here is an example of how to use hard money to buy and rehab your foreclosure purchases, all the way thru refinancing them to a conventional 30 year loan. Yes, I agree that you can get properties for far less money and fund them privately and other ways, however this is a good way to go if you live in a high value market and dont want to drop a huge load of cash down.
Step 1. Start by setting some cash or income goals for yourself and determining what opportunities are available to you.
Lets assume that you have a desire to increase your net monthly income by at least $1,200 so that you can add more to your monthly savings and investment accounts; your desire is to safely accomplish this through rental real estate.
This also assumes that you don't want to write a huge check to purchase and rehab a property, you are willing to use financing to get the job done, but don't want to have to put down the 20 to 30% that a bank would require for a purchase, nor do you want to wait 35-45 days for the bank to make a decision on funding the deal, which may be gone by then.
After reviewing your personal finances you see that you have credit scores in the 680-700 range, household income of about $100k and a light monthly debt load where all those payments do not exceed 35% of your total monthly income.
You are comfortable paying at most $1,500 a month total in mortgage, taxes and other expenses on an investment deal and expect your property to begin generating your desired income within 6 months.
Based on your research, you have determined that on average, rents in your market for 2 bed room apartments are running at about $900 a month, property taxes are high and insurance rates are reasonable (for Chicago, at least). There are a decent number of foreclosure deals available via your local realtor and a large pool of qualified renters too. Rents have also remained stable or are rising due to the fact that a large number of people can't qualify for a home loan, which has increased demand for rentals. With all that info in mind, you have to get at least a duplex to get the $1,200 increase in your net (after expense) income from the property.
Step 2. Find a potential deal based on your goals and what's available in your market
Use the notes in this forum for the best ways to find deals and negotiate the best purchase prices. For this case lets assume that after working with a Realtor, you found a foreclosed, triplex or three-flat (three unit apartment building) where each unit rents out at $920 a month ($2,760 total), taxes and insurance are $2,100 and $1,200 a year respectively and property management fees are 10% of the gross monthly rent collected ($276 @ $2,760 a month).
Sounds promising if only you can buy and finance it quickly.
This property is in an area where property values are reasonably stable and where banks are not afraid to lend due to a large number of recent foreclosures. This was confirmed with your Realtor and investing lender.
The bank is asking $180k for the property, which needs $50k in repairs with an estimated value after all the repairs have been made is around $250k.
Step 3. Evaluate the potential deal to ensure that it gives you the $1,200 needed to achieve your goals and that it makes sense to do it.
Potential Monthly Rents $920 x 3 = $2,760
Less Expenses:
Taxes $2,100 /12 = $175 a month
Insurance $1,200 /12 = $100 a month
Management Fees @10% of rents= $276 a month
Total Monthly Operating Expense $551
Total Net Monthly Operating Income $2,209
Looks pretty good so far. Next we have to deduct the $1,200 a month that you want to net each month to see the max you can afford each month in mortgage payments and to also see the max amount that the mortgage can be.
That being the case, subtracting $1,200 from $2,209 leaves $1,009 a month for mortgage only payments, which equates to a conventional 30 year mortgage of about 159k at 6.5% APR (ask a lender to run some number for you).
Step 4. Calculate the numbers to see if the banks asking price makes sense and how to make the purchase price work
The bank is asking $180k for the property, which also needs $50k in repairs, meaning that the total cost would be at least $230k. At this point the deal is not going to work as is based on your goals and abilities. Especially since you don't want to have to put out a huge chunk of cash.
That being the case you have to negotiate a purchase price of at least $50k below the max loan amount of $159k to ensure that the property is going to give you a net cash flow of at least $1,200 a month. A target purchase price of $100k or less and a hard money loan with 100% financing of the purchase and repairs addresses both of these issues.
Step 5. Figure out how you are going to finance the deal
Conventional Bank Lenders
Most Conventional lenders (banks) will only lend a limited amount to you for non owner occupied properties, usually up to a max of about 75% of the purchase price; with the repair costs being absorbed by you. So if you are to buy this property at $100K they'll lend you up to $75k and expect you to come up with the remaining $25k on your own and the other $50k for repairs, a total of $75k out of pocket.
