Would using hard money/private money be a good first deal?

15 Replies

Hey guys!! I am super anxious to go ahead and get my first property. I am sending offers for owner financing and networking as much as my college and work schedule allow. Would using private money or hard money be a good way to get my first deal since my financials aren’t solid enough for normal lending standards?

Hi Jenna! (Warning this is a long reply but it's going to give you a pretty in depth look at working with an HML!) Keep in mind that while you said that you don't have super solid financials just yet - skin in the game from you will be a necessity. One HML that lends here in Indy and a few other states for example requires you to have $16K in an account (in your name) for 3 months. Another thing to keep in mind is that some HML's aren't super keen on the idea of financing a first time flipper- HMLs that will lend to first time flippers do exist obviously, just don't be surprised when this question comes up from one.

So here’s an example deal; (Just trying to make sure you have an example deal to see how working with an HML would work and in my quick typing I may have gotten something wrong so please use just as a basic outline for an idea in concept!)

Deal:

ARV of $143K

Purchase of $75K

Repairs are $25K

Total capital is $100K (70% of ARV remember)

Turn around is 4 months

Draws 8

This is what the Hard money lender terms would look like;

LTC (loan to capital) 80%

Term 6 months

Interest 12%

Points 2%

Misc fees $1500

(add ext fees if extending if not ideal stuff happens for an example ) 2 points for 6 month extension

Inspection fees of $175 each (remember an ‘inspection’ for each draw to make sure you’re doing the work they think you’re doing with hither money)

Now if this flip takes 4 months, here are the total carrying costs;

Total loan amount cost $100K (.8 how much lent ) = $80K

The two points at 1% = $80K x .2 (for two points) = $1600

Interest so the amount lent of $80K x .12 (12% interest) = $9600 in interest (the total ANNUAL interest) so to carry that for a total of four months would be $9600/12 = $800 in the deal for 4 months = $3200 in interest payments

Inspection fees cost (remember 8 @$175 each for each ‘draw’) = $1400

Now if you didn’t exit the deal in 4 months and added the extension of 6 months you’re adding in the points for the extension (avg of 2 points per 6 months)

So points $1600

Misc $1500

Interest $3200

Inspect. $1400

(not including an extension) all fees ‘carrying’ costs of the hard money are $7700

Where does that come from?

Sale $143K

-Purchase of $75K

-Rehab of $25K

-Carrying costs of $7700

-$11.5K of closing (remember you might be paying yourself here as licensed pro if you're a PM in a state that requires you to be a licensed real estate professional)

___________________

Net profit of $23,800

So the ‘cost of capital’ in this case is $7700 to net $23,800

While intimidating in concept, HML (hard money lenders) are a go to source of funding for many flippers. The idea is to be able to have (near) immediate access to funds to close/rehab/sell quickly as the turn around on an HML is much faster than traditional financing. The investment property itself is collateral for the loan. Meaning they aren't funding YOU personally, rather the property being invested in.

Now to minimize the monthly payments there is a deferred payment style fix and flip loan - this would be where the payments are paid back from the ‘exit’ of the deal (sale) this would be where the position of payments is paid on the ‘back end’ (at the sale of the house) of the deal and not ‘over time’ during the ‘term’ (life/period) of the loan.

To be clear on a common misunderstanding is that hard money lenders are ‘loan shark’ kind of lenders while this is more of a commonly used source of capital funding in fix and flips than not. The idea of ‘oh no, this is going to be foreclosed upon’ is taken back to they are funding the property, not you- meaning before a ‘judgment of default’ was to transpire (aka foreclosure) you would sign over the deed of the property to the hard money lender- but realizing before it ever got to that point they want you to be successful because the more success you have, the more times you will come back to them and they will make more money (repeat business for them) . 

Now to prove that you totally mismanaged their funds- it would have to be taken to civil court, they would have to prove that you were not doing everything in your power to sell the property (again, this is where if you think like a hard money lender yourself and ask, "what are they not doing that I would to sell this, or are they doing everything to sell it?" (they don't want it back and to move it themselves, they want you to sell it and come back for more business) Now considering the number of properties funded at any given moment and the ROI these HML's are getting, it would be quite an extraordinary thing to go through this entire process and not having them work with you on this (because the amount of money stood to be lost in these proceedings eats back into the amount derived from things such as an extension on the loan and simply charging you points for doing so) Again, the ‘worse case scenario' here I'm describing.

