What Price for This Loan?

Question

So my first oppportunity to make a HML fell through as the buyer lost the house to a higher bidder at the last moment.  Here is another loan request I received:

Amount of Loan: $100k
Buyer Cash-in: $38k
Property Purchase Price: $65k
Renovation Costs: $70k
Estimated ARV: $178k (Desktop Analysis from local RE agency)
Property: 1,750 sq/ft SFH in lakeside community in CT (4 bdrm, 2bth)
Credit Score for Borrower: mid 600s
NO Personal Guarantee
Exit Strategy: Sell house or Refi - DU Underwriting Findings - Recommended/Eligible

Borrower is an accountant.  Don't know if this is his first project - I obviously will ask about this.

Broker is asking for 9%/2% and the no guarantee.

Would you guys do this loan and if so, at what price (9%/2% seems rather low and no guarantee seems out of the question to me)?

Thanks!

Jeff S. · Answer

I wouldn’t do this deal for several reasons Luc; some financial and some not:

1)	It does not appear you know who you are loaning to.  In my view, lending is first about character and experience and then about the numbers.  No broker can help you here.   If your borrower is an accountant, presumably working full time, how and who does his rehabs?  Plus, has he ever done this before?  Need more info from you on this.  I don’t advise you loan to anyone without substantial rehab experience.

My suggestion is to find, meet, and get to know those you are loaning to.  You’ll probably need a broker to originate the loan, but that’s it.

2)	Have you seen the property?  What kind of shape is it in?  Do you agree with the comps and also with the rehab cost?  You mentioned the borrowers exit strategy, but what about yours?  If you had to take this house back, could you immediately sell it to another flipper and come out whole?  Or, are you in a position to complete the job yourself and make an adequate return?  If something goes bad at any point in the rehab, how would you get your money back?  The answers will be different at the start, middle, and end of the job.

How does the borrower’s credit rating or a personal guarantee play into this? Unless he has other collateral you can tie up as security, your only backing here is your first position loan on the house.  It is a first, isn’t it?

3)	The numbers here are terrible.  $70k is a serious rehab for a $178k property.  Your borrower is paying $65k+$70k=$135k, or almost 76%, for a $178k home.  I wonder if he’ll make money, which makes me wonder how much experience he has and how skilled he is at finding deals.  If you’re into this place for $100k, who would buy it from you for that and then put $70k into it to make it livable -- no one that I know.

Is 9% + 2 points the prevailing HML rate in your area?  Seems low to me but I don’t know Connecticut.  How much is the broker taking for this awesome opportunity.  Does he really think this is a good deal for you?

Jeff

Jon Holdman · Answer

9/2 is on the low side.  What's the borrower actually paying?

Valuation is key.  You want a real appraisal from an appraiser you choose.  Borrower pays.

The guarantee isn't very useful anyway.  You want to be sure the value is there in case you have to take it back and sell.

Borrower's money, or, at least some chunk of it, goes in a closing.  You absolutely do not want to hand over $100K to the borrower at closing.  If you do, you will have $100K on the line on a property that's only worth $65K.  I would not put out more than $50K at closing and hold the other $50K in a repair escrow.  Only disburse that once the work is done and you inspect it.

Require permits and only hand over money once the inspections have been signed off.

Account Closed · Answer

Depending on the role each person plays in the transaction, everyone has different perspectives and will generally push for what they want. The deal only works as smoothly as possible when the terms work for everyone involved. I agree with Jeff's suggestion to define your criteria first. Also consider what are the negatives if you accept things outside of your criteria and how can you tolerate them. Stick with what works for you and let the brokers send their non-qualifying deals somewhere else.

By the way, consider your exit strategies over the borrower's or the broker's proposed exit strategies. DU eligible and current borrower FICO's may or may not help too much for the borrower's future refinance. What if conventional lending criteria changes in the future? Or the borrower's FICO lowers or he has changes in income and employment? Plans are made with good intentions but what are the chances that things are actually followed through? As a lender with most of your money into a deal, you need to make plans for every situation possible.

Luc M. · Answer

Jeff,

The broker and I sat down regarding what I would like to see a couple of weeks before this prospect came up.  I also told him that my minimum rate would be 12%+2-3pts.  He sent this request along anyway.  I posted it here to get people's thoughts as I'm sure rate could be negotiated.  This broker tried to trick me into a resi loan when I said that I would only do commercial loans.  He even said that I should only do commercial loans when we first met.  So I think the real lesson is trust nobody and verify everything - a rule that has served me well in my other endeavors.

Jeff S. · Answer

The real lesson Luc, is to clearly define your investment criteria in writing.  Broker or not, it’s important you know when you’ve been presented with a viable investment.  How will anyone know what you want if something comes up? How will you know what to ask them?

With the banks choked off as they are, there’s currently an unbelievable demand for private cash.  The clearer you are in advance, and the better you are at publicizing it, the more likely