Q: My wife and I have excellent credit scores and secure incomes and yet we have been unable to refinance some rental residential properties that we own because appraisers are not able to locate comparable properties.
Our current 30-year mortgages are around 6.75 percent and the current market rates for such properties are at least one percent lower. But our town is so small there are few, if any, sales to use as comparables.
When we approach potential lenders they are invariably eager for our business (and eager for our deposits) but only after we have spent days tracking down and filling out all the required forms, are we then told: “We are sorry but the appraiser was not able to find comparable properties sufficiently close in time and distance to appraise your property.”
I further emphasize that we were disqualified, not because the comparable values were too low but because they could not be found. I will also add that although we are near retirement age, we intend to hold onto these properties for many years to come and plan to live nearby and one day manage the properties ourselves.
A: You are between a rock and a hard place. If a lender can’t get comparables to determine what your properties are worth, that will make it very difficult for lenders to refinance these properties. But you already know that.
While you did not indicate the types of lenders you approached to obtain the loans on your investment properties, you might want to try your local savings and loan to see if they have a better feel for the market in your area and are perhaps more willing to lend money to your community.
(Of course, many local banks and savings and loans have been hit hard with bad real estate loans made to local developers and may not be in the position to do any lender at the moment.)
If you’ve tried your local banks and were unable to get anywhere, your options might be limited. You didn’t indicate how long you’ve had your loans in place. If you have had the loans for some time, you should consider whether the reduction in the interest rate is enough to overcome the expense of refinancing the properties. While there may be some benefit, it may not be enough to recoup the costs of refinancing your investment properties.
Usually, lenders charge more to refinance an investment property than your primary residence. Their fees may even include upfront points and other charges.
Please consider these fees and the length of time you have had these properties before you decide whether to keep searching for another lender. If you have had these loans 10 years, you’ll be done paying them off in about 20 years.
If you refinance into a new 30-year loan, your payment will be much lower, but you will end up paying another 10 years of interest. To compare apples-to-apples, you’ll need to compare the interest rate on any new loan you could get but amortize the amount you are refinancing over the same length left on your current loan.
When you compare loans this way, you effectively can compare the monthly payment on both loans and determine how many payments it will take to pay off the expenses of refinancing the investment loan.
Finally, while the appraiser or appraisers couldn’t find comparables, there are three methods for evaluating investment properties: (1) finding comparables; (2) the income method; (3) the replacement method.
The income method means the appraiser looks at the income generated by the property to determine its value. In using the replacement method, the appraiser determines what it would cost to replace the property if it needed to be built from scratch today.
Using these other methods allows a lender to determine if a property is worth even what comparable properties say it’s worth. If the income for a property is quite low and the income method says a property is only worth $100,000, even if there are comparables for $300,000, the lender should be suspicious of the appraisal.
With the replacement method, if it would cost about $300,000 to rebuild the property, the bank and appraiser can use that as a guide for determining the property’s value.
All three methods taken together are used to gauge the value of the property. When one of those methods is off, the appraiser may have a hard time evaluating the property, but the bank will need to make a determination if it’s willing to accept other properties that are income producing in the area, while not comparable in size or type, but are useful in determining the value of your properties.
It seems as though you might want to speak with an appraiser who specializes in investment property or ask a local bank if they would approve of using an appraiser who understands these other methods of evaluating investment property.