The Quick Facts
- Cap rates on properties can be misleading without proper expense reports
- Many small to mid-sized multi-family buildings don’t have accurate expenses records
- By only looking at cap rates can cause you to lose out on potential good deals
- It is imperative to do your due diligence and analyze the expenses
- Pairing yourself with proper representation (commercial broker) can make a huge difference
- Learning standard expense multipliers can save you a lot of time and money
So, you’re looking to purchase your next multi-family building. You’ve selected a few perspective properties, gathered the financial reports, and are trying to decide which is the best investment. How do you know which one is the best deal? Many investors would run straight to comparing capitalization rates (AKA cap rates).
While this is a good start, I’d argue that you should be cautious when comparing cap rates. It is crucial never to take a cap rate at face value and always conduct proper due diligence and seek appropriate representation. Not only could you overpay for a property, but you could also miss out on some great deals. The answer to this dilemma lies in the expenses.
First, I will explain why cap rates can be inaccurate due to inaccurate expenses and then offer a more accurate and efficient alternative.
If you’re unfamiliar with cap rates, get caught up to speed by checking out my earlier blog post on cap rates.
To understand cap rates better, it is best to take a look at a crucial component, the net operating income (NOI).
To arrive at the net operating income, we must subtract gross operating income from operating expenses; but what if the operating expenses are misreported? That can have a drastic effect on the final calculation of a cap rate.
Most small to mid-sized apartments available on the market don’t have actual expense reports or profit and loss statements from the owners.
This could happen because the owner is:
- Hiding expenses
- Doing repairs themselves and not factoring in things like labor costs
- Miscategorizing capital expenses as maintenance expenses
- Keeping incomplete expense reports or in some cases, no reports at all.
Other times it can also be the broker’s fault because they don’t ask for the expense reports from the owner.
A failure to have actual expenses can lead to you, the potential buyer, to purchase an over-priced deal or worse, walk away from a great deal.
Here are some ways it can be inaccurate
I’d like to introduce Mr. Magoo, a carpenter, and the owner of a small apartment building that has recently been put on the market. He’s seen a couple of Martha Stewart shows and thinks he’s quite the handyman, so he decides to do all maintenance and repairs himself. He’s made some questionable decisions like when he mixed several leftover paint cans to paint the exterior of the building, or when he patched a leaky roof with plywood. He’s also read online about property management and decides he can manage the building himself.
By doing this, Mr. Magoo has been able to save thousands of dollars on labor and maintenance expenses. He’s able to avoid placing these line items on his expense report, which makes his NOI appear higher than it is.
So, one day you’re on LoopNet or Costar looking for commercial property and stumble upon his building and decide to give him a call. When you speak to Mr. Magoo, he tells you it is an excellent building with little expenses. He claims that maintenance and repairs only cost him 5% of total expenses, which is drastically different from another owner who may assign 25% of their total expenses towards maintenance and repairs.
After doing some math on the given expenses, let’s say you calculate the cap rate of his property to be 6%. You think this looks like a great deal and are considering making an offer.
This can pose a severe problem if you, the potential buyer, take his expenses at face value without conducting any due diligence.
If you were to look into the expenses on Mr. Magoo’s property, you would find his cap rate is inaccurate unless you plan to hire yourself to be the painter and the property manager. The reason his cap rate appears to be high is that he was not accounting for the labor or market costs of maintenance. Unless you’re making less money than a property manager or painter at your current job, you should hire professionals. You’re going to save more money by paying them to do these services, and a lender will always add these expenses to their underwriting criteria. Your job should be running the operations, finding more properties, or continuing your career that pays you more than painting or managing your property. So, in this scenario, the cap rate is useless because Mr. Magoo’s expenses do not represent what you, the new owner, would be paying.
Without digging into his expenses, you might end up paying far more for a property that doesn’t produce anywhere near the stated NOI.
Now I’d like to demonstrate how over-reporting maintenance expenses can drive you away from potential deals.
Let’s say you stumble upon a 6-unit apartment building that has everything you are looking for in a multi-family property. The only issue is that it has an alarmingly low cap rate of 3.5% and very high expenses. Many inexperienced investors or brokers may walk away from this deal without even digging into the expenses.
