One of the most common methods to fund a fix and flip project is to request a short term hard money loan. The professional house flipper is looking for short term capital to buy, rehab and sell the property quickly. This type of lender fulfills this need as they are most interested in a secure loan with a high interest rate. The loan is secured by the property and the investor will pay monthly interest payments until the project is complete.
It’s important to understand the steps and requirements for an investor to acquire a hard money loan. Planning and execution is of key importance as the lender wants to see a plan and someone who can execute it properly.
When preparing to flip the first house it’s important to do your homework and accurately estimate the costs of the entire project. A hard money lender will be charging high interest plus points and most likely requiring a monthly payment schedule. These numbers can be reduced if they recognize a committed investor with a plan even if the buyer has bad credit.
There are thousands of companies around the country that specialize in lending money to real estate investors and specifically house flipper. It’s a good practice to fully understand what a hard money loan is, how to request it and what to expect from the lender.
What is Hard Money
Hard money loans or rehab loans are loans from private investors instead of a bank. These money lenders are more flexible in regards to the qualifications for the loan, the time period for funding and credit or financial requirements for the individual. Loans are usually higher in interest but funded much more quickly, usually within a week and sometimes can be reduced to days.
This type of lender are more flexible but they do have requirements. Expect that the lender will only lend up to a certain percentage, such as 70-90% of the current value (LTV) of the property. Other will lend up to 75% of the after repair value (ARV) . Normally each loan is handled on a case by case basis so the same deal may not apply to another property in the same way.
Hard money lending is good for borrowers with questionable credit and those who can’t arrange financing through other methods. The lenders make money on short term interest so they are there t hep you succeed not just add another road block.
Loan to Value & Interest Rates
The loan to value (LTV) is a comparison in percentage of the loan amount and the actual price of the property. The lender is more focused on the value of the property when issuing the loan and terms.
Lets say the price on a distressed property is $70,000, to buy this property the hard money lender will offer 80% LTV so 80% of $70,000 is $56,000. The investor will need to come up with the remaining $14,000 as a down payment to buy the house.
Each lender will have different policies and they will charge higher interest rates usually in the neighborhood of 10% to 20%. In addition expect points to be charged if your new to the business or a first time flipper. Points are just interest rate percentages, they can vary from 2-5%.
Most of the hard money lenders I found had terms from 1-5 years where 1 year was the most common especially for the house flipper. The average hard money loan has a one-year term, although longer options are available.
Buyer Requirements
The hard money lender provides a short term loan that can be approve for less qualified borrowers. Less qualified can mean many things such as a credit score under 600, low or no income and possibly bankruptcy. Loans are considered on a case by case basis so each project may have different terms and interest rates but there are some common requirements I found for each hard money lender.
Part of the benefit in using hard money is avoiding the traditional bank red tape that includes credit reports, income statements and an approval process that takes 45 days or more.
The borrower will be required to create a plan for how the property will be fixed and returned to market value. It should also show how they intend to payoff the loan after the property has been sold. The plan should describe the work to be done for each room as the scope of work. The lender will also want a list of the contractors and possibly verification that they are licensed and insured contractors.
Normally the hard money lenders are not concerned with the buyers credit report or tax returns so they usually do not ask. On some pages though I did find that they may look for credit scores over 550 or 600 if the buyer is a first time flipper. They really want to see experience, which is tough for the first timer, but an excellent plan along with a great team can sway them. It’s best to ask what their approval process is and the exact criteria to avoid surprises.
Hard Money Planning
Planning to request a hard money loan is more than just filling out a form and waiting to see. Each case or property is treated differently as they have differing situations. The house price, repairs required, contractor work, market timing and more are important to a successful flip. The lender is looking for someone who can complete the work and give them a return on their money without needing to take possession of the property.
They are very cautious as to who and what they are lending for so documenting your plan is important and valuable. If you have already created a scope of work for the project then this will be easier to finish.
