Your acceptance of risk as an entrepreneur makes your personal balance sheet profile greatly different from most professions. You chose a non-W2 earning lifecycle where cash flows and earnings vary greatly. Financing a home as an entrepreneur warrants a mortgage lending discussion with a distinct understanding of atypical finances. Like most SVB Private Bank clients, you require a mortgage advisor familiar with venture financing, private equity, and post-IPO planning who can help make home financing a simple and smooth process.
First a holistic financial review
To navigate home financing decisions, it is best to discuss your unique balance sheet and cash flow projections with a trusted mortgage advisor. This will uncover how to optimize interest rates, maximize purchasing power, strategize on expenses and highlight expected liquidity events. The goal is to explore home financing in a way that supports your immediate needs while being mindful of long term projections.
Together you'll review how stock options, bonuses, consulting income, fund distributions or other variable income are considered through the lens of qualifying income. In a scenario where income is very strong compared to debt, the post-close liquidity requirement is less of a concern for approval. The opposite is true when cash flow is tight; more reserves are required to mitigate the risk of income loss.
With much of your worth tied up in private assets, entrepreneurs are in a unique position. In addition to rarely understanding the entrepreneurial life cycle, non-portfolio lenders (retail lenders) often run into roadblocks once they learn a borrower owns >25% of any company. Those same retail lenders often sell the mortgage to third-party institutions and may or may not service the ongoing payments themselves; adding another layer of scrutiny.
We are looking at buying a house, but every lender I’ve talked with is asking to collect tax returns on my company because I own more than 25%. They are treating the company’s cash burn and expenses as if they were my own and eliminating the possibility of qualifying for a home purchase.
In this scenario, SVB Private Bank was able to help this client purchase a home for their family, and provide additional guidance and planning around the expected IPO liquidity event.
The appropriate loan structure for you
The traditional 30-year fixed rate mortgage is often the only option from retail lenders as it is one of the most conservative loans available. This type of interest rate protection often has a trade-off in the form of a higher rate, or even pre-payment penalties. When you’re comfortable self-insuring against interest rate exposure due to a plan to rebalance debt and assets in the coming years, paying a rate premium for a longer term fixed rate may not be ideal. This is especially true for first-time home-buyers, those expecting future liquidity events or those planning to sell the property in less than 10 years. While still a 30-year loan term, a 5/1, 7/1, or 10/1 Adjustable Rate Mortgage (ARM) may be the optimal solution.
Things to review: An ARM is the preference of most entrepreneurs due to lower initial rates and monthly payments, rate adjustment maximums and interest only payment options. After the initial fixed-rate period, the interest rate adjusts annually to a specified index plus margin. However, these rate adjustments are capped offering you some protection; typically there is a 2% maximum rate increase per year and a lifetime rate cap of 6% above the initial fixed rate. ARMs can be structured with a set amortization schedule consisting of principal and interest payments for the full 30 years or with interest-only payments, typically for the first 10 years of the loan. Fully-amortized structures will maximize your purchasing power through lower down payment requirements and a longer amortization schedule, while interest-only structures will offer lower initial monthly payments and greater flexibility with cash-flow planning for principal reduction.
The power of a good pre-approval
Pre-approvals are important negotiating tools, and mortgage advisors who provide fully-underwritten, credit committee-approved pre-approvals will help give you (and the seller) confidence when you decide to forego a finance contingency in your offer. Through the underwriting analysis, you and your mortgage advisor will uncover if you have additional borrowing capacity or if there is a need to right-size your maximum purchase price.
Things to review: Ensure you have a fully-underwritten approval. With a fully-underwritten approval, you can demonstrate your preparedness, strength in your ability to perform, and focus on negotiating the purchase terms rather than your ability to obtain financing.
If you have a meaningful equity position in your existing home or are expecting a windfall of liquidity, you may be able to strengthen your negotiations by offering an all-cash purchase by leveraging a short-term bridge loan or a securities-based line of credit. Your mortgage advisor can discuss these tailored strategies with you, and they just might give you that differentiation you need to win a bidding war in purchasing your next home.
Refinances and HELOCs (Home Equity Line of Credit)
Many factors play a role in deciding how much and when the timing might be right for you to refinance. Refinancing for an attractive rate, perhaps a new term, pulling cash out through a new mortgage, or layering in a HELOC can be advantageous in any rate environment.
Things to review: current rate versus prevailing rates, consolidating short-term debt into a lower rate, expected changes in cash flow, and interest deductibility. This might also be a great way to finance a home remodel or provide additional capital for investment fund commitments.
A HELOC is unique in that you will only pay interest due on the principal balance of the line amount. If you layer in a HELOC while you are refinancing your mortgage, you can potentially save on additional closing costs (appraisal, title fees, etc).
Tax implications are a key consideration when obtaining a new loan. It’s important to review interest tax deductions available to you with your CPA, whether you are buying a new home or refinancing an existing mortgage. See our article highlighting deductible interest beyond the mortgage interest deduction limits.
Asset protection through estate planning is another important discussion during any real estate financing exercise. Planning experts recommend you vest title to your home in the name of your family trust. If you do not have a trust established in time for the closing, you can still transfer the title into the name of your trust post-acquisition. Consult a trusted estate planning attorney.
As part of the holistic planning, be sure to discuss other life events that can impact your decision, such as starting a family, a spouse re-entering the workforce, or even working for a stealth startup with fluctuating cash flow.
Talk to your mortgage advisor
If you are considering purchasing a new home or refinancing an existing mortgage, your Relationship Manager can introduce a mortgage advisor to help you find the right mortgage to fit your unique financial situation.