a multitude of terms in the loan docs.

Typically, the prepayment penalty period lines up w/ the portion of the term that is fixed rate and its assumed that the loan will be refinanced at year 7 or earlier, BUT at the end of the day, this is a 30-year loan that does not have a looming balloon payment at the 7 year mark

4. "SFR"

I'm still unsure myself if the SFR acronym means "Single Family Residence" or "Single Family Rental" - but the issue here is when people mistakenly call 2-4 unit properties a "SFR".

Generally, 1-unit properties (SFRs) are financing in the same type of loans as 2-4 units

The problem? Its important to make a distinction whether a property is a true "SFR" or has multiple units.

The reason? There is a valuation discount for multi-unit properties?

Why - all things equal, there is a much smaller buyer pool for multi-units vs. SFRs. There are way more people that either want to live in a SFR vs. buyers that are investors (by definition investor if you buy a multi-unit). More potential buyers = higher values.

Because of this a duplex or triplex that is mistakenly referred to as a "SFR" means the value is probably being overstated, which is a critical error in real estate.

5. "Broker"

This is mostly just a bonus misnomer for mortgage industry professionals, but its important to understand that there are multiple types of brokers with vastly different role in real estate transactions.

Important to differentiate a "mortgage broker" (an intermediary between borrowers and lenders for loans) and a "real estate broker" (an intermediary for buyers and sellers of actual real estate properties). Make sure you know what *type* of broker you're talking to!

Hope this helps, and would love to hear other terms that people are/were unsure about!

[Scott Trench]

Great list - what do you call different types of loan products for investors? I hear a lot of naming conventions (conventional, private money, hard money, bridge, DSCR, balance sheet, "alternative to conventional" and more).