Upon further investigation, you discover the current owner has been overstating expenses because they don’t know how to accurately spread out repair costs over the life of the repair. When looking at the report, you see that there were two consecutive years of significant electrical upgrades that cost about $30,000 per year. This adds up to $60,000 in total expenses for new electrical that was meant to last 50 years. The owner should have spread out that $60,000 expenses over the life of the electrical rather than doing it up front. An experienced broker would be able to spot this and reallocate the expenses to the property area. After correcting the error, you will see that the cap rate will go up and expenses will go down.
As you can see, by the owner not understanding how to report expenses accurately, the property seems to be a bad deal. You may have walked away from a great opportunity had you not conducted a little due diligence.
Another way cap rates can be misreported is through property taxes. The property taxes for multi-family apartment buildings in San Diego is 1.2% of the purchase price of the building. Where many inexperienced brokers can make mistakes is by basing their cap rate calculation off the old property taxes which is not accurate of what the new owner will be paying. Here’s an example:
Let’s say you have a property that the current owner bought for $1,000,000 over ten years ago.
Currently, the owner would be paying $12,000 a year in property taxes. The property is then listed on the market for $2,000,000. Instead of calculating the new property taxes, which would be $24,000 per year, the broker decides to use the same $12,000 that the current owner is paying.
What results is that the expenses will be reported at less than what they actually will be. This has the unfavorable result of artificially increasing the cap rate. When the new owner acquires the property, they will not be receiving that same income as their property taxes will be based on the new purchase price.
Furthermore, this could cause you to pay more for the property than it’s worth. Take a look at the following spreadsheets.
The difference between the old and new property taxes comes out to be $12,000. If we value the $12,000 difference at 5% cap rate ($12,000/.05) we get a value of $240,000. Now, let’s say the property requires a 25% down payment. If you were to pay the original asking price of $2,000,000 assuming the old property taxes, your down payment would be $500,000 ($200,000 * .25). If, however, you took into consideration the reduced value given the updated property taxes, you would see the offer price comes down to $1,760,000 ($2,000,000 – 240,000). This makes your 25% down payment $440,000. That’s a $60,000 savings by accurately accounting the property taxes.
This is why it is crucial to pair yourself up with proper representation. An experienced commercial broker would realize this and account for it in the offer.
The pay between experienced commercial brokers and new ones is not far off, so why not pair up with one who is experienced?
So now that I’ve demonstrated some ways that cap rates can be inaccurate let’s look at a better alternative.
Standard Expense Multipliers
With properties that may not have accurate expense reports (especially small to mid-sized apartment buildings), I recommend that you use standard expense multipliers to learn the price per square foot. This puts you in a much better position to understand a properties performance and overall value. I have found the Institute of Real Estate Management (IREM) Apartment Expense Multiplier sheet to be extremely valuable when determining baseline expenses.
When used appropriately, this will allow you put a better estimate on what your actual expenses may look like on a price per square foot basis.
This will allow you to compare the owner’s expense report versus your estimate. Any significant discrepancies could be a red flag that requires further investigating. These calculations will save you a lot of time and potential money spent.
If you’re trying to look through 180 listings, you can’t underwrite every deal promptly. Instead, what you can do is quickly look at each deal and say, “okay, this is a $170,000 unit. It’s a 14 times GRM. If you put about a 40% expense on it, it is going to be in the 4% cap range”. Using this approach is going to make it much quicker for you to go down the line of properties. Also, sometimes you’re going to find very similar buildings. If you saw something that sold for a particular gross rate multiplier, that may be a better way to sort through properties quickly. It will become easier to make apples to apple comparisons because those rents that they listed are usually accurate as long as they’re not pro forma rents.
So, when do you use Cap Rates?
Well, the larger the property or, the more organized an owner is, the more likely it’s going to be accurate. Also, the more respectable and experienced the broker is, the more likely it’s going to be a precise number. If the pay difference between an experienced and new broker isn’t far off, why not pair yourself with an experienced broker?
Rarely, when you get down to it, will expenses be precisely what any owner says. The question becomes; how far off is it? So, my first piece of advice is to try to deal with people who are reputable and looking at the numbers. If everything you see in the market is at a 5% cap rate, and all of a sudden you find a property with a 7% cap rate – you should think to yourself, “that’s suspicious, why is it still on the market?”. Another example is if you see two comparable buildings with similar rents but drastically different cap rates; this could indicate something is off.
If you’re looking at larger properties or ones run by management companies, the numbers are more likely to be accurate because the owner is going to be able to print out a profit and loss statement. However, another problem arises.
What you could find is that the owner wants to write off as much money as they can on the property. Besides depreciation, they can achieve write-offs through two main ways.
