What is a Rehab Loan?

Question

Oftentimes a subject of some debate is the reality of what is a renovation or “rehab” loan. Simply put, a rehab loan is a specialty loan program that allows the borrower to purchase a run-down home and to finance an additional amount of money above and beyond the sales price to use in renovating or “rehabbing” that home. In some cases the loan may also allow the borrower to finance the closing costs, so that he/she comes to the closing table with very little, if any, money out of pocket. This makes the program ideal for many real estate investors who wish to put as little of their own money as possible into their rehab projects. Terms and conditions for these rehab loans will vary widely from one lender to the next, from very short term, high interest loans to more conventional long term, low interest loans. Things that are usually taken into consideration during the underwriting process for these loans include: the borrower’s personal credit and finances, the size of the proposed renovation or “rehab”, the condition of the home being financed, the area where that home is located, and the borrower’s plans for repayment of the “rehab” loan.

What a rehab loan is not is a “hard money” loan (although the terminology is used interchangeably across the industry). “Hard money” loans are very short term, high interest loans used to help struggling homeowners try and avoid foreclosure. These loans are usually underwritten based more on a borrower’s character and situation rather than their personal credit.

It is important that borrowers understand this difference so that they do not walk into a potential loan situation with the wrong idea of what to expect. While some rehab loans may have similar terms to a “hard money” loan, they are not used for the same purpose and therefore will be underwritten differently.

A borrower for a “hard money” loan is someone who is usually facing the foreclosure process on their own home. Their credit is most likely in pretty bad shape and they will usually have next to no savings in the bank.

On the flip side of things, a borrower for a rehab loan is a businessman. Regardless of the terms and conditions offered for the loan program, it is expected that the borrower will have very good or excellent personal credit and that they will have at least a minimum amount liquid cash reserves in the bank with which to run their business.

Knowing and understanding these differences can make your next rehab loan experience a more smooth and efficient transaction.

John Worley RTL Financial

John Worley · Answer

Raj,

I'm not sure that I see your point as it relates to the topic being discussed. Can you please explain what you are getting at here?

Rajendra Mackinley · Answer

single person or an individual and his or her spouse who have not owned a home (as a tenant in common or as a joint tenant by the entirety) during the three years immediately preceding the date of application for the 203(k) rehab loan. Any individual who is legally separated or divorced cannot be excluded from consideration, because the three-year waiting period does not apply, provided the individual no longer has an interest in the home.

John Worley · Answer

jason,

True hard money lenders are indeed just as i described (lenders that are not focused on credit, assets, documentation, etc, but rather the situation surrounding the borrower and the loan). A true hard money lender will not ever consider an investment property because they (like most all lenders) consider investment property financing to be head and shoulders riskier than any other type of lending, including forclosure bailouts, which is what most hard money lenders deal in.

Now your opinion is not an uncommon one. The term "hard money" has been used around the REI industry for years and we could argue all day about what to call REI financing, but that's really missing the point that i was trying to make. Too many investors think of their financing in terms of no credit, no assets, no docs needed and that thinking is, in its very nature, wrong. Real estate investors are businessmen and we have to think and conduct ourselves as such, especially when approaching a lender to obtain financing for a project. No succuessful businessman walks into a potential financing situation with nothing to offer on the deal, but that is exactly how many investors want to operate. Even if you work with a lender whose guildlines allow for no money down, all costs rolled into the loan, etc; that does not mean that its ok for you as a businessman to have nothing in savings or reserves on which to run your business. Yes, lenders have let that slide for many years now and have made loans that they shouldn't have, but those days are long over. The investor who doesn't bother with keeping a fairly large amount of liquid reserves is, for all intents and purposes, living paycheck to paycheck. It is a practice that investors should have never gotten into and it is a practice that many have to now break themselves of or get out of the business altogether. Changing this way of thinking was more of the point I was trying to get at, rather than arguing over the names used to describe REI financing.

Jason Cummins · Answer

I disagree with this statement. There are many investors that use hard money to buy properties in distress to rehab and sell them. Hard money is a great tool for many investors who are not people with bad credit or in bad shape, it's just another tool in the belt of creative financing options.

I have used HML's before and will continue to do so in the future.

And although I am sure you are right that people use HML's to stop forclosures, I would say that both the HML and the home owner would then be morons to do so.

We have also used rehab loans too, just depends on the situation and how many projects we need to finance.

What is a Rehab Loan?

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