Non-Traditional Real Estate Mortgage Financing: What is it and how does it work?

By:?Dheeraj Nair, MBA

Background:

Your business has an immediate cash need. This cash shortfall can be due to the cancellation of a major order, new regulatory requirements requiring additional licensing costs or investment, acquisition of another business, or an expansion of the existing business. As a result, the business is cash strapped and the existing traditional bank is not willing to extend further financing. If the business is a service-based business it may lack tangible assets such as inventory, receivables or equipment to support a loan from a non-traditional asset-based lender.

?What is Mortgage Financing?

Assuming the existing business is viable, and that additional cash injection will bring the business back on track, then real estate mortgage financing would be an apt choice. It can be treated either as an additional equity injection or a shareholder loan. In summary, mortgage financing is a way of leveraging your personal real estate asset to source financing for your business. The existing traditional lender may potentially see this favourably as you put in more skin in the game.

?For example, your house is worth $700,000 against which you have a traditional mortgage of $400,000. This leaves you with $300,000 in equity in the house. Against this $300,000, there are non-traditional mortgage lenders that can lend up to a certain amount. The size of the amount is determined by the LTV (as described below).

?Some key features of these lenders are as follows:

• Appraisal – Lenders require an appraisal of the real estate from an appraiser of their choice and at the expense of the borrower. This could take a week or two to be done, or in more urgent situations, within a matter of a few days. Albeit, at a higher cost.
• LTV (Loan to Value ratio) – One should note that they will only lend up to a certain percentage of the appraised value (typically 70% to 85% of the appraisal).
• Term – Mortgage lenders typically provide short term financing solutions up to 12 months, with renewal options.
• Repayment Structure – repayments can either be monthly interest plus principal or interest only. They are generally open to early repayment.
• Interest cost – Unlike traditional mortgage lenders, they are more expensive (in the range of 8% to 12%). This would largely be driven by the location of the property and how high the existing traditional mortgage is as a percentage of the total value of the property. The reason these loans are more expensive than a traditional mortgage solution is because these lenders are willing to sit in second place behind the existing traditional lender and inherently assume more risk.
• Other Costs – Other costs generally include a lender's fees (3% to 10% depending on the loan size) and legal fees (depends on the lawyers selected).
• Quick approvals – These lenders have less stringent loan qualification requirements than traditional banks and as such can provide a quick “Yes” or a “No”. These lenders will generally lend where businesses are underperforming provided, they feel the business or business owner can adequately service the debt.
• Security – These lenders will place a charge on the real estate and sit behind the existing mortgage lender.
• Exit Strategy – Lenders will want to know how the loan is going to be repaid – is it through the sale of the real estate? or from the cash flow from the business? or through personal the net worth?
• Ability to make the monthly payments – Several factors such as personal credit scores, the income of the borrower, dependency on the business as the source of debt service, rental income from the property (if any) is considered by the lender.

?Conclusion:

Assuming you are comfortable with using your home or other real estate as collateral, non-traditional mortgage financing can be considered as an alternative source of business financing. Particularly when a business owner is looking for a quick and cost-effective solution to source a more pressing need for financing. It can act as an additional lifeline or bridge solution until a more permanent solution from a traditional source has been secured. Due to the large number of mortgage lenders in the market, a wide variety of flexible and innovative solutions are available.

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