Hard money loan example/explanation
Hello all,
First time posting here. Long time podcast listener. Would someone please explain the below scenario to me? I understand hard money when the ARV is much higher than the purchase price, but what about when it's not?
Purchase price: $60,000
Repairs: $15,000
Appraisal before repairs: $75,000
Hard money loan: $75,000
Down payment: $25,000
Estimated ARV: $75,000
When the repairs are done and it's time to lease the house, how will the financing look when refinancing to traditional financing? Will any cash above 75% financing be given back to the borrower? Thanks for your time. I hope I've communicated clearly.
-Casey
This isn't a great deal for hard money. Purchase plus rehab is 100% of ARV. This would be a non-starter for most investors because you're paying "retail". Frankly, if you're willing to pay retail you would be MUCH better off to just buy a move in ready house for $75K and get conventional financing right from the start. That will be MUCH cheaper.
I'll assume the HML will lend 70% of ARV at 15% with four points. And that you can then refi using the new value after six months, so I'll assume the hard money loan is in place for seven months. I'll also assume $1000 in other costs to the lender up front (appraisal, underwriting fee) plus another $1000 in other closing costs. I'll assume $3000 in costs on the refi. I will also assume the HML will hold back the $15K rehab budget and pay that to you in draws as the work is completed.
hard money loan: $52,500 (70% of $75K)
points: $3000
HML costs: $1000
other closing costs: $1000
purchase: $60,000
rehab: $15,000
Total money out at closing: $80,000
Less loan of $52,500, cash you need to bring to closing: $27,500
Now, over seven months you'll make monthly payments of $656.25, interest only.
Payments for seven months: $4600 (rounded)
You will spend the $15K doing the rehab and then get the $15,000 rehab budget from the HML. So that parts a wash. You will need cash to pay for labor and materials first, then get it inspected and you'll get the rehab money from the lender. Typically in two or three "draws".
Net holding: $4,500 to you (rehab budget less payments)
So, at this point you have $31,900 of your own cash into the deal.
Refi at 75% of new value.
Loan amount: $56,250
payoff to HML: $52,500
closing costs on new loan: $3000
cash back to you $750
So, you will end up with a $75K property with a $56,250 loan and you will have $31,150 of your own cash in the deal. I'd say you need at least $5000 in additional cash to complete the rehab. $10K would be safer, since you will likely exceed your initial rehab budget.
OTOH, if you buy a move-in ready $75K property with 20% down you would put down $15,000 (plus maybe $2000 in closing costs) and have a loan of $60K. This is a much better approach in a case like this. Hard money makes sense if you have a much better deal.
@Casey Jones you will not get a HM loan for 100% of ARV.
The basic formula is ARV x 70% - Repairs - Holding Costs = Maximum Purchase price (of course if you can buy for less than that, that's even better)
This is a rule of thumb (ROT) and like all ROT, its good for quick screen analysis and tells you whether or not to look closer and continue your due diligence. Generally this ROT is more useful for properties below 100-150k. As ARVs rise, the dollar amount becomes more of a factor than the percentages to determine how much potential profit is worth pursuing?
Knowing how to determine ARVs is the first and most important part of the equation to understand, IMO. Until you know how to accurately determine property values, you aren't ready to try to figure out the next steps or strategies.
Estimating repairs takes time to learn and it's never exact. You have to factor in for the unexpected. The more experience you get, the more accurate you will get. That goes together with holding costs and estimating what they will be. If you don't know how long it will take to complete the repairs, how will you estimate holding costs? Holding costs are the highest when using HM.
HMLs are pretty easy to find. Look at their websites and look at what terms they offer. There are endless possibilities of different down payment, ARV limits, interest rates, points, loan to value ratios etc, etc... keep reading, you'll learn.
NOTE: Apparently @jon holdman was typing at the same time I was. He gave you a thorough breakdown of the things to factor in to your analysis. Welcome to BP!
@Jon Holdman I know this is an old thread but I'm new and trying to learn how to run "the numbers" on hard money deals. I have a few questions about your example. Thanks in advance if you have a chance to answer.
Why did you calculate the origination fee from the ARV rather than the loan amount?
Does the borrower pay interest on the draw amount before it is used?
What is a "net holding"?
How did you determine a $4,500 net holding? With your note, I got $10,400. (rehab budget, $15,000 - payments, $4,600 = $10,400)