Why do HML charge "points" and not lend 100% LTV?

14 Replies

I've been talking to someone I know who did a few flips over the past few years, and he mentioned he's always looking for people to fund his flips. I have some cash I want to invest so we talked about how I could potentially be his lender for a flip.

I've been researching what typical hard money lending terms are so that I would have a better idea of what to ask/expect from our arrangement.

I have 3 questions about this:

1. Why is it standard practice to charge origination fees/points upfront on the loan? It seems counter productive to me, because the whole point of me lending him money is because he needs the capital to purchase a house and rehab it, so why would I say "here's 100k, but first give me 3k"? For example, if the terms are 10% interest and 3 points (assuming 1 year), why not just say the interest is 13%? I may be misunderstanding how the points work, but more importantly I don't understand why they're needed.

2. Similarly, why is the loan usually between 70%-90% of the home value, why not 100%? The way I see it, the reason he needs my money is because he doesn't have his own to invest in the project, so why is it so common to say "you do need to put in X%"?

3. This doesn't relate to the title of the post, but I was wondering if there are any specific terms that are a good idea to include when lending for a flip. For example, some term that somehow increases/guarantees my return? I was also wondering if, when talking about a flip loan, the LTV value is using the value of the house+rehab in the calculation.

I'd be happy to receive any sort of feedback on these topics. Thanks!

1. Why is it standard practice to charge origination fees/points upfront on the loan?

These folks are typically trying to finance properties that someone like me can't touch, so they squeeze every dime of profit out of it they can. This is like asking why a landlord charges $1500/mo in rent when they "could" charge $500/mo. For a loan that someone like me can do, it's sold to Fannie/Freddie/BigBank/etc on the secondary market, so there's another point or two of profit on the back end. HML don't have that, so every dime of profit must come from the borrower.

2. Similarly, why is the loan usually between 70%-90% of the home value, why not 100%?

The ones doing 100% financing already went out of business.  

@Chris Mason so you're suggesting that allowing him to borrow 100% of the funds he needs is a terrible idea :) Why is that? Why should it matter to me if he takes 80% or 100% of the money from me, if I get the return anyway after the year? Is it just a security measure in the event that he doesn't pay me back, so I can claim the property without having put 100% of its value down?

I will try to answer you as honest as I can.....

What you are talking about is an private investor not Hard Money Loan.

You have to make sure that the flipper has something of value that he will loose if he defaults that is his down payment.  Its called having skin in the game.  The 100% thing is the same as the 2nd question. 

The amount due for a loan before you get one is called a loan origination fee and that is usually done by someone with a license (which you do not have) this is so the lender knows that the paperwork is done correctly. And why the fee? Here is where it get tricky......Some want a fee just to make money, some take a fee that comes off at closing, and some just want to rip you off.

IF you have any other questions please feel free to ask.

Just FYI if you loan someone 80% ARV of the money for a fix and flip then you make sure the deal says......you get your original money paid back first and at least 50% of the profit made. most will do 80 % from what I have seen.

Good Luck!

1) they charge points to a) increase the yield...3 points for 6 month loan is another 6% annual yield, not 3%. b) typically a HML is using some other investor's money.....the investor makes the interest, the HML makes the points.

2) the 65-70% BML's Lender is 65-79% of the ARV....value after the house is repaired. But they generally won't tge rdgabber to some if their own money in it too.....10% or so or purchase and rehab.

Other typical terms would be : no second mtgs allowed, 6 month term, etc. 

I'll gladly take your money for deals you are funding at 100% and charging me no points on.  Risk free for me, huge risk for you.  I can walk away from the property with none of my own money in the deal and leave you holding the bag.

Originally posted by @Russell Brazil :

I'll gladly take your money for deals you are funding at 100% and charging me no points on.  Risk free for me, huge risk for you.  I can walk away from the property with none of my own money in the deal and leave you holding the bag.

This has got to be one of the funniest posts I've read on BP. Is there any way to give more than just one vote on a post?

1.  Take the extra 3% for a 13% rate instead of 3 points up front and they pay you back any time less than 12 months...well you didn't really make 3 points, did you?

2. Depending on where you live (no idea the usury laws of Canada), but 13% first lien could be considered usurious, so your interest rate needs to be in line with law.

