A hard money lender makes short-term loans based on the value of an asset, in this case a property, with little regard to the borrower’s credit and/or finances. Hard money lenders charge higher interest rates than standard banks due to the high risk nature of these loans. Unlike traditional banks, hard money lenders can provide funds quickly, usually in 10-14 days, to purchase and rehab distressed properties. These properties can be in need of significant repairs or be in various stages of foreclosure. This makes these loans popular with first time real estate investors that have little working capital or poor credit scores. Look to use hard money loans to rehab foreclosures as your means to purchase and rehab your first couple properties.
Hard money lenders will only provide loan terms of 4 – 6 months at which time the investor has to sell or refinance the property. It is EXTREMELY important that the first time rehabber have a rock solid exit strategy, otherwise his rehab investments will soon belong to the lender. Not having a SOLID exit strategy is the biggest and most common mistake that a newbie home flipper can make when utilizing hard money. If this happens to you, work with your lender to get at least a 6 month extension and ask them for referrals to end-lenders that specialize in refinancing these situations.
In order to refi the hard money loan, you will need to find an investor friendly lender that has no seasoning requirements and will appraise the property in its newly remodeled condition and not at its most recent sale price. Also, do not list the property on the MLS (multiple listing service) if you are planning to refinance. Lenders will not refinance a property that is currently for sale. The bottom line is that you either have to have the property pre-sold pending completion of repairs or have guaranteed refinancing in place. Otherwise, you are setting yourself up for failure.
A typical hard money lender will lend up to 65-70% of the after repaired valve (ARV) of a distressed property. The ARV is calculated by the lender’s appraiser and is based on an expedited sale scenario in case the lender has to foreclose on the property and resell quickly. This gives the lender the safety margin needed to minimize their losses when things turn sour.
100% of Rehab Funds
The lender will typically provide 100% of the rehab funds needed to make the property saleable or rentable as detailed in your rehab estimate that you will provide to the lender. This rehab estimate needs to correctly address the rehab plan in its entirety. It is very difficult and time consuming to ask for more money in the middle of a project because you missed something in your initial estimate. It often makes more sense to fund that portion out of your own pocket if possible. Otherwise you most likely will be waiting for another appraisal and/or underwriting (or committee) approval for the additional funds.
The rehab funds will disburse in 3 – 4 draws as work is completed throughout the project. Most hard money lenders will not issue your first draw until a portion of the home rehab has been completed. Work with your contractor to have him put up the initial money to start the project. If your contractor refuses or says he has no money then you shouldn’t be using him in the first place if he is that poor. Be wary of giving unknown or untested contactors money upfront in order to start construction. You will get burned eventually.
High Interest Rates
Depending on the lender, the down payment will vary from 0 – 10% of the purchase price and the origination points will also vary from 0-10% of the purchase price. Interest rates will typically vary from 13 – 18% and will be charged on a monthly basis on your outstanding balance (only the money you have actually used).
Hard money lenders vary greatly so the newbie rehab investor must shop around to find the best programs out there. Local rehab clubs and real estate investment groups are a great source for finding hard money lenders you can trust. Be wary of unscrupulous private money lenders and expert real estate investors that drive themselves around in their own limos. This may sound funny, but you wouldn’t believe how many crazy people are out there. Stay away!
I have personally purchased HUD foreclosures with only $500 out of my pocket using a hard money lender to finance the whole project including all closing costs. Once you have some cash in your pocket, look for cheaper ways to finance your deals. Community reinvestment banks are who you need to develop relationships with next.
Example of Hard Money Financing:
After Repaired Value (ARV) is $90K
70% of the ARV is $63,000.
As long as the total loan amount is less than $63,000 the deal will work.
Bank foreclosure (REO) purchased for $25K
Rehab Estimate is $30K
10% down payment on purchase price is $2,500
4% origination is $1,000
Closing, attorney, insurance, titles fees – $2,000
Total loan amount in this case would be $55,500 (assuming the lender rolls in closing costs and points). This deal will work every time.
Note: Remember to subtract your down payment from the calculation of the loan amount. Depending on the tax pro-rations (in most states the seller has to give you the prorated amount for the current year’s taxes) you may not have to bring the full down payment to the closing table.