- First is by doing maintenance and writing it off the in the year you did the work. This could be things like fixing your toilet or patching the roof.
- The second is capital improvements. Capital improvements typically have a long life but can range from one year to several years. A roof, for example, is a capital improvement because even though I paid $10,000 for it today, that write-off might be over the ten-year life of the roof. Because of this, I’m only able to write off $1000 per year against my income. Although this is the case, a seller may say, “no, that’s still maintenance, so I’m going to write off the entire $10,000 this year”, even though it’s very questionable if not outright fraudulent to do so – but it still happens more than you’d think. A good broker would be able to spot this right away and reallocate it to the proper area of the financial statement. This would change your overall NOI.
So, when working with cap rates where you get income/expense reports, it is imperative to take a look and identify which numbers are actual maintenance and which ones are capital improvements. You also need to see if they’re moving their maintenance into capital improvements. Sellers often do this so they can report more income in the year that they sell, which gives them a higher sale value. Doing your due diligence here can save you a lot of time and money.
Here’s a great example of a multi-family apartment building in San Diego that I bought a while back. The property had a very low cap rate, which typically means that it’s not producing a lot of income. Many investors would walk away right there without digging into the financials. However, after we got into the property, we realized the expenses were misallocated, and the CAP rate turned out to be higher than it was initially stated. We were able to turn a healthy profit on the building by not taking the CAP rate at face value right away.
The moral of the story is be careful when you rely on the CAP rates of small to mid-sized properties.
- Learn your expenses
- Learn the price per square foot
- Learn the market rents in the area so you can apply those metrics to buildings you are analyzing
- Take a look at who is listing the property. Is it somebody who has experience? Are they missing a lot of financial numbers?
- Do they have expenses listed out, or do they just give you a bottom line number?
- Do they have a marketing package? Are they seeming overly aggressive with what they’re proposing?
Sometimes the best deal you buy are the properties that were not marketed correctly. These can often be opportunities for you get a lower price if you conduct the necessary due diligence.
Please leave in the comments below any thoughts you have on cap rates and valuing a property or any stories you may have run into…
Curtis Gabhart, CCIM
Edited by: Blake Imperl
Disclaimer: I’d like to point out that none of the content in this article is absolute. It’s just food for thought and is based on my numerous years of experience dealing with commercial real estate.
These are just some things you may want to think about when analyzing commercial properties. It isn’t always advantageous to rely heavily on CAP rates when looking at properties where you don’t know their actual expenses. This post was designed to offer an alternative for when you’re looking at dozens of properties and trying to find the best deal available.
Looking for some more tips on buying multi-family properties? Click here to check out my multi-family inspection tips!
Want to get more return on your investment? Here’s a great article on how to increase your buildings’ property value fast by investing in a new paint job.
How to Value Commercial Real Estate 101 Slideshare – This crash course will take you through the basics of valuing commercial real estate. It has over 106,000 views so far!
You’re Invited to Learn About the New Tax Laws That Are Affecting Commercial Real Estate
Please join us for an informative live presentation with Dan Adams, Senior Vice President & Commercial Lending Manager at Wells Fargo. Dan will be taking us through the changes, how they affect commercial real estate, and also conducting a Q&A to answer any questions you may have. Come prepared and ready to learn how you can maximize your business, personal, and investment strategy.
Date: March 29th, 2018
Location: KW Commercial Del Mar/Carmel Valley
Seats are limited to 30! Sign up today to secure your spot!
Registration is free and we encourage donations to Autism Tree Project Foundation (ATPF).
The Autism Tree Project Foundation helps spread community awareness for autism. Their goal is to give children on the autism spectrum a voice and additionally aims to build community compassion towards the parents and families of these special children. ATPF helps thousands of families with autism create a roadmap for their child with autism and navigate a very complex system of care required for children with Autism Spectrum Disorder.
All monies donated to ATPF go straight to helping real families in our community through one of their 20 critical programs. These programs are on-going and provided to families at no charge, making the Autism Tree Project Foundation very unique. They are a grassroots foundation and have only 1 full-time employee on staff. They do not charge any of their families for ATPF programs.
Earlier this month we asked you for your top questions on the new tax law. Dan was generous enough to answer some. Here’s the top 5:
1. There are new rules for Sub S corp and LLC’s. Do they apply to real estate in single asset entities?
Yes, the new pass-through rules apply to single asset (real estate) entities. This means that the 20% deduction of pass-through net income applies to the rental real estate owned by a business, an individual, or a living trust.
