Max-out Conventional Loans or Straight to Commercial?

[Austin Montgomery]

Hi BP,

Looking for advice on choice of financing for our first few residential investment properties.

Background: No loans in our name to date. Bought and renovated in cash and doing cash-out refinances to recoup capital. Looking for fast paydown on these loans, as we're currently in a high tax bracket.

Two debt options we've got lined up at the moment:

Conventional Loan - 30 year fixed at 4.5%
Commercial Loan - 10 year fixed at 5.5%

Neither has a prepayment penalty or title seasoning requirement. In either case, we're aiming for a 10 year paydown on these properties - though having the ability to 'switch on the cashflow' in the case of the 30 year is very appealing in the face of any looming economic turmoil. Additionally, we'll be transferring property ownership to an LLC we own and operate for asset protection above and beyond our general liability & individual property insurance policies.

We understand that eventually we'll need to go with commercial to achieve scale. We're primarily wondering about any hidden downsides of maxing out conventional loans before moving to commercial debt products. Currently our thinking is as follows: 

Downsides of commercial:

Higher interest rate
Higher closing costs
Higher property insurance premiums
Locked into higher monthly loan payments

Downsides of conventional:

Higher borrower debt/income ratios 
Lender could technically call the note (after property is transferred into an LLC, though we've also heard this is extremely unlikely)

In summary, should we max our conventional loans first or go straight into commercial?

Thanks for any thoughts in advance!

Best,

[Kevin Romines]

As my friend @Chris Mason showed me a while ago, Fannie Mae changed their guidelines and now allows you to finance in your personal name and afterward, move the loan into an LLC that the borrowers are the majority members of. This was huge for the real estate investors out there. Generally speaking, what Fannie Mae does, eventually Freddie Mac will do also? Freddie hasn't caught up with that particular change just yet, but I think its in their future?

That said, if you did your 10 financed properties through Fannie Mae, you will have generally gotten your best terms on those. From there, you can go Portfolio lending. Most portfolio loans have limits of 15-20 loans or a max. $$ to any one individual or LLC. If you cap out with one portfolio lender, then move on to the next. Portfolio tends to be better terms than a commercial loan. You can get 5/1, 7/1, 10/1 ARMS, 15 Yr. & 30 Yr. fixed rate loans. Most commercial is a 5/1, 7/1 or 10/1 ARMS only. They generally don't offer 30 year fixed, so you spend more on those loans because of closing costs over the years.