This is like a business plan with more detailed milestones. I added this under the Planning section because this is something that can be submitted to the lender when you are a first time flipper to show that you are organized, with a plan and a team that can complete it.
Be as precise as possible and include rooms, the work to be done there and the contractor that will perform the work. The person reviewing your document should be able to easily see the work to be done, the cost and an approximate time line for everything.
- Summary
- Property Details
- Market Comparative Analysis
- Your Team
- Real Estate Agent
- Contractors
- Accounting
- Schedule
- Buying or closing
- Work for each milestone (rooms, repairs, inside and outside)
- Staging and sale
- Exit Strategy
- Cash out refinance
- Fix and flip
They generally extend the loan in parts so completing each stage or milestone may be how you get to the next round of funding. First, they’ll give you the money for the home purchase and the first set of renovations. Once the contractor completes initial renovations, you’ll get the money for the next set of renovations, and so on until the project is complete.
Earnest Money
Earnest money is a deposit given to the seller in good faith and will need to be included in the purchase amount stated to your lender. It is not required but often requested. It can be said that the property is now ‘under contract’. It is important when buying the property as you pay this deposit in promise to purchase the house and you now have ‘skin in the game’. The amount and when it becomes ‘nonrefundable’, (option period) is stated in the initial home offer.
The amount is negotiated with the seller and there are posts showing from $5 – $5000 within a 10-30 days. The typical percentage I found were between 1% and 5% of the properties purchase price. So if put a distressed home under contract to buy for $70,000, you might expect the seller to ask for 2% or $1,400 as earnest money. In the purchase contract this would be subtracted from the final purchase price.
Points
Points are calculated as a percentage of the loan amount and the lender can use this in place of closing costs or in addition to them. The amount is dependent on the loan amount and other requirements the hard money lender has as a policy. When calculating the amount you will need cash and loan, closing costs and possible points should be estimated so it does not appear as a surprise from the lender.
Going back to our $70,000 purchase price, if we assume that the after repair value (ARV) is 100,000 and the lender is providing 70%, they may add 3 points to the loan to cover closing costs. This is 3% or $3,000 added to the final loan amount of $103,000.
Down Payment
When purchasing a new home using a bank and the traditional mortgage there is usually a request for a down payment. This might be 20% of the price of the home and the remaining amount, plus fees, becomes the mortgage balance. The hard money loan can also requrie a down payment at a lower rate. There were minimum rates at 10% of LTV or 25% of ARV.
I found sites stating that they offer 100% of the loan to value (LTV) with no money down but this is usually based on a larger equity and upside available in the property. Each lender will have their own policies on the down payment.
Closing Costs & Fees
Just like purchasing a home to live in, there are closing costs to complete the sale and this is usually payed by the buyer. The lender will also pass the closing costs on to you for a fix and flip project. Above we mentioned ‘Points’ and how the lender can add this to the loan for various reasons and it equates to a percentage point added to the loan.
The closing costs can also be added to the loan in the form of points as opposed to another line item. This should be discussed with the lender so your loan estimates are accurate and there is a clear understanding on where the costs and fees are paid.
The fees seem to be documentation and processing fees that the lender passes to the borrower.
Example Hard Money Fix and Flip
As an example we will use a house with a 100,000 purchase price with a $150,000 selling price or after repair value (ARV). According to the hard money lender we will be limited to 70% of the buy price but will also lend the full 100% of the rehab costs ($20,000). If they would not agree to loan the rehab costs this would need to be provided by the investor.
Here is a simple example of what a hard money loan looks like:
Buy Price: $100,000
After Repair (ARV): $150,000
Loan (70%): $70,000
Rehab Loan: $20,000
Interest Rate: 12%
Term: 12 Month Loan
Closing and Fees: $1,800 (2 points) + $500 fee = $2,300
Loan Total: $92,300
Monthly Payments: $923
If this project takes 6 months to complete, the interest paid in that period of time will be ($923 x 6 months) $5,538. Simply running calculations like this on paper offer a better understanding of where the investor can consolidate, save time and become a valuable resource for an hard money lender.