2. Are there any changes in expensing acquisition costs that were capitalized in the old tax rules?
No, those rules remain exactly the same.
3. Are there changes in the Alt Min Tax rules for passive investors?
Yes, there are significant changes to the Alternative Minimum Tax (AMT). Generally speaking, the AMT has basically been eliminated. It would be extremely rare for an active or passive investor to be subject to the AMT anymore. I have read some comments that the IRS now expects the AMT to impact fewer than 1,000 individual taxpayers going forward.
4. Any changes in 1031 or installment sale rules?
Yes, we can now only exchange real property (not tangible personal property like improvements). That creates a difficulty for buildings which had a cost segregation study done, in that the short-life assets would be taxed as boot (taxable gain) in the exchange. Ideally, the replacement property would need to have a cost segregation study done immediately so that the additional depreciation from that could be used to offset the taxable gain from the exchange boot.
5. How are the taxes on each property affected as far as tax write-offs? It seems if they only allow a certain amount of taxes to be written off, it is going to affect the property prices?
The $10,000 state and local tax limit applies to state income taxes and property taxes paid on your primary, secondary, or investment properties only. There is no limit on business properties or rental properties that are owned by a corporation/LLC. There is a chance that owning a home is less lucrative now because of the tax limitations. This could artificially increase demand to rent a home instead of own it.
Click here to check out our tax article about the Tax Cuts and Jobs Act
Interview with Globest
In a recent article with Globest, Dan discussed some of the recent changes.
Below are a few highlights of the article, to view the full interview, click here
- Dan believes the new tax laws are positive for the industry by creating certainty.
- The tax policies ability to spur GDP growth is an indicator of the increase in the demand for office, industrial, warehouse, and other commercial property.
- The new tax law made numerous changes that will favorably affect commercial real estate as an asset class, including indirect changes such as reductions in tax rates.
- The law provides for a 20% reduction of business income for most pass-through entities.
- 1031 Exchanges are now only available with real estate.
- The increase in estate-tax exclusion to $11 million per person should be viewed as favorable since those are the assets that most often appreciate and are inherited by heirs.
- The demand for single and multi-family properties will go up as the tax advantage of owning a home has been significantly reduced.
- US-Based Manufacturing will increase, which could drive demand in that sector.
- Although it’s been said California was hit harder than other states, much has been exaggerated. The $500,000 capital-gain exclusion for sale of principal residence still exists.
- The new tax law isn’t a “one size fits all” situation. Brokers should consult their tax professional and figure out how to structure their business, their income, and their investments in a way that maximizes the advantages of the new tax law.
Daniel Adams – Senior Vice President, Business Banking Area Manager, Wells Fargo Bank – Dan leads a team that provides commercial real estate loans, treasury management, and credit lines to businesses in Southern California and Nevada. They provide loan structuring, underwriting and risk analysis for operating businesses and commercial real estate investors, and also offer working capital optimization technologies to help businesses operate more efficiently. Dan’s team originated over $300 million in loans in each of the past four years, including Small Business Administration, Healthcare Finance, Equipment Leasing/Purchases, and conventional lending products. Dan is a veteran U.S. Marine artillery officer with multiple deployments to the Middle East and Southwest Asia and also an adjunct Graduate Finance Professor at several local universities.
Wells Fargo’s Business Banking Group serves the needs of small- to mid-size privately held businesses throughout the country. They provide a proactive approach to a team of local Relationship Managers and others to provide customized service and rapid response to help our customers succeed financially.
Questions about the event? Contact us here
How My Views on Commercial Real Estate Are Changing
By: Blake Imperl
As I am approaching the end of my first month as an intern at Gabhart Investments, I’d like to reflect on what I’ve learned, and what has changed thus far.
What I’ve Been Doing
Over the past few weeks, I have been spending a lot of time reading the material Curtis has provided me on Property Valuation & Investment Analysis. Although it is mainly an overview of the subject, it has proved to be some highly valuable content. This material essentially picked up where I left off in my Real Estate Investment Analysis class that I took last semester at San Diego State. I have been brushing up on subjects like tax benefits, 1031 exchanges, expenses, leverage, returns, evaluating cash flow, and much more. I still have a great deal of learning to do on these subjects, but it is exciting to see how what I’ve learned in the classroom correlates to real world applications. It is my intention to continue to read up on these subjects and ask as many questions as I can.
