Private Money: When 18% is Less than 12%
I was never late. I always paid my bills on time. The mortgage. The credit card. The car payment. Electric, water, phone and cable – like clockwork every month. Heck, I even paid for magazine subscriptions 3 months prior to expiration.
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Then suddenly, in August of 2007, there was too much month and not enough money. My real estate business collapsed faster than you can say mortgage backed security.
I got behind on the mortgages – first on my rental properties and then my personal residence. The credit cards too. In less than six months my 740 credit score dropped to under 600. Poof. Gone. No more lines of credit or traditional bank financing for me.
Fortunately, things have turned around a little since then. I’m generating revenue from my fix and flip business and I’d like to invest the extra cash in a few rental properties.
But what’s a guy like me, with subpar credit but enough cash to put down on a rental property to do? The answer is private money, also known as hard money.
Now I already have a hard money lender for the fix and flip business. Their terms are straight forward Ã¢ÂÂ 18% simple interest, $900 loan origination fee. I make monthly interest payments and the loan matures after one year. Expensive? Yes. But I only hold onto the property for 2-3 months.
For rental property I need a lower interest rate. So I made a few calls and found a local company that will lend at 12%. Good, not great. However, even at 12% interest, with property taxes, HOA dues and insurance I can cash flow $300 a month purchasing a short sale deal I just found on the MLS.
I started thinking – why don’t I use this private money lender for my fix and flips? The interest rate is certainly better. Then I considered the terms.
The 12% lender charges 3 points and a $900 loan origination fee. In three months, the average time it takes me to flip a house, I'd pay the lender $8,100 in fees and interest on a $120,000 loan. I'd pay $6,300 to my 18% lender for the same deal. As a matter of fact, the 12% loan doesn't become a less expensive option for me until month 7. If it takes me that long to flip a house then I've really done something wrong.
The lesson here is if you're considering a private money loan to fund a deal, no matter your exit strategy, be sure to examine the terms closely. Sometimes more is less.