That really sucks. Especially when you consider the fact that once you write one of those big checks, that money (which you may need for other, more important things) is gone til the property is either resold or refinanced or as it slowly comes back to you in the form of rent. They will also take a good hard look at you and your finances plus the property itself, which will force the closing to take at least 35 to 45 days from the date you submit your offer. The property could be sold to someone else long before the bank decides to lend you any money!
The better way to buy and rehab investment properties is with a hard money investor loan
Hard Money Lenders
Hard Money Lenders on the other hand, try to make it a lot easier for you to get things done. While they do take a good hard look at you and your personal financial situation, they look more at the property when making a decision and are much faster in closing your loans.
Most of the decision to lend is based on quality of the property you are interested in buying and the discount that you are buying it at. If the property is in a highly desirable area for people to buy and live in it'll be easier for you to secure funding.
If however, the property is located in a dangerous, crime ridden area or one where most of the properties for sale or that have recently sold are foreclosures, then you'll go thru a struggle securing your funding. You should also be aware that most lenders don't want to lend in areas where property values are extremely low, as they know that the odds of you either refinancing the loan or getting someone else to buy the property from you are really low. This is one of the main reasons why you can houses sell for $5,000 in some areas (sellers know that most people can't secure financing for them, leaving only cash buyers as the market).
Terms usually are a bit higher than banks for interest rates and origination fees, and term financing period will be shorter, in most cases 6 to 12 months max with some exceptions for certain situations. Most will lend a max of 65% of the total after repaired value of the property to qualified borrowers for the purchase and repair of single and multifamily homes that the investor will not be living in. Some lenders require zero down while other up to 10 to 20 percent; everything depends on the strength of the borrower and the property.
The major benefit that you receive from working with some hard money lenders is the fact that you do not have to put down the huge chunk of cash that a conventional lender would require, nor did you have to cover the rehab cost out of pocket or put up with a long closing period, as a decision and funding can usually be made within days.
Step 6: Do the math for your hard money loan
Assuming that you can get the bank to accept your offer of $100k for the property, and if you qualify, the hard money lender may be able to provide financing that covers 100% of the purchase price and 100% of the total rehab costs, just as long as it fits within 65% of the value of the property after all repairs have been made, at a rate of between 9 and 18%.
So in our case where your lenders' appraiser gave an after repair value of $250k, the max the hard money lender could provide is $163k ($250k x 65%), which would more than cover the purchase price of $100k and the Repairs of $50k. There would other costs involved with closing the loan, such attorney fees, appraisals, insurance, taxes and origination fees that would affect the total amount provided, however the total hard money amount would not exceed 65% of the after repaired value.
The funds needed to cover the repairs would be distributed to you in the form of draws based on a percentage of the completion of the work per the agreement with the lender, lets say 25% per stage.
If you borrow $150k at 9% interest only rate, your monthly payment would be about $1,050 a month, excluding other rolled in costs, such as points and origination fees.
The term on this loan would probably be somewhere in the 6 to 12 month range, after which you would have to either have sold the property or refinanced it via another lender. You would also have to take into consideration the hard money-lender's origination fees of about 5%, underwriting, attorney fees, appraisals and other expenses.
Of course you have to balance the total hard money borrowed with the terms you'll get on your refinance to make sure that your goal of netting at least $1,200 a month is reached.
Step 7: Get the terms of your refinancing to ensure that your numbers will work
Once the rehab work is completed and after you have held title on the property long enough to satisfy a conventional lenders qualification terms, you may be able to refinance up to 80% of the newly appraised value of the property. More than likely you would qualify for a simple rate and term refinance where the higher rates of the hard money loan are replaced with lower rates and a longer financing period, usually 30 years; which should significantly lower your monthly payments.