I’ve also been observing how Curtis and his team assemble marketing packages for commercial properties they are listing. I was doing things similar to this at my last internship at Realty National, so I’ve enjoyed seeing how this translates in the commercial arena
Commercial Real Estate Blog Posts
Another task I have taken on is the editing of Curtis’s blog posts. My first edit was a post on property walkthroughs. One tremendous benefit of doing this has been the information I’m learning is sticking much deeper than if I just glanced over it. It’s proved to be a great learning tool for me and I’ve even taken on the task of researching some of the topics I was curious about. Writing has always been a passion of mine, so getting the opportunity to revise and write some stuff has been great. I’m excited that I will get to continue to edit blog posts during my time here.
This past week I had a great learning opportunity with Curtis to do a walkthrough of a 13-unit apartment building in Fallbrook. I was able to learn about some of the things you should be looking for in a property, both on the interior and exterior. This was a neat real life application after reading Curtis’s article on property walkthroughs. This is certainly the kind of stuff you’d never learn in a class room.
13-Unit Apartment Building In Fallbrook
La Jolla Multi-Family Building
Another property we looked at was a 5 unit multi-family building in La Jolla. This was a very intriguing property because it had great bones, was less than a block to the beach and offered several routes for renovation. When walking the property, we looked at things like the condition of the floors, the bathrooms, kitchens, balconies, electrical, etc… It was far from move-in-ready, however, at the right price this could prove to be a great deal.
Curtis and Abe inspecting the condition of the upstairs balcony
the interior of the detached studio
Co-Star Lunch & Learns
In addition to the property walkthrough, I’ve also attended two Co-Star lunch and learns with Curtis and his assistant Dianne. The one that stood out to me was on the housing forecast over the next few years in San Diego County. I enjoyed this meeting because this is a real problem we will be tasked with fixing over the next decade. This past semester in my investment analysis class I did a great deal of research on this subject, so it was neat to hear the industry take on the issue.
Lastly, I have very much enjoyed the opportunity to pick Curtis’s brain. He’s always offering me valuable tips and knowledge about real estate and just life in general. Whether it be tips on client relations, listing properties, or even just financial management, I’ve been trying to act like a sponge of knowledge. He’s always honest about things and I respect that.
My views on real estate are growing stronger than ever and I’m excited all the learning opportunities that lie ahead. I am finding that the San Diego Commercial Real Estate Market contains more possibilities than I ever could have expected. Stay posted for my final update in August!
In a bit,
Intern, Gabhart Investments
Blake Imperl – 22 Year Old Aspiring Commercial Real Estate Professional
I moved from Milwaukee to Scottsdale, Arizona when I was 5 years old. Spending my formidable years in the desert climate, I always had dreams of moving to the beach. As the son of a former real estate developer, I was exposed to real estate from a young age. My dad specialized in multi-family and student housing developments in and around the Milwaukee area. Upon graduating high school at 18, I moved to San Diego to study marine biology at San Diego State University. I quickly realized I wasn’t cut out for the science world and changed my focus to pre-business. It wasn’t until my sophomore year that I decided I wanted to be a management major with a real estate minor. I accredit this route to the all inspiring business professors I had at SDSU and to my involvement with The Real Estate Society. As a person who thrives on leadership and entrepreneurial opportunities, the knowledge and values I acquired during my time at SDSU will serve me for the rest of my career. Outside of real estate, I am an avid musician who plays in a local indie rock band called Stray Monroe. We’ve had the fortune of playing at some great venues around San Diego including The Casbah and Soda Bar and have also been played on 91X and 94.9FM. I also enjoy traveling, spending time with my girlfriend, and practicing Portuguese.
Why did you choose to intern with Gabhart Investments?
I chose to intern with Gabhart investments for several reasons. First, Curtis seems to have an amazing drive and motivation to succeed. From the first time we met, I could sense that he carries himself to a high level of professionalism with an immense entrepreneurial spirit. Though I had been exposed to commercial real estate before meeting with him, I never entertained the idea of making it into a possible career. He definitely opened up my eyes to all the opportunities that could be had in commercial. Second, Curtis is a very generous person who gives back to the real estate community. His involvement with past interns, students, and aspiring professionals, really spoke volumes to me. I sensed that if I gave it my all during this internship that I would get a lot back. Lastly, I really liked the opportunity to learn in a small team environment. I felt that I would get a great deal of hands-on experience and intangible knowledge.
How did you hear about the internship?