Having said ALL of this and hopping over to PMI- this really depends on your PMI source- it could be easily assumed that for some people, working with the 'Frist Bank of Mom and Dad' as your PMI would be less complicated and seem less cumbersome (not in all cases and 'mom & dad; could be anyone) Odds are if they aren't related to you the ROI they expect could be much higher than a relative (on avg it seems maybe around 10%+, whereas a family member may ask for prime alone or something like .5%-1% above prime)

My best advice would be to speak with possible PMIs you may already know as well as HMLs and simply become educated on what their requirements are- knowing what you qualify for, or alternatively don't (if you can take HMLs off the table right away knowing before you apply you don't qualify, it's going to save time in working your PMI angle faster)

The single MOST important thing to keep in mind above all else is this; no matter who you work with PMI or HML- keeping lines of communication open is virial to not only the deal, but any future deals you will have with them (as they are financing) - IF anything looks like it's going to go wrong (say missing a payment) let them know so they can work with you and NEVER against you

Hope this helps! Thanks = ) 

Hi @Jenna Barnes ,

Private or hard money is certainly an option.

I would recommend reaching out to a variety of capital sources, e.g. local banks, credit unions, and private/hard money lenders to get a sense of the market.

If by "financials aren't solid enough" you are referring to a lack of liquidity, then that will still be an issue for most hard money lenders, even if they are willing to provide higher leverage than traditional capital sources.

Again, it wouldn't hurt to reach out to a variety of capital sources, just so you have a good idea of your options.

Best of luck!

Michael

Jenna - The above posts have some very valid points. You might also consider partnering up with someone who has the ability for better financing. You can use your sweat equity to earn part of the equity in the deal without having to put down hard cash or co-sign a loan. 

Mike

If it's a good deal and you have reserves then it can be a good move. There are different types of HM. Some for fix and flips and others for rentals that are longer terms loan. If it cash flows, has equity, and/or you have enough reserves, you should be in decent standing. The goal would be to refinance out of the loan though to something better when you qualify.

Just be careful and make sure the numbers and your financial wherewithal check out to handle whatever deal you get into.

@Michael Kinsella

Thank you Michael!! I am

Currently pre-approved but the lender I am working with wants me to wait until credit shows up since I just opened my first credit card. He also wants me to bring in some more income since I’m only doing part time in college so I’m taking on a full time position. I’ve called about 5-6 others lenders/banks and they want me to have a co-signer but I am still looking for other creative lenders.

@Jenna Barnes Anyway you can finance a good deal is still a good deal. Good deals are one of the hottest commodities these days, so once you find one you'll be able to find investors/people willing to help fund it. 

Hard/private money put more pressure on the investor to perform than conventional lending, but they are still great options. Hard money is more expensive, so you will be working under time pressure (3-12 months) to quickly refinance into conventional. With private money your relationships are on the line, whether it's family, friends, co-workers, or friendly BiggerPockets members.

@Jenna Barnes Yes I'm going to send you info on a full list of helpful folks and HMLs are on there = ) There are people from all walks of real estate life on my list (so keep it and it may come in use later on) but for sure have some people on there now for you to connect with. Happy to help!

@Jenna Barnes wow, amazing post by @Anna Laud . I don't see any reason for you to have to use HML - your $11K is not enough. But, you're in an ideal position to house hack. Get a W2, save up a little more so you both a down payment and reserves, and off you go. Waiting until you are in a stronger financial position is not going to hurt you long term.

Originally posted by @Nicholas L. :

@Jenna Barnes wow, amazing post by @Anna Laud . I don't see any reason for you to have to use HML - your $11K is not enough. But, you're in an ideal position to house hack. Get a W2, save up a little more so you both a down payment and reserves, and off you go. Waiting until you are in a stronger financial position is not going to hurt you long term.

Nail on the head Nicholas:

Anna good post pretty well dissects the industry.. that is a pretty cheap HML you describe.. its hard to be in the business without making at least 4 to 5k a file you would go broke as a lender doing it for less. Keep in mind HML are lending others money either on a credit line Investors or a fund.. so the 12% rarely goes in total to the HML they may make a service fee of 1 to 2% but the rest will go to their cost of capital so their income is the points and junk fees..

in the scenario described above the OP will find it quite difficult to impossible to get a HML.. I would caution anyone who says you need to work on your credit score that is not HML speak .. CASH in the bank and experience is HML speak. Fico is down the list of requirements.

as noted above far to under capitalized to do this suggestions is get a money partner / experience partner and do your first 3 to 5 that way then you should have some money and experience and could try this on your own..

Lastly its rare for a flipper to do a deal in 4 months total .. very rare. 6 to 12 is what these normally take.

 

Originally posted by @Jenna Barnes :

@Jay Hinrichs thank you for the advice!!! I am building trust with my investor relationships now but I know it will take a good bit of time. For someone as young as me what’s your best piece of advice for moving forward?

work for a design company  /  bigger rehabber that has a show room.. learn from there get paid to learn.

then find capital partners.

 

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