Are these terms good?

Question

Hello,

We are new to investor lending posted below is the offer we have. I not sure what it means by what they are holding and the reserves part. Could anyone shed some light on this? And if its a ok deal or not? Any comments would be great! Thanks!

The loan will be $46,250  (55% x 85k)

Were holding 45k rehab + 20% = 54k

You will be 9k short + closing costs and reserves(that you will need to bring at closing)

Interest will be 1.5% per month

No prepayment penalty

6 month term

Marshall Ryan · Answer

K. Marie,

We are looking at about a 10 week completion, so 6 months should cover it. We do plan on a 10% to 15% discount when selling so it should go quick. We are a property management company we have done rehabs for investors before. We have employees on staff and some great tradesmen we work with closely so we can turn properties quickly.

Account Closed · Answer

Dion gave you the numbers story.  But what about the six month term.  Can you do a big project and re-sell in 6 months?

Dion DePaoli · Answer

Marshall, that is not a good deal.  
	
	I will translate:
	
	The loan will be made for $46,250.  Somebody did bad math.  They are implying the loan is at 55% LTV (Loan to Value [of property]).  The property is noted as being worth $85,000.  The loan amount is 55% of $84,090.91.  The proper math based on the statement is $46,750.
	
	The next line is the rehab reserves.  They will capitalize $45,000 for rehab purposes.  It appears they have mandated a 20% contingency on top of the total amount estimated for rehab.  There is absolutely no need for such a thing.   Experienced folks would never agree to this feature.  Since they will be the ones funding the rehab capital, they are actually driving the cost of the loan up for you.  I really do not like this idea.  This screams somebody is taking advantage of you or they don't know what they are doing.  
	
	If the lender capitalizes 55% of the purchase ( per their numbers 54.41%) and then capitalizes the total rehab for $45k, you will have a loan amount of $91,250.  It is not clear if the rehab dollars will accrue interest, but that would be customary so we will assume so.  The plus 20% means, they are actually writing you a loan, secured by the property, for $100,250.  So they have an additional $10k in there that would likely accrue interest that frankly they didn't actually give to you to use but it appears they want interest on.  That does not fly.
	
	The interest of 1.5% per month is actually 19.56% annual interest.  That is pretty high for residential hard money compared to what some other folks are willing to lend at.  It is not clear, now that I wrote that, what the type of property is (commercial/residential) or what inherent risks come with but since you are new to the game, I will assume it is not all that bad of a property.  So I do not see where that type of high rate is warranted.  
	
	The loan will have no prepayment penalty and with that sort of interest, it should not.
	
	The loan matures in 6 months.  I am guessing, since it is not explict in the post, the loan will be interest only.  (If it was not your payments would be amortized over term either not given or the 6 months, which would make this a tough loan to pay).  So at the end of the six months, you pay off the entire balance of the loan.  So we are back to, what the heck happened with this extra $10k?  
	
	If they write the note for the $100,250k, then you will have to pay that at maturity.  Yet they didn't "really" capitalize the $10k.  You can't touch it or use it.  From the post, it seems pretty certain they are writing that amount into the loan.  This is why they show you the total cost on that line is $54k.  If this were some other type of reserve not included in the principal balance of the loan, it would need it's own line to explain the details of how that would work.  So, therefore, somebody wants you to pay an extra $10k that you technically didn't borrower and couldn't use.    
	
	Moral of the story, as I said, this is NOT a good deal.  It is actually worse than a bad deal.  The person who created these terms does not really seem to know what they are doing in structuring the loan to reduce their risk it seems.  If the above is addressed and you find that is not what they meant, I would still have issues with their failure to do simple math to calculate the loan amount.  I would also have a big problem with their inability to properly communicate their terms.  
	
	Moral of the story.  I recommend you find someone else.

Marshall Ryan · Answer

Thanks,

Since most of my experience is completing the actual work and getting properties ready to rent or sell, I lack knowledge of how to finance my own deals. We had serious concerns about these terms that why i posted on biggerpockets.com. Thanks again Dion for the detailed explanation! This information is great!

Dion DePaoli · Answer

No problem.
	
	I do not want to gloss over Marie's question as I alluded to it in my post.  A responsible lender is not going to give you a six month term here.  That is pie in the sky thinking based on the numbers here.  $45k in rehab is not going to be some quick overhaul.  Bare in mind, you need to do the rehab and like sell the property (or refinance) in order to pay the loan off.  The lender should really be setting you at 10 or 12 months in my opinion.  Remember a general rule of thumb is to capture the value of a property in a market properly generally the marketing time required is around 90 to 120 days.  So, based on this deal, you are done with rehab in 90 days and you sell or refinance in 90 days.  
	
	In my opinion, that is a risky "fire drill" in regards to time allowed.  If I were you ask for 12 months and let the lenders counter offer you.  Plan for the worst and hope for the best.  
	
	One other idea to watch for, look for inflated interest upon maturity or default.  If they are demanding high interest, such as here, they don't need to jack it up further if you can't pay the loan off by maturity.  Not overly common but also not uncommon.  
	
	Good luck.

Marshall Ryan · Answer

Dion thanks for the great breakdown. We noticed the math was off from the very beginning. We have never seen a loan configured like that and just didn't understand it. We really appreciate the explanation!

Dion DePaoli · Answer

Just saw this when I posted.  The idea that you already own the house does change my interpretation here.  
	
	I still do not like this offer.  It is poorly written.  I see what they are trying to communicate if it is a refinance.
	
	The loan amount is sum of the $45,000 plus the 20% contingency.  That contingency is still $10k.  They still want to write the note for a total of $54k.  So you will pay interest on the contingent amount ($10k).  That is not a good deal or structure.  
	
	The idea still inflates their dollars lent causing you to pay more interest.  The $10k in the note would mean you need to pay it off.  It does not appear you can use it in this structure.  
	
	The problem is they are not adjust for their perceived risk in the right places.  The interest rate and loan to value should be adjusted.  (Well, think the rate is still too high no matter what, I think you can find 10% and 12% all day long).  Point is, this extra $10k, if they need it should be reduced in LTV.  Problem is then you don't get your requested monies.  
	
	They could have set aside the $10k as an interest reserve so the +/- $5k in interest you will pay over the life of the loan comes from that $10k but should be marked as non-accrual.  It does not explicitly say that.  
	
	I am not a fan of this deal.  I am not a fan of the way they presented terms to you.  I do not see between the lines that the lender is trying to make sure the deal is a win win.  Yes, they have some risks but so do you at 55% LTV.  Granted you are only into this for $8k so they need to offset that.  I really just don't like the way they did.  
	
	I would shop around still.

Marshall Ryan · Answer

We have already closed on the house using our cash, we paid 8K for it. (we like big projects).

ARV is 85k.

We requested 45k for rehab.

Dave Savage · Answer

Might need a few more details to figure this out.

What are you buying the house for?

What is the ARV?

Did you give them a $45k rehab budget?

Are these terms good?

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