That being the case the lender would payoff the existing hard money loan, rolling it into a new loan where the closing costs of the new loan included. Take the time to reach out to a conventional lender for current rates and programs.
In this case, you'll want to make sure that your new loan does not exceed $159k and that the interest rate does not exceed 6.5% APR so that you can start earning the $1,200 a month in net income desired.
There will also be some closing costs to cover on the refinance so take some time to figure out what those look like and factor them into your purchase price. In this case I would give myself about a $14k cushion to cover the costs of both loans, unless willing to pay those out of pocket. In other words, try to get a lower purchase price.
Step 8: Get pre-qualified for a hard money loan
The hard money lender should use the same criteria for credit as a conventional lender does. On approval, you'll have a clear idea of what is actually possible for you. TO get started, you will usually need to show the following:
Brief bio of you, which indicates the level of experience that you have and a plan of action for the property
recent bank statements
recent paycheck stubs
tax returns
Personal financial statement
List of properties that you already own. Include rental income and expenses, plus copy of leases.
Credit report (lender will pull)
If you already have a deal negotiated, you'll also need to show:
Signed contract
Detailed repair list with cost
Your proposed exit from the deal, either resale or refinance
Contractor contact info
Other info will be needed as questions will arise, so please be prepared to answer them
Step 9: Negotiate your deal
Using the number you need to make the deal work, contact the seller and stay engaged til you are able to seal the deal via a signed contract for purchase. Start the negotiations with an amount that is well under the max that you can borrow for purchase and repairs so that you don't have to come out of pocket. That being the case, I would target $100k as the max purchase price and begin negotiations at around 85% of that ($85k).
Keep going back and forth on the negotiations til you get a price that works for you, just as long as it doesn't exceed your target price. Prior to starting negotiation, it is a really good idea to have a pre-qualification letter from your hard money lender to prove your ability to close the deal. Once you have the signed contract, submit the contract and other info needed to the lender for processing.
Step 10: Close the sale and begin the rehab work. Once the repairs are completed, you may consider working with a Realtor or professional property management company that was referred to you to assist in renting the property out (or reselling it if desired).
Step 11: Contact your conventional lender to begin the process of refinancing the property out. You will more than likely need to provide them with the same updated info that you submitted to the hard money lender. Let the lender know of all loans against the property as well as the terms you desire. I would also contact them prior to beginning the process just to make sure that you have considered all your options and are informed about the latest loan programs available and guidelines.
The lender should be able to roll into the loan the closing cost and other expenses into the loan, which will increase the loan amount above your payoff amount. The result however should be that you have no out of pocket expense except the cost of your appraisal and credit reports.
Step 12: Repeat the process on the next property ASAP.
Recap Working Backwards To Get Desired Net Monthly Income Of $1,200
a. Potential Monthly Rents $920 x 3 units = $2,760
b. Less Monthly Principal & Interest Payment -$1,009
c. Less Monthly Taxes $2,100 /12 = -$175
d. Less Insurance $1,200 /12 = -$100
e. Less Management Fees 10% x $2,760 Gross Rents = -$276
Total Net Monthly Income $1,200
Refinanced To Conventional Loan
30-year conventional mortgage, which refinanced the hard money loan and rolled in the closing costs, origination fees and other expenses at 64% of appraised value = $159,000
Monthly Principal & Interest Payment on a 30-year mortgage, 6.5% interest rate loan on $159,000 at 64% of appraised value = $1,009
Buying & Rehabbing The Foreclosed Property With Hard Money Loan
a. Purchase Price = $90,000
b. Repair Costs = $50,000
c. Cushion For Closing Costs, Origination fees and other expenses = $10,000
Total Loan On Purchase and Repairs = $150,000
Monthly Hard Money loan payment @ $150k X 9% / 12 = $1,125
After Repaired Value Of Property = $250,000
Max Hard Loan @ 65% Of After Repaired Value = $163,000
Hopefully this helps to explain the situation better. Of course each case on the purchase and refinance is unique, so in most cases the end result and terms may vary depending on your situation and the capabilities of the lender used. Good luck...
