Many people watch their local real estate market blossom, and see friends,
neighbors, or colleagues making money and wonder what they need to do
to participate. There are ways to use traditional financing to buy investment
properties, but if you are entering a hot “fix-n-flip” market,
you do not usually get the latitude to wait for bank approvals. Buying
and selling investment property requires finding deals and making immediate
financial decisions. In this market, waiting on financing could mean the
difference between making thousands in profit or missing out.
Private money (‘hard money”) is a financing option available
to investors where lending requirements are based more on the asset rather
than the borrower. Sure, credit history and financial stability matter,
but if you have an investment property with a high upside or at least
a reasonable loan to value, that asset can be used to qualify for a private
loan. While a hard money loan is a good option, it is not without cost.
You should borrow only what you need to make the purchase and rehab the
property, and use the money no longer than is necessary. A typical hard
money loan can offer a term from anywhere between 6 to 12 months, but
if you pay it to offer sooner, you will save yourself considerable interest.
What is Hard Money Lending?
Hard money lenders use investor capital (or their own) to fund the loan.
So, since they make the rules, their terms are usually entirely different
than from traditional lenders. First, expect to pay about double the interest
rate you would see from a mainstream bank. Interest rates from between
12 to 16 percent are to be expected, including points. Up-front fees and
points are usually charged by the lender to pay the loan officer, as well
as protect the lender for early termination (payoff). Since hard money
loans are typically used for short-term finance, the lender expects to
get their funds repaid sooner rather than later. This uncertainty about
the term of scheduled interest payments is calculated into the closing
costs in the form of points, as a percentage of the total loan amount.
These points can add up quickly depending on the property type and qualification
of the borrower and can be in the range of from three to six points total.
Why Use Hard Money?
Hard money loans are a good option for fix and flip properties because
of the easier qualification criteria. These loans can usually be closed
within a week’s time, provided you have all your paperwork in order.
This short funding schedule allows investors to make quick decisions on
the purchase of an investment property. Even if it is a property that
you plan on renting, a hard money loan can enable you to close the deal
and work on refinancing options later, once you have a tenant. You may
also be able to get more purchase money than you would typically see from
a bank loan. If the property is a fixer, most private lenders will base
the loan amount on the after repair value (ARV), or the amount the house
will be worth once it is renovated. So, you may be able to qualify for
a loan that is say 75% of AVR, and not based on the purchase price. This
technique gives an investor more options and more opportunity when seeking
out an investment property that will offer the best profit potential.
How Hard Money Loans are Structured?
There are a couple of different scenarios that can happen with a hard money
loan. You can decide to pay a down payment, obtain a hard money loan for
the difference, and pay for all repairs out of pocket. Alternatively,
a second option would be to obtain a loan amount greater than the purchase
price, based on a significantly higher ARV, and use the extra cash to
pay for the remodel. In the second option, the loan would work more like
a construction loan, paying contractors directly for repairs or paying
invoices for major purchases such as appliances. The lender may be able
to structure the loan to pay 25% of the renovation cost to the borrower
at closing and allocate the rest in 25% increments as the rehab progresses.
Depending on the lender, you may also have the option to pay all the points
and fees after you sell the property, similar to a balloon loan. Finding
the right private lending partner will allow you to explore all the different
financing options they are willing to offer. And building a relationship
with a quality private lender is key to obtaining financing when you need
it, and with the most favorable terms.
Other Financing Options
Other financing options could include borrowing money from friends or family,
or possibly even using money that you have sitting in a retirement or
IRA account. An IRA account typically offers a set annual interest rate
based on the type of investments empowered to your financial advisor or
accountant. Using the funds from an IRA account to purchase investment
property can be a good plan for both flip houses and prospective rental
properties. By the numbers, using IRA funds for investment property buying
can be much more profitable for your retirement plan than collecting simple
interest. You are essentially borrowing money from yourself and paying
it back at a much higher interest rate than you would earn from a traditional
IRA account. Even if you decide to sell the renovated property and carry
the loan for the new buyer, you can pay yourself back over a 30-year term
at triple or quadruple the interest rate you were previously earning.
While every real estate market is different, becoming an investor could
provide much better returns than you could ever get from traditional investment
accounts. With current CD rates hovering around 1%, investment properties
can be a sound way to diversify and build a stable retirement faster than
you would ever be able to do otherwise.
Keep in mind that real estate investing is not for everyone. Knowing your
market, researching the costs associated with renovation, and understanding
the costs and fees related to financing the properties are the first step
for any person considering this type of investment. However, rest assured,
if you find that real estate investing is for you, there are many innovative
and opportunistic financing options available to help make your dream
Geraci Law Firm is one of the few law firms with true expertise representing
hard money lenders across the country for loans secured by properties
throughout the country.