Hot Topic: Rates don't matter nearly as much as you think they do

[Clayton Silva]

Before people get in my DMs or up in arms about how important interest rates are please take a moment to read in its entirety to understand what I mean.

As a mortgage broker and banker, I often hear that a client of mine is "shopping" interest rates.  (This is already a bit ironic, because my full-time job, 50+ hours and 5-6 days a week is shopping for rates and products, so I am pretty good at it).  But I get the sentiment and understand why people feel the need to do this.  I see this mostly with new and inexperienced investors which is why I wanted to write this post to help newer investors avoid some of the pitfalls I see every day.  Caveat, experienced investors rarely "shop" they usually have one or two lenders that specialize in certain products, keep all of the investor's data on file with current documents and they tend to care more about convenience, experience, and just getting the deal closed so they will continue to go to the same lender who can make that happen.  Granted that relationship likely took years and a few transactions to cultivate.

The 3 biggest mistakes I see new investors make when "shopping":

1) Tunnel vision on the interest rate.  As I stated above this does not matter because banks and brokers do a lot of different gimmicks to try and make their rate look better.  Example: I say that as of today your rate is 7% for an investment, but Lender 2 says he can get you 6.75%.  If you look at the rate in a vacuum, you will miss all the other charges on the Loan Estimate.  Getting a full, locked loan estimate is the only way to truly compare the two.  If the 7% has no points and the 6.75% has 1 point in cost, then you would have to go back to me and ask me what paying 1 point in cost would get you as a rate, and that number might be 6.5%.  So how do you cut through the noise to find the base rate?  *Lenders are going to be mad at me for this one* ask them what their base rate is (ask them what the par rate would be for that product if it was "borrower paid compensation").  This filters the rate down to show what their actual rate is with none of their compensation, or anything attached to it.  You will start to see the actual variations in the rate.  Also worth comparing processing and underwriting fees, and really any fees that are in Section A of the Loan Estimate. 

2) Not understanding the value of experience and relationships. I have had clients switch lenders over $500 on fees. (Often, they end up coming back to fix the deal after they realize that you get what you pay for, yes, even in lending). While I do price competitively, I am personally not competing with the "race to the bottom" lenders that will do loans for almost free because their model is volume. I personally prefer to be more on the advising and relationship side so I can give my clients more tailored solutions, help them avoid pitfalls, connect them to people that can help them grow and structure their portfolios and I treat this industry more as a relationship business rather than a transactional business. I am an investor first and remember how frustrating lending was when I was starting out, so I try to be a coach, cheerleader, and trusted advisor for clients and these things take a lot more time and require more intangibles than just rate and costs. It is the difference between a Hilton and a motel 6. One gives you microwaved waffles and a room, the other greets you at the door has hot towels ready, tells you where the sights and sounds are and caters a multi course meal to your room. Sure, both gave you a place to stay, and the motel six had the "better rate" as far as pricing. But when you are making a large multi hundred-thousand-dollar investment, why would you want the cheapest person in your corner helping you make that decision. Would you want the cheapest accountant or the cheapest wealth advisor or the cheapest surgeon? My point that I am trying to drive home is that most lenders are within a pretty tight shot group, and I would rather pay $500 - $1000 more for better advice, better service, better follow up, better communication etc. Just like many people ask about real estate friendly CPAs or investor friendly agents, I would be looking for experienced loan officers who also "buy what they sell". Do they just sell DSCR loans, or do they have them? Not to beat a dead horse here, but find a lender that you like working with, trust, and one that does a lot of transactions similar to yours, and is willing to say the hard things (i.e. "I am not a good lender for this program, you should go to..." or "that seller carry on a residential transaction is not actually possible in the lending landscape of today" etc).

3) Better rate, wrong program. This one is huge and pretty easy to illustrate. Conventional vs DSCR is the first that comes to mind. As investors we need to analyze things holistically not just in a vacuum. So, one of my favorite examples is this. Self Employed borrower makes good money in his/her business. They bring in, say 300k a year in revenue on the business with 200k being net profit. They have been in business for years and live in a home that they plan to live in for 5+ more years. They want to buy a rental property and are meeting with their CPA and lender to determine how much income they need to show to qualify for a conventional loan on an investment property. Lender determines they would need to show 150k in income to qualify for a 500k rental property. They live in California so their federal taxes on 150k would be about 23% ($34,500) and their state income taxes would be about ($13,950) for a total of $48,450. Let's say now that a conventional investment loan is 7% and they are taking out a $400k mortgage they will pay $2,661/month in principal and interest on a 30-year note. Now let's compare that to a DSCR loan where they pay 7.75% *screams in higher rate*. Now they are paying $2,866/month in principal and interest. That is $205/month or $2,460 a year more!! Who would do that? Well, the lender and CPA go back and look and see that client is not moving primary residence any time soon so now the CPA, lender, and client meet again to discuss income requirements. CPA knows that the business has a lot of expenses that could be written off if the borrower does not need to show as much income as before because DSCR does not look at income and the client does not need to take a large salary from the business to afford their lifestyle. So, CPA determines that actual taxable income for the year could be as low as $85,000. Now client will owe $10,200 on their federal taxes and $7,905 on the CA state income taxes for a total of $18,105. The client is saving over $30,000 on their taxes and only paying $2,460 extra in interest for the DSCR loan. This nets to a total savings of $27,885 for the client even though the rate was significantly higher. This scenario is extremely common and while I exaggerated numbers for effect, I have had this conversation with clients and their CPAs and the client is usually surprised when you put the numbers on paper. P.S. I know this, because I DO this, I have been variable/commission based for over 4 years now and I have a good real estate friendly CPA. I use DSCR products every time because of this exact analysis with my own CPA.

Sorry for the novel, but I find myself having these conversations over and over and I hope some people can benefit from some different perspective on lending.  :)