"What's the Deal With Minimum Loan Amounts?"

Read the Full Newsletter Issue 2605

"What's the deal with minimum loan amounts?
I would think a loan is a loan is a loan."

Just like when you, Real Estate Investor, have target returns and strategies to meet those when you decide to make an investment, so do lenders. Of course. So, let's work backwards.

Let's imagine that I am a fund manager targeting a specific return for my investors. In order to attract these investors and their money, I have committed to buying certain types of loans, with some specific risk tolerance guidelines, that should yield the target return I have promoted. To fulfill my commitments to the cash investors who have trusted me with their funds, I need to have a reliable pool of loan originators who will make loans according to the guidelines I have set, and sell those loans for me to manage in the portfolio I have assembled. I tell these loan originators that if they make loans according to my guidelines, I will buy $30MM of them per month.

The loan originators love this! Perhaps, for example, they have calculated that $30MM in loans per month will bring them about $300,000 per month in revenue. (These are completely made up and arbitrary numbers for the sake of describing this flow of funds.) The loan originators have expenses in their business, like all businesses do. They have underwriters, processors, a building, and electric bill, etc. They have calculated that each loan costs them an average of $2500 to originate before they sell the loan to the fund manager who is actually going to carry the debt. Because they are running a business that they want to be profitable, they determine that they would rather make thirty (30) $1MM loans per month than three-hundred (300) $100,000 loans per month. Why?

30 loans x $2500 in cost per loan = $75,000 in business expenses.
$300,000 in revenue for selling $30MM in loans - $75,000 in expenses = $225,000 in profit.

300 loans x $2500 in cost per loan = $750,000 in business expenses.
$750,000 in expenses > $300,000 in revenue. They don't get to be in business very long.

The originators decide that they need to cap their expenses at a total of $200,000 per month from their $300,000 revenue, gaining them $100,000 in profit.

$200,000 in expense cap / $2500 per loan cost = 80 total loans.
$30MM in loans they can sell to the fund manager / 80 total loans = $375,000 minimum loan amount.

Again, these numbers are completely made up and totally arbitrary just to illustrate the point of why minimum loan amounts exist.

As an individual contributor, it costs me pretty much the same number of hours and mental energy invested to make a $1.5MM loan as it does to make a $150,000 loan, and I earn 10 times as much on the $1MM loan. I have the same license, the same laptop, the same phone number either way. But I'm not nearly as picky as the fund managers, so I'll make as many of both as they'll let me!

For those lenders that have lower than market average allowable loan amounts, by necessity, they must also have higher than market average interest rates and fees.

I wrapped up the conversation with the client who asked me about minimum loan amounts by telling him, "It's pretty much the same reason that you can't buy a 4 pack of toilet paper at Costco. You can get a 40 pack, but not a 4 pack."

Please note: the minimum loan amount that has been set for me is (mostly usually) $150,000.

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Do you have questions about DSCR loans or want a quote? Email me at [email protected], or click HERE.