Hard money lending leverage.

17 Replies

I'm looking for a deal for my first flip, my lender tells me, won't give the loan unless he makes sure the deal I'm getting in to is good, also saids once we buy the property he will provide funding as the project is being completed, using a schedule of values. This sounds great! since recognizing a good deal is one of my biggest worries, also offers me General Contractor they usually work with. But the whole thing sounds a little too good. I would like to know if this is a common practice in the Hard Money lending world. Any experience, advice o recommendation would help.

I guess, my roll would be deciding the level of improvement the house will get, making sure the GC does the work correctly and on schedule, deal with all the logistics of selling the house.

In my experience HML's like to do 65%-70% LTV, and some also fund the cost of repairs based on a pre-arranged schedule that they approve. Not surprising that the lender would know of a GC who worked together in the past. So, this looks pretty good but not so out of the ordinary that it looks like a scam. Of course, the interest rate and points matter a lot.

Using hard money as a newbie is a good way to lose all your money. There's lots of surprises and risks with doing a flip and you need to have experience and be well capitalized for when stuff goes over budget. I always recommend starting with lower risk cosmetic rehabs using conventional financing. 

Originally posted by @Juan Martinez :

Interest rate would be 10-12%

Yeah, so you're borrowing hard money.  Not necessarily a bad thing, but take an accounting of your deal.  Remember that financing is extrinsic to the fundamentals of the deal.  You might have a homerun deal that you just can't do because you don't have the ability to finance it at a low enough cost.  Here's an example of flip using somewhat simplified numbers to help illustrate the point.

$100,000 Purchase Price
$50,000 Renovations Budget (including, we will suppose, six months of carrying costs from close to close)
$200,000 ARV

So we've got $50,000 in equity to build. But then we account for the disposition. I advise investors to just underwrite for 10%. You might end up under, but 10% would be prudent. After you consider brokerage fees and closing costs that you may have to pay as a part of your deal, plus maybe even a couple of small repairs and maybe throw in a home warranty, 10% is probably a good number to work with. So your $200,000 sale will already only be worth $180,000. Now so far, these figures are true no matter how you finance it. These numbers still only pertain directly to the deal itself. This is your starting point for when you go to analyze it in terms of your ability to undertake it. If you are buying cash, then your deal will pretty closely resemble these numbers. If you're financing in some way, we will need to account for the ways in which this will impact your costs. If you're borrowing hard money, then we need to look at the expense profile associated with that form of financing. We can typically presume something along the lines of a $2,000 fee associated with the loan origination, as well as 2 points as a fee, and the interest will be, suppose 12%.

Let us suppose that your lender is willing to finance 80% of the total project cost.  That means that your loan amount will be $120,000.  This is the basis upon which your points and interest will be determined.  Given this, we can determine your financing costs to be $2,000 from the fixed fee, $2,400 from the points, and if you are in and out of your project in 6 months, then you will pay 6%, or $7,200, (12% annual rate means each month is 1%) in interest.  Thereby, total financing costs come to $11,600.  So the project may net you $30,000, but your cost of capital is $11,600.  So really you stand to make $18,400 in this deal.

Again, these are rough numbers, so yours may be completely different.  This deal as I've wrote it is actually not that bad.  The Capital Share Of Productivity (meaning the $11,600 versus the $30,000) is 38.66%.  That's essentially the lender's cut of your project.  It seems like a lot, but remember it gives you the ability to make $18,400.  You might consider that the deal may be worth it even if the Capital Share is 80% and you were only left with 20% of the net profit.  Because it's still enabling you to play with someone else's money in order to make money.  You just have to weigh the risks associated with the project overall against the return that is in it for you at the very end of the day.  It's all a decision that you have to make based on your risk tolerance and your opportunity costs.  Just make sure you are applying the right formulations in your analyses.

Dan, Thanks men, for taking the time, you make a very good point that I was completely overlooking, the loan costs, specially the origination point, I just contacted my lender about this.  Also, I was trying to calculate the 10% underwrite a little differently but it always came out to be 7.5 to 9%. Now that I know the 10% is a common practice I feel more comfortable plus it will save time in my analysis. This really helps.

Originally posted by @Juan Martinez :

Dan, Thanks men, for taking the time, you make a very good point that I was completely overlooking, the loan costs, specially the origination point, I just contacted my lender about this.  Also, I was trying to calculate the 10% underwrite a little differently but it always came out to be 7.5 to 9%. Now that I know the 10% is a common practice I feel more comfortable plus it will save time in my analysis. This really helps.

Are you putting the numbers and the loan in the calculator/spreadsheet? 

 

Hi Ari, I literally just saw this, the quick answer is no, I'm still all over, I got this capital just enough to buy the cheapest house in Long Island but no money left to repair it, so that's how I end up in the hard money lenders office, they looked at Credit report and scores and agreed to buy me a property 80% LTV at 10-12% with NO origination points, but honestly, I'm terrified to jump in alone. This is my life's savings.

@Juan Martinez

What the lender is doing is very normal. Most lenders will only lend if it looks like a good deal. It is expensive to take back a property so that is not the goal at all. A good lender should work with you and provide as many resources as possible. However, they should not be running the property or making finishout decisions, only providing advice or a list of names of possible contractors. You should still be free to do what you want and choose who you want to work with. If that is not the case, there there could be some legal issues with you working as an agent of theirs and not independent.

I think when you are staying LTV you are actually meaning LTC. I get to this conclusion because you are stating that they are lending 80% and you are paying 20%. That is a loan to cost equation. When looking at the maximum loan they are willing to give based on the ARV, you are looking at LTV (most lenders are between 65% and 75%). As for LTC most lenders fall between 80% and 100%.

While I don't disagree that the borrower should be able to choose their GC, the lender is still going to want to feel comfortable that the GC has an excellent track record/references, is licensed, etc. The lender may even want to meet the GC and see examples of his/her work to gain assurance that the GC is well qualified to bring the project to a successful conclusion.



Originally posted by @Ryan Blake :

@Juan Martinez

What the lender is doing is very normal. Most lenders will only lend if it looks like a good deal. It is expensive to take back a property so that is not the goal at all. A good lender should work with you and provide as many resources as possible. However, they should not be running the property or making finishout decisions, only providing advice or a list of names of possible contractors. You should still be free to do what you want and choose who you want to work with. If that is not the case, there there could be some legal issues with you working as an agent of theirs and not independent.

I think when you are staying LTV you are actually meaning LTC. I get to this conclusion because you are stating that they are lending 80% and you are paying 20%. That is a loan to cost equation. When looking at the maximum loan they are willing to give based on the ARV, you are looking at LTV (most lenders are between 65% and 75%). As for LTC most lenders fall between 80% and 100%.


Thanks Ryan, The most I hear from experts like you the better I feel, May be he meant LTC, but he wrote on a piece of paper LTV and also saids Loan to value 80%, he also told me I have to put 20% down. I will definitely clarify this with them.