Real Estate Articles » Mortgages & Lending

Business Credit For Rehab Flippers; Better Than Hard Money Loans?

By: Paula S.
Submitted: 07:04PM on Thursday 28 May 2009

The concept of “hard money” is fairly well known in the real estate investment community. It has its place as an investment finance option when a mortgage loan would be impractical, or in many cases, simply impossible to secure. Hard money funds can typically be obtained quickly to allow an investor to jump on a good deal before another buyer snaps it up.

Real estate investors have a smart alternative to the hard money lender. It is, in many investing situations, a better option for those who currently work with hard money lenders. For the investor expecting to flip multiple properties this option comes with a much lower cost of financing, which is usually realized by the second purchase transaction, therefore leaving a greater profit margin for the investor.

This preferred financing method is called unsecured business credit. The concept of unsecured business credit is simply this; the credit within a corporation is developed to meet the lending guidelines of the banks, lines of credit are applied for and obtained. An investor now has the credit to use for his rehab and flip projects.

Many companies that provide corporate credit depend on adding tradelines to the corporation’s credit report. These tradelines are one of the major points required to meet banks’ underwriting criteria for granting maximum unsecured lines of credit without a personal guarantee.

A better process involves building a strong credit history through actual large dollar transactions. As opposed to buying tradelines, the credit builder generates real truncations that get reported as tradelines to Dunn and Bradstreet and other business credit reporting agencies. Once the corporation has a strong credit report, bank lines of credit are secured.

Business credit isn’t for everyone, and investors need to look at the details. Unlike traditional banks or hard money lenders, business credit programs require one-time origination fees. The fees are sometimes broken up into two payments; one is paid upon submission of the application, the other is paid once the first credit account is obtained. Since the process of developing the corporation typically takes two or more months, the lower the up front cost the better.

Both fees can vary greatly depending upon the credit amount, the broker used and the business credit service provider. Without understanding the process, it’s quite possible that the real estate investor is working with a sub-broker of a sub-broker, of a broker, who is the real entity working with the credit provider. These hidden broker and sub-broker fees can stack up quickly, creating the most expensive entry into the unsecured business credit world. Investors frequently pay $7,500 or more in up front costs, plus 10 points when the program is funded. Ask the right questions, and you’ll find the more competitive, lower cost providers.

Despite what appears to be a large origination cost, investors accustomed to paying large origination fees to private hard money lenders will appreciate one of the crucial elements where business credit differs from hard money - the origination fees are paid only once regardless of the number of properties it is used for. Remember, the credit is revolving, so the funds can be used over and over. A huge cost savings is realized when flipping multiple properties. Even though the business credit origination fee might be larger than a single hard money transaction, the advantages begin to emerge when the investor embarks on the second purchase transaction.

In another notable difference, hard money lenders typically charge a very high interest rate on the outstanding loan balance. When business credit is used, once the credit is obtained, the only debt servicing cost is the interest rate on the outstanding balance which is typically low to moderate, more like that of a non-owner occupied mortgage, usually prime plus 2 to 5%. Because it is the investor’s own credit, or rather the credit of the investor’s corporation, and revolving, it is available for him to use at any time.

The advantage to the investor is that the business credit can be used in any manner, or for any purchases of the investor’s choosing. It can be used across all properties simultaneously. So, if the investor is in the middle of rehabbing Great Deal 1, he can quickly snatch up Great Deal 2 and start work on it, if it happens to come along before Great Deal 1 is completed. Of course, hard money funds are limited to fix up of the one subject property for which it was approved.

Example

Let us say an investor is going to purchase three properties, all with similar figures. He figures he can flip each in 6 months: Purchase price: $80K, repairs: $20K (total needed $100K), ARV: $146K. Let’s also say a hard money lender has a program where the origination fee is 5 points and a rate of 12% on funds used. Now, the $100K unsecured business credit has an front/service fee of $5995 and a backend fee of $4000, for a total of $9995 and an average rate of 8.5% on the outstanding balance.

Total cost of funds:

Hard Money Loan: $95K
Per property:
Origination Points: $4750 (5% of $95K)
Interest (6 mos): $5700 (12% of $95K)

Property 1 total cost of funds: $10,450
Property 2 total cost of funds: $10,450
Property 3 total cost of funds: $10,450
Total cost of funds for 3 properties = $31,350

$100K Unsecured Business Credit
Origination cost: $9995
Interest (6 mos): $4250 (8.5% of $95K)
Property 1 total cost of funds: $14,245
Property 2 total cost of funds: $4,250
Property 3 total cost of funds: $4,250
Total cost of funds for 3 properties: = $22,745


Look at it this way. If unsecured credit was the established “standard”, and hard money was the new kid on the block, we’d all be saying, “Hard money? That’s really expensive! I have to pay that big origination fee every time I buy a property!”

With a solid business credit program, you only pay one origination fee, and just like with any credit program, responsible investors can apply for additional credit by keeping the payments current.