The majority of today’s traditional commercial mortgage lenders will require applicants to provide their tax returns as a basis for their loan’s approval.
This is a major pain point for investors and small business owners. It’s also an opportunity to provide real value as a commercial loan solution provider.
If you can identify situations where a prospective borrower may not have to provide tax returns and other types of documentation to get qualified for financing, you’ll have a better chance of closing more loans each month.
But that’s not all. Understanding the different types of reduced documentation solutions available will also help you determine when a full documentation solution – that is, one requiring tax returns – meets the greatest number of borrower needs.
Here are some key questions and answers regarding light or reduced documentation commercial loans. Keep them in mind the next time one of your borrowers struggles to meet bank documentation requirements.
1. Why Do Lenders Require Tax Information?
In short, tax returns help lenders gauge all sources of the borrower’s income, verify their revenue, track any business losses, and determine the applicant’s overall eligibility for the loan.
This works in the best interest of traditional banks who seek to guard against fraud and ensure their borrowers are fully able to repay the loan amount plus interest.
2. Why do Borrowers Struggle to Provide Tax Returns?
Investors and small business owners often have difficulty producing the amount of documentation traditional lenders require, though not always for the same reasons.
Perhaps the most common issue has to do with the tax write-offs real estate investors and self-employed professionals can take advantage of each year. The way these borrowers report on their income can negatively impact the DTI (debt-to-income) calculation a lender is likely to run when qualifying financing requests.
But prospective borrowers have other reasons for chafing against tax return requirements. Some have experienced significant fluctuation with their business profits that is not reflected on their latest tax return, while others would simply prefer to provide as little as possible when seeking a loan.
3. What is the relationship between documentation and monthly interest rate for commercial loans?
A general rule of thumb: the more documentation borrowers are willing to provide, the more likely they will be to secure the lowest possible interest rate for their commercial loan.
To be sure, every piece of additional information helps a lender feel more confident about their approval decision. And with less risk, the lender can offer a more attractive solution for a prospective borrower.
That being said, non-bank lenders in the small-balance commercial arena recognize the demand for alternative solutions that allow a greater number of investors and business owners to get approved for financing.
As a result, lenders have begun to offer reduced documentation or stated income solutions with competitive pricing.
While these loan products can’t match full-doc alternatives when it comes to rate, they offer more overall value for a wide range of today’s borrowers.
4. What are Common Reduced Documentation Loan Options?
Traditional lenders, like banks, are likely to offer only full doc loans. On the other hand, non-bank alternative institutions can offer a range of solutions based on the amount of information a borrower is willing to provide.
Stated Income Loans: On the far end of the reduced documentation spectrum are stated income loans, which are typically offered by private, or hard money, lenders. The underwriting for stated income solutions typically involves a review of the borrower’s credit and the subject property’s cash flow. These types of loans often close in a short period of time and carry the highest interest rate.
Light Documentation Loans: This a blanket term that describes a wide range of solutions offered by non-bank lenders. Generally speaking, lenders will review some combination of the borrower’s credit and their property’s cash flow and appraisal.
Bank Statement Loans: A smaller subset of commercial lenders offers an additional alternative solution that allows business owners to qualify for financing via business bank statements. This is often a preferable solution for owners who feel as though tax returns don’t tell the whole story of their business’s success.
As an example, Silver Hill Funding, LLC offers a bank statement solution that calls for 12 consecutive months of business bank statements in lieu of tax returns.
5. How Can You Tell Which Solution Best Meets a Borrower’s Specific Needs?
No two situations are the same. A good commercial mortgage broker always takes their client’s unique situation into account in order to provide a solution that meets the greatest number of needs.
It’s vital to analyze each client’s request on a case by case basis in order to point them in the right direction. If you’re interested in improving your skills in this area, see our Definitive Guide to Qualifying Commercial Loan Deals.
Ultimately, the key to identifying the best reduced documentation solution for your borrower will come down to your understanding of their needs and your familiarity with the lending options in the current market.
To learn more about Silver Hill’s non-bank loan solutions, see our Program Overview page.