What Is a Supplemental Loan?
A supplemental loan refers to obtaining a secondary loan on your property on top of the senior debt in order to pull out equity and re-leverage the property.
Let’s say when you originally purchased the property you received a 75% LTV loan and by year 4 your LTV is now 65%. A supplemental loan will allow you to get a secondary loan on the property to pull out the 10% of equity in the property and re leverage the property back to 75% without having to completely refinance to prevent paying pre-payment penalties.
*This article will focus on supplemental loans on Fannie and Freddie products with a section in which we discuss supplemental loans on community banks. Please reach out to us at email@example.com for questions supplemental loans for alternative products.
Table of Contents:
- The most important thing to do when considering a Supplemental Loan
- Supplemental Loan Terms
- LTV limitations
- Minimum loan amount
- Interest Rate
- Amortization vs. Interest Only
- Supplemental Loans from Community Banks
What is the Most Important Thing to do when Considering a Supplemental Loan?
Overall, if you want to make sure you fully understand the details of a supplemental loan, the most important thing to do is to speak to the lender that is currently servicing the loan. As I was once told “There are the rules and then there are the exception to the rules”. While there is a general framework of supplemental loans there is no exact answer to each question as each deal, borrower, and lender will be a little bit different. If you are going through an assumption, make sure to speak with the lender servicing the current senior loan and ask about the terms and possibilities of the supplemental.
In order to provide a general framework, we have put together a chart of terms below and answers to common questions however we cannot stress enough the importance of having a conversation with the lender who services the in place loan.
Supplemental Loan Terms
|Fannie Mae||Freddie Mac||Community Banks|
|Minimum loan Size||$500,000||$1,000,000||No Minimum|
|Rate||100 to 125 bps above standard pricing||100 to 125 bps above standard pricing||15-25 bps above standard pricing|
|Term||5 – 30 year may or may not be coterminous with original Fannie Mae mortgage||Usually will be coterminous with original mortgage||Usually will be coterminous with original mortgage|
|Amortization||Up to 30 years||Up to 30 years||Usually will be coterminous with original mortgage|
|Interest Only Options||Yes||Yes||Cases by Case|
|DSCR||1.30x (may be more under certain circumstances)||1.30x (may be more under certain circumstances)||Case by Case|
|Timing||45 – 60 days||45 – 60 days||30-45 days|
|Pre-Payment||Matches Senior||Matches Senior||Matches Senior|
|Costs||Typically requires $10,000 in lender fees for 3rd party reports and lender legal. 1% Origination Fee $8,000 to $12,000 of legal fees.||Typically requires $10,000 in lender fees for 3rd party reports and lender legal. 1% Origination Fee $8,000 to $12,000 of legal fees.||$5,000 – $8,000 in lender fees for 3rd party reports and lender legal.1% Origination fee $2,000 to $3,000 of legal fees.|
How much seasoning is Required on Supplemental Loans?
Both Fannie and Freddie will require at least 12 months to pass after the closing of the senior loan or the most recent prior supplemental loan. If you are assuming a loan as long as at least 12 months have passed since the original borrower originated the loan you can immediately apply for a supplemental after assuming the original loan.
What is the Loan to Value limitations on Supplemental Loans?
For the most part your supplemental loan will be limited to the original LTV of the senior loan. For example, if 4 years ago when you bought the property you received a 70% LTV loan and now your total LTV is 60% due to the principle pay off and increase in value, you are still only able to re-lever up to a total of 70% LTV with the new supplemental loan. The main reasoning for this is due to the senior loan receiving an interest rate based on a 70% max LTV therefore, if the supplemental loan allowed you to achieve a 75% LTV then the level of risk and interest rate would be in an imbalance from the lender’s perspective. Additionally, the loan was probably limited to a 70% for a specific reason whether it was due to the market or property type and that reason is most likely still there when applying for a supplemental loan.
There are scenarios where you can surpass the LTV of the original loan. To account for the imbalance of the new total leverage and the interest rate on the senior loan the lender will mark up the interest rate of the supplemental loan. The mark up will depend on the level of perceived risk in the eyes of the lender which is why it is vital to speak with the lender servicing the loan to understand what their perception is.
What is the Minimum Loan Amount on Supplemental Loans?
The minimum loan amount is important to be aware of because if you are limited to a max LTV of 70% or potentially even less you need to make sure you are able to meet the minimum loan amount requirements. Fannie Mae’s minimum loan amount is $500,000 however some lenders will not do less than $750,000 and Freddie Mac’s is $1,000,000. So, if you are only able to obtain a 70% LTV and that would equate to about $500,000 in additional proceeds you may not yet have enough room to obtain a supplemental loan.
What is the Interest Rate on Supplemental Loans?
Each loan will be priced on a case by case basis however any additional debt on a property has a slightly higher risk level as well as it will generally be a lower loan amount so the lender will want to price the interest rate slightly higher. A good rule of thumb is 100 to 125 bps above where current senior loans are pricing.
Are Supplemental loan Interest Only or Amortizing?
Typically, they will match your current senior loan. If you have 3 years left of interest only on the senior loan, then they will match the supplemental with the amount of IO on the senior loan.
What Costs are Involved on a Supplemental Loans?
For the most part the costs for doing a supplemental loan are the same as if you were originating a brand-new loan. On most occasions you will have to pay for a new appraisal, engineering report, 1% origination fee, and legal expenses. If you recently ordered any of the 3rd party reports, you may be able to re-use these reports and save on those costs but that would be outside of the norm.
Do Community Banks offer Supplemental Loans?
Yes, community banks will offer supplemental loans however they will generally refer to them as a “second lien”, it is the same thing just different terminology. In most scenarios banks will be less likely to provide a second loan solely to pull cash out. The banks we have spoken with want to see the equity put towards the property in the form of capital improvements, but a good banking relationship will do what it takes to help out their customer.
Since Pre Payment penalties are mostly zero to none on community bank debt a lot of the time it may make more sense to refinance rather than get a second lien on the property since you will probably still have to order 3rd party reports and pay similar closing costs.
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