Jobs of the Broker

In This Article

• The Broker and Structuring the Loan
• The Broker and the Loan Term
• Improving the Property
• Seasoning
• The Broker and Refinancing
• The Owner’s Guide
• FAQs
  • About the Author

The Broker and Structuring the Loan

The most basic measure of any loan is its interest rate. It is the first goal of the client and, therefore, you, the broker, to lock in as low a rate as possible for the longest possible time. However, there are other aspects of the deal to keep in mind when arranging a loan. First, the term length must match the needs of the borrower. For example, if the borrower is looking for a place to put away his money for a while, you may take a long-term loan if that will ensure a low rate. If, however, he is an investor in constant need of cash with which to invest in other real estate, you want to avoid tying up his money for too long.

Another point to remember is the type of lender you approach for the loan. For example, a Wall Street lender may offer a lower rate than a savings bank, but not all loans suit all lenders.

Below are some examples of the different angles to consider when appraising your client’s individual situation.

The Broker and Loan Terms

The term of a typical loan is five years. Rents increase every year, and as the rents increase, the value of the property increases. After around five years, enough equity is built up in the property that refinancing becomes worthwhile.

The general rule is that the longer the loan term, the lower the rate that can be obtained from the loan. As mentioned above, the disadvantage of a long-term is that the client can find refinancing costly due to prepayment penalties. These two aspects must be balanced according to the individual investor’s situation.

One situation which can influence the length of the loan term is the current interest rates at the time. If the rates are especially low, and the investor feels that they will not stay this low for long, he may take a ten-year term so as to lock in a low-interest rate for a substantial amount of time.

Improving the Property

A situation in which taking a short-term loan is prudent is when an investor is looking to buy a low-valued property and then invest in improving it, thus increasing its cash flow. Because the building in its present state does not have a high value, the investor will not be able to get a large loan for the property or very desirable terms. In this case, you should arrange a shorter-term loan. After the building has been improved and the cash flow has become considerably larger, he can then take out a new loan on the now higher value of the building.

To illustrate: An investor is considering a property valued now at $8,500,000. By making some basic improvements, the investor calculates that the building can be brought to a $10,000,000 value within one year. To take out a long-term loan would mean getting a loan of only a little over $6,000,000 on a 75% LTV. After a year, he is stuck with a $6,000,000 loan on a $10,000,000 property.

Instead, he should obtain a short-term loan for a smaller amount, even if the rate is slightly higher. After he has worked through the loan (12—18 months), he can take out a $7,500,000 loan on the property now valued at $10,000,000. The slightly higher rate that he paid for the small amount of time of the first loan will now have been well worth it.

You must remember, however, that all of the above applies only to an investor who is looking to have as much cash on hand as he can. For a client who has more than enough cash for his investment needs, it may be better to take the longer-term loan for the lower amount and enjoy the larger cash flow after his building rises in value.

Seasoning

Another time when taking a shorter loan is prudent is when the client gets a bargain on the property, and the purchase price is lower than the actual value. In that case, the bank will not lend 75% of the value of the property, but 75% of the cost (see 11.1). However, most banks engage in a practice called seasoning. This means that after a certain amount of time that one has owned the property (usually one to two years), the bank no longer looks at the cost of the property but only at the current value. By taking a short-term loan when buying the property and refinancing after the term is up, the borrower can get a larger loan on the property at the time of the refinance, even without increasing the value  of the property.

For example, a client buys a $1,000,000 property for $900,000. The bank will only lend him 75% LTC ($675,000), not 75% LTV ($750,000). By taking the shorter-term loan, he can refinance after the seasoning period and thereby pull out an additional $75,000 on the property.

The Broker and Refinancing

When a client approaches you that he wants to refinance, it is important to know the motives behind the refinance. You must ascertain his current loan balance, interest rate, and which prepayment penalties are in place for the loan. By comparing the currently available loans, you can calculate if the new rate and cash out are worth the prepayment penalties and closing costs.

While there are times that a client may need to pay more attention to the cost-effectiveness of a refinance, sometimes a client has a pressing need for cash and must refinance no matter what. It is, therefore, extremely important to always ask a client for his motivation for refinancing so that you may best structure his loan.

The Owner’s Guide

Other aspects of the broker’s job include dealing with the client and the bank and negotiating between the two. As a broker, you must ask yourself about each deal, “If I were asked to lend my own money, what questions and concerns would I have? Do I really understand this deal?” You must also be able to answer the question, “If I had the money, would I buy or lend on this deal?” If you can answer with a confident “yes,” then you will be able to find a lender and work out a loan. If not, in all probability you will not be able to place the deal.

A good broker is one who is able to place himself in the position of the buyer and thereby provide him with objective opinions, not only about which type of loan to get but also about the deal itself.

