Surplas of rehab funds from hard money?

Question

Got some numbers from a hard money lender who had me itemize and budget me reno. Playing it safe, I over estimated some cost to get to the allocated budget. Question is, when the time comes and I finish work, what happens if I do so under the rehab budget? What happens to the funds? Do they go back to the loan balance? Can I pay myself as a contractor? Just trying to grasp the process here.

Shafi Noss · Answer

Yes it depends on the lender's process.

The benefit of paying yourself and paying the lender back is you can then refinance that as a rate/term refinance rather than a cashout refinance which can get you more leverage and better terms on your long term debt.

Bryan Hartlen · Answer

@Hoa Nguyen it depends on your terms.  Some HML charge you interest on your max loan amount from day 1 (they call this Dutch interest or loan) others only charge on funds actually drawn. If your loan is interest is Dutch (charged on max loan amount) you should sharpen your pencil and balance the cost of the overestimated rehab costs before closing - make sure you know how much playing it safe is costing you.

Regardless of the type of loan (Dutch or non-Dutch), HML’s only provide rehab funds for work completed after some kind of inspection (in-person, photos). They call these draws. The max amount of the draw will be from your agreed rehab budget.  Most HML will let you make draws less than budget and some will let you make partial draws (eg you have $6000 for new floors, you draw $3000 against the floors completed in half the property). Most HML charge a fee for each draw. So optimizing your draws will improve your return. If your loan is Dutch, there’s no incentive on you to draw less than budgeted (you are already paying interest on the full amount).  If it’s non-Dutch, you’d typically only draw what you needed (especially if your lender allows partial draws). The other consideration for non-Dutch draws is if you came across an oh-$hit in the project that wasn’t budgeted for. In these cases, you can use the full value of your budgeted line items to help offset the out of pocket impact of the oh-$hit.

At the end of the project when you close the sale of the property, you’ll have to repay what you borrowed. Any ‘left over’ rehab budget, doesn’t matter you only repay funds received from the HML.

Christie Gahan · Answer

You are asking good questions.

The lender is not going to just send you a check for the construction costs.  Banks will require that you hire a licensed contractor.  The contract will specify when the money gets paid out.  It is not paid out on a calendar deadline but on when certain goal posts on the building are met.  There may be regional differences.  Something like: when the foundation is finished, the framing, electric and plumbing are in, roofing and siding, etc   They will usually hold back 20% or so until the house actually has cleared all permits including the final permit of occupancy.

Generally, hard money is expensive you want to borrow as little as possible and pay it back as soon as possible.  You have to switch to long term loan and pay off the HML.  It is possible to set up the final end financing before you start building.  Folks who did not do this and saw rates double are hating life.  It is possible, to do something like a cash out refi at this point if your numbers work.  For example:  Your hard money loan could be 15% - 20%.  Your long term rate could be  7% or 8%.   Hard money term is 12 to 18 mos and long term is 30 years.  So you would have to pay the HML in 18 mos.  To do anything like a refi you would pay all of their fees again and start a new loan at 15% - 20%.  The math isn't gonna work.  You would do that with the new loan at the much lower rate.

Hope that helps.  A lot to explain.

Chris Seveney · Answer

If you take it from the lender you owe it back to them. For example:

$500k acquisition cost. You budget $400k in renovation. The lets assume the loan is $900k with draws from the lender.

If you draw the $400k and it only costs you $300k to renovate, you took a $100k and are paying interest on $100k you did not need to take.you can keep it as long as you have the $900k to pay the hard money lender.

The key is if it costs you cheaper, then you get more profit. Do not take it from the lender as you are paying a lot of interest on that money.