3.  Give someone 100% and charge your points to the back end of the loan and sh*t goes awry, they are a hell of lot likelier to shrug their shoulders and say "oh well, i have nothing in this deal anyway, so, see ya lender...thanks for letting me have zero skin in the game from the get go.  Sorry it didn't work out and I lost your $100K, but it's all good, I'll send you a nice holiday card at the end of the year."

4. Yeah, there are some good terms that are a good idea to increasing your return. They're called profit participation/JV terms, and if you plan to give 100% of the money to your borrower, they should be paying you a healthy percentage of the profits because at that point you are their partner, not a lender.

@Dean Attali Here's my random two cents:

1. Why is it standard practice to charge origination fees/points upfront on the loan?

Someone has to pay the cost of conducting due dilliegence on the borrower. The lender sure as heck isn't going to front that just to find out a borrower is horrendous. As far as 10% interest and 3 points vs 13% interest is concerned, covering their bases, TVM, etc.

2. Similarly, why is the loan usually between 70%-90% of the home value, why not 100%?

It's as you've surmised, for security. Not to mention, lenders talk a different language. "Talk is cheap. Money speaks."

3. This doesn't relate to the title of the post, but I was wondering if there are any specific terms that are a good idea to include when lending for a flip. For example, some term that somehow increases/guarantees my return? I was also wondering if, when talking about a flip loan, the LTV value is using the value of the house+rehab in the calculation.

I wouldn't know, I'm not at that stage yet. 

LTV's are calculated differently between lenders. It can be based on the ARV like you're thinking, actual LTV (as-is), or some other algorithm(s) specific to a lender's risk tolerance, experience, knowledge, etc.

Thanks for the inputs everyone, and thank you for not taking my questions seriously, as I'm sure for anyone slightly more experienced these questions may have looked a bit silly :) I've gotten more than what I expected to learn from this post, it seems that I didn't even properly differentiate private vs hard money! Thanks everyone

Originally posted by @Dean Attali :

I've been talking to someone I know who did a few flips over the past few years, and he mentioned he's always looking for people to fund his flips. I have some cash I want to invest so we talked about how I could potentially be his lender for a flip.

I've been researching what typical hard money lending terms are so that I would have a better idea of what to ask/expect from our arrangement.

I have 3 questions about this:

1. Why is it standard practice to charge origination fees/points upfront on the loan? It seems counter productive to me, because the whole point of me lending him money is because he needs the capital to purchase a house and rehab it, so why would I say "here's 100k, but first give me 3k"? For example, if the terms are 10% interest and 3 points (assuming 1 year), why not just say the interest is 13%? I may be misunderstanding how the points work, but more importantly I don't understand why they're needed.

2. Similarly, why is the loan usually between 70%-90% of the home value, why not 100%? The way I see it, the reason he needs my money is because he doesn't have his own to invest in the project, so why is it so common to say "you do need to put in X%"?

3. This doesn't relate to the title of the post, but I was wondering if there are any specific terms that are a good idea to include when lending for a flip. For example, some term that somehow increases/guarantees my return? I was also wondering if, when talking about a flip loan, the LTV value is using the value of the house+rehab in the calculation.

I'd be happy to receive any sort of feedback on these topics. Thanks!

The answer to your question is risk.

Did you ever notice when you really need money, banks say no, but when you've got money they're looking to give it to you?  That's because there's less of a risk for them to lose their money when they loan it to someone that has money versus someone that does not.'

Similarly; if you've put your money into a project and the project is in jeopardy of going sideways, you're more likely to lean into it and get it done and either sold or rented vs walking away because you're losing someone else's money.

They also don't go to 100% because it costs money to foreclose and if they're already at 100% loan to value, they lose money if they even have to enlist a collection agency much less foreclose.

In response to #2, I agree with what has been written (that foreclosures cost money. It will also potentially cost the lender MORE money than it would cost you to finish the project). 

Another risk variable of making a borrower having "skin in the game" is market corrections. If the market dips, but you lent only 80% of the original value, you still have a good chance of being able to get your money out of the property if the borrower walks away. 

I would recommend researching "Capital Stack" - this may help you understand the borrower position vs. the lender position when it comes to equity and lien positions in real estate.

Hope your venture goes smoothly!

@Dean Attali also you as the lender will often have lawyer fees to get the mortgage recorded against the property. You want To pay for that? Probably not, hence the points. You don’t do 100 percent financing because that is very very risky. Don’t do that

OP, I do not think you should be lending any money to anyone any time soon until you really learn the game. I read your opening post, and a old folktale comes to mind...  A fool and his money are soon parted.