A buyer can many times be affected by factors external to the deal itself, and having an objective person to concur with or constructively criticize his decisions can be very valuable for him. Just as an investor will personally visit the site of a potential acquisition, so should the broker. A broker, upon visiting the site, may notice details that escaped the attention of the buyer. For example, he may bring to the attention of the client that down the block from the property that he is looking at, there is a strip of vacant stores. The broker should urge the client to consider how this can affect his deal. Or, the broker may be able to point out to his client that a comparable building two blocks over has a doorman, whereas his client’s building does not. A broker must survey every angle of the deal and lay all possible scenarios on the table in order to best serve his client.

With regard to the loan, a broker must guide his client through the various options available to him, both in the structure of the loan and in the choice of lender. Many times you will have to explain to the owner why the bank underwrites many of the expenses differently than his own calculations. The best way to explain this to him is to say, “You know how to buy and manage; a bank only knows how to lend. If the bank gets stuck with the property it will not be run at optimum efficiency, and they will be stuck with more vacancies and expenses.”

Finally, a broker is the borrower’s representative in dealing with the bank. An investor wants to maintain his rapport with the bank and therefore minimizes his own personal dealings with the bank. It is your job to do the haggling for him and negotiate all aspects of the deal with the bank, from the interest rate to the amortization schedule.

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FAQs:

1. When is it not cost-effective to refinance?
   • Refinancing can be a beneficial financial strategy in certain situations, allowing borrowers to secure better loan terms, lower interest rates, or access equity in their property. However, there are instances when refinancing may not be cost-effective. Here are a few scenarios:
     1. Short remaining loan term: If you have a relatively short remaining term on your existing loan, refinancing might not make financial sense. This is because the costs associated with refinancing, such as application fees, closing costs, and prepayment penalties (if applicable), may outweigh the potential savings from a lower interest rate or better loan terms.
     2. High prepayment penalties: Some loans come with prepayment penalties, which are charges imposed when you pay off your loan before a specified period. If the prepayment penalties on your existing loan are substantial, refinancing may not be cost-effective unless the potential savings outweigh the penalty costs.
     3. Low-interest rate differential: Refinancing is typically most beneficial when there is a significant difference between your existing interest rate and the new rate you can secure. If the potential interest rate reduction is minimal, the savings generated from refinancing may not justify the associated costs.
     4. Relatively small loan amount: If you have a small loan amount, the potential savings from refinancing may not be substantial enough to outweigh the fees and costs associated with the refinancing process. In such cases, it might be more cost-effective to continue with your existing loan.
     5. Poor credit or financial situation: If your credit score has significantly declined since obtaining your current loan, or your financial situation has deteriorated, you may not qualify for favorable refinancing terms. Lenders often offer better rates to borrowers with good credit, and if your creditworthiness has diminished, refinancing might not result in cost savings.
     6. Plan to sell the property soon: If you intend to sell your property in the near future, refinancing may not be cost-effective. The costs incurred during the refinancing process may not be recouped before you sell the property, rendering the refinancing effort less beneficial
   • Remember, each individual’s financial circumstances are unique, and it is important to evaluate the specific costs, terms, and potential savings associated with refinancing to determine its cost-effectiveness in your situation. Consulting with a financial advisor or mortgage professional can provide personalized guidance based on your circumstances.
2. Is there anything a broker is not allowed to do? While some of the answers may seem elementary, it’s good to be reminded.
   1. Provide false or misleading information: Mortgage brokers must provide accurate and truthful information to their clients. They should not misrepresent loan terms, interest rates, fees, or any other aspect of the mortgage process.
   2. Engage in discriminatory practices: It is illegal for mortgage brokers to discriminate against borrowers based on factors such as race, color, religion, national origin, sex, marital status, age, or other protected characteristics. They must adhere to fair lending practices and treat all borrowers equally.
   3. Charge excessive fees: Mortgage brokers are generally prohibited from charging excessive fees or engaging in unfair fee practices. They should disclose all fees upfront and provide a clear breakdown of the costs associated with the loan.
   4. Guarantee loan approval: Mortgage brokers cannot guarantee loan approval or make promises that a loan will be granted. The decision to approve a loan ultimately rests with the lender, based on the borrower’s financial qualifications and other factors.
   5. Act as a lender without proper licensing: In many jurisdictions, mortgage brokers are required to hold a valid license to operate as intermediaries between borrowers and lenders. Brokers must adhere to the licensing requirements of their jurisdiction and comply with all applicable laws and regulations.
   6. Provide legal or financial advice without appropriate qualifications: Mortgage brokers should not offer legal or financial advice if they are not qualified to do so. They should refer clients to appropriate professionals, such as lawyers or financial advisors, for specialized advice.

It is important to note that regulations and restrictions can vary between jurisdictions, so it’s advisable to consult the specific laws and regulations in your area to understand the limitations placed on mortgage brokers in your location.