Can you take pay from your hard money loan during construction?

Question

We are looking at a new construction project, a single spec house with a hard money loan. Can we take pay out of the loan since we are acting as the general contractors? I think I read/heard discussion of this on BP, but I can't find record of it, and I'm wondering how that is structured.

Jon Holdman · Answer

It almost always works the other way around.   As the rehabber, you will end up putting cash into the deal, even with a HML.  You would need a very good deal along with a flexible lender to actually get money in your pocket during a rehab.  Your payday comes on the sale.

Lets say you have a lender who will go 70% of ARV, and will fund up to 100% of the rehab and purchase.  And you find a deal where rehab and purchase is exactly 70% of ARV.  That would be a really good deal, and tough to find in most locations.  You might think that you don't need any of your own cash.  In fact, you should expect to have at least 15% of ARV of your own cash to complete this deal.  You will need to pay closing costs out of pocket (typically 2-3% of purchase).  You'll need to buy insurance up front.  You will have utility bills.  You will typically get the rehab money in increments.  Perhaps a slice up front (maybe a quarter or third), and you will have to complete work and have it inspected before you will get the additional increments.  Typically the last increment is only given to you once all work is completed.  If you end up going over budget on the rehab (VERY common), you will need to fund that out of pocket.

The danger of not having enough of your own cash is that you end up with unexpected costs you cannot cover and you lose the deal.

J Scott · Answer

I would talk to your lender about it.  Did he ask for a cost breakdown of the project?  Is there a line-item for GC costs?  Did you disclose that you'd be the GC and that you'd be taking payment as the GC?

As long as you disclosed, and as long as your lender is okay with it, I see no problem with it...

But, if you're doing this behind your lender's back, that's an issue (in my opinion)...

Sarah Lorenz · Answer

@jscott I agree that I would like to be upfront about it, so it sounds like I should consult with several lenders to find the ones that will allow this. We have exact cost breakdowns from another project that is nearing completion with another partner, that we are hoping to replicate on our own, so hopefully that will help our case. Thanks.