In this strong seller’s market, many investors are turning to rehabbing houses since you can sell them quickly – and usually at slightly above market prices.
It’s a great strategy to maximize the profit from each deal that you find. Wholesaling is fantastic, but if deals are limited, you want to pull as much profit as you can from each deal.
I am seeing more and more of my private mentoring clients switching to this strategy. As they work to get loans through Hard Money Lenders they are finding that the terms of the loans are a bit confusing. I thought that I’d share with you what I have been sharing with them.
Here are some of the different terms that show up in these loans offers and it is important that you understand the implication of each and how it affects the funding of your project.
Interest: This one is pretty straight forward – it is the price you pay for the use of the money for just the time you use the funds.
Points: A fee charged at the inception of the loan as a cost of getting the loan. Each point is 1% of the loan. So a $100,000 loan at 3 points equates to a $3,000 fee. Points are fully earned at the beginning of the loan. In other words, unlike interest, points are not based on how long you have the loan. So whether you keep the loan for 1 month or 1 year, the fee remains the same.
Something to consider…if your loan will be outstanding less than a year, it is better to pay an additional percent in interest than an additional point.
Amount of Loan: Lenders base their total loan amount using Loan-To-Value (LTV) ratios. Most Hard Money Lenders (HMLs) will loan between 65%-75% LTV. The difference is that they typically utilize the After Repair Value (ARV) versus current market value or purchase price.
However, a new trend if for HML is to also add these ratios as well – Percent of Purchase Price and Percent of Rehab. For example, they will say that they will loan 90% of Purchase Price and 100% of Rehab up to a total of 75% ARV. What this means is that they will never loan more than the 75% ARV, but even if the LTV is under that mark, they still want you to come up with a percentage of the Purchase Price and the Rehab Costs.
Prepayment Penalty: It’s a good idea to make sure that your loan does not have a prepayment penalty – which is a penalty the lenders adds to the payoff amount if the loan is paid prior to a certain date. Sometimes this penalty is just during the first three months of the loan which is generally fine for a rehab project. Other lenders assess the penalty unless you pay on the exact day it is due. It is a sneaky way for them to increase fees.
Prepaid Interest: Many HML require that you set up an escrow account and prepay some of the interest. Typically none of this escrow can be used towards the actual monthly interest payments. It is just a security for the lender and will reimbursed to you when you pay off the loan.
Term of loan: The length of time until the loan is due. Rehab loans are usually one year or less. Sometimes a lender will offer a 6 month loan with an automatic 3 month extension for a specified fee. It is important to know the term of the loan to ensure it fits in with your rehab plan.
Rolled In Costs: Some HMLs will allow you to roll in the cost of the points into the loan – although most will not for a first time borrower – as long as the total loan does not exceed the LTV cap.
Repair Escrow: What many first time borrowers don’t realize with HMLs is that they do not release the rehab funds at closing. Instead these are placed in escrow and released as the project work is completed. It is important to know how often draws will be released and what is the fee for each draw. Remember, you have to front the money for repairs until the next draw. You will not be made whole until the entire project work is completed.
Out of Pocket Cash Requirements: It is important to consider your total out-of-pocket cash requirements which include: the percentage of purchase and rehab not covered in the loan; closing costs; points; prepaid interest; and working capital for the project between draws. The sum of these is the additional cash you’ll need to fully fund the deal.
Subordinate Mortgages: A great way to fund this difference is with smaller private loans. HMLs will always require their loan to be in first position. Some also add the requirement to be First and Only – meaning that you cannot place subordinate mortgages on the property, thus eliminating your ability to secure
Time to Close: Press the Lender form the beginning to understand the entire close process and how long it will take to close from the time the application is submitted. You’ll want to know how long it takes to obtain approval, and then how long before they are ready to close and fund the deal.
Armed with this better understanding of the loan process you should be able to consider multiple lenders and make an informed decision about the ones who best meet your needs. There is far more to consider than just which provides the cheapest interest rate.
Expect abundance,
Lou Castillo