I heard about this internship through my former boss, Randy Zimnoch, who is the owner of Realty National. Realty National is an investor-friendly and full-service brokerage based out of Pacific Beach. They’ve developed a stellar team of over 30 agents since their inception in 2011. Randy was crucial in setting me on the career path that I am on now. Without his guidance, I think my focus in real estate would have been entirely different.
Why would you work for free?
Knowledge is invaluable. What I will be learning over the course of this internship far outweighs any minute compensation I could currently earn elsewhere. I realized early on in my college education that you can’t monetize the value of experience, because it’s that very experience which will make you more money down the line. In my initial meeting with Curtis, he asked me about my professional goals. One of the things I told him was that it was a personal goal to be a millionaire by the time I’m 30. He told me through hard work, smart decisions, determination, and a bit of luck that it could be possible. This isn’t to say I anticipate real estate being a get-rich-quick process; I fully understand you need to be in for the long-haul. Judging by how successful he has been thus far, I think it’s safe to say I’m learning from somehow who could teach me some things on how to make that possible.
What are you trying to accomplish?
It is my goal to walk out this internship a much stronger professional that I was before. I will achieve this by applying myself and acting like a sponge of knowledge. I want to understand the commercial arena better and pick up on some things that have made Curtis so successful. I’d like to also understand how I can hit the ground running upon graduation in December of this year. It is my hope that I can add many invaluable tools to my real estate belt that I will be able to utilize for years to come. Lastly, and most importantly, I want to add as much value as I can to Gabhart Investments.
Why is it you are interested in Real Estate?
I touched on this early, but I attribute my interest in real estate to my father and The Real Estate Society at SDSU. From a young age, I remember walking properties with my dad, doing napkin math, and talking real estate. Though I may not have realized it at the time, he was planting the seeds that would eventually grow into a profound interest. Once I got involved with The Real Estate Society in my sophomore year, I began to apply a lot of those concepts my dad and I initially discussed. I went to every guest speaker event, every case study, networked, took notes, and constantly worked on my professional development. I also served as Director of Marketing during my third year and this past year I was Vice President on the executive board. Lastly, I need to thank my many mentors who have helped me along the way; David Smith, Sean Bascom, Kris Kopensky, Mark Goldman, Mike Wolfe, Cody Zindroski, Jessica Barber, and many others. Their support and knowledge have proved to be invaluable.
I will be making monthly posts on my progress here at Gabhart Investments, how my views are changing in regards to real estate, and any other new updates. Stay posted!
In a bit,
The HARP2 program, combined with the $25B bank settlement (providing $20B in loan modifications), will save some underwater mortgages from foreclosure and help long-term market stabilization. However, part of the bank settlement requires banks to adopt standardized (and hopefully more efficient) servicing and foreclosure processing measures. I think better processing, combined with the sheer volume of underwater mortgages is going to keep the short sale floodgates open for quite some time.
According to researchers at CoreLogic, a leading analytics firm, 11.1 million or 22.8 percent of all residential properties in the United States were worth less than the amount their homeowners owed on the mortgages used to purchase them.
The federal government originally rolled out the HARP program in 2009 to help homeowners who were underwater or near underwater. However, the program was recently broadened to reach even more borrowers. Originally, HARP applied to 895,000 underwater borrowers; and now HARP II is expected to help up to double that amount. According to HUD, about 400,000 homeowners have taken advantage of the program since it launched in April 2012…that’s less than 4% of underwater mortgages.
HARP II allows underwater homeowners who are continuing to make payments to refinance their loan. The new program offers a number of advantages over the original HARP loans. First off, there is no loan-to-value or combined loan-to-value restriction on fixed-rate loans with terms of 30 years and under. In other words, it doesn’t matter how upside-down borrowers are on their mortgages. Previously, there was a cap that restricted borrowers who owed more than 125 percent of their home’s current worth from accessing the program. In addition, an appraisal may be waived if a value for the home can be automatically generated, and the borrower only needs to have a 620 FICO score.
There are three main components to qualifying for a HARP II refinance loan. The first requirement is that the loan must be owned by either Fannie Mae or Freddie Mac. Second, the loan must have been sold to Fannie or Freddie before June 1, 2009. Third, a HARP II refinance must benefit borrowers in at least one of four ways:
- Reduce the loan’s monthly principal and interest payment.
- Reduce the loan’s interest rate.
- Reduce the loan’s amortization term.
- Transition the loan to a more stable type of loan. (i.e. interest-only to fully-amortizing, adjustable-rate to fixed-rate, 30-year to 15-year).
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