The problem with banks

|

I’ve been working on a simple bridge loan for a month.

We bought the property all-cash and are capitalized with additional cash to fund the rehab (which has already begun).

We paid $2,051,000 for the building and intend to spend another $700k renovating.

I have asked a bank to provide the following loan:

  • $1.2MM
  • 5% interest only
  • Term of 12 months
  • They asked, and I agreed, that we keep $700k in an account at their bank and use it to pay for the construction

This is a very, very safe loan for a bank to make. Why?

Well, first of all, they’re loaning $1.2MM on a $2.05MM property. That’s $1.2/$2.05 = 59% LTV.

Second: A whole bunch of the cash is staying at their bank during the rehab.

Third: I’ve done this a million times (though never with a bridge loan).

Fourth (and most importantly): We have investor commitments for the $700k we need for the construction, so they’re not loaning to 59% LTV… they’re loaning to $1.2MM / ($2.05 + 0.7MM) = 44% of the total capitalization of the project.

The above is pretty much all you need to ascertain that, yes, there is plenty of security for the loan.

Do you know what would happen if I didn’t pay back the loan:

  1. They would take the building back from me at a basis of $1.2MM plus whatever it would cost to foreclose. They could turn around and sell it for $2-2.1MM that day;
  2. I would lose the ability to work with this investor ever again; and
  3. I would have a foreclosure on my record, dramatically increasing the difficulty of accessing capital for a long time to come.

In light of the above, what are the chances I don’t pay this loan back? Zero, right?

You’d think this would be a simple “yes”. But you’d be wrong. Do you know what they’re doing as I write this? They’re messing around with my (very complicated) tax return trying to figure out what my income is. Look back at the information above… where does my personal income come into the security for the loan? It doesn’t.

And that’s the problem with banks: They fall all over themselves to make risky loans that fit into their cookie-cutter boxes, but can’t get out of their own way on the simple ones where the risk is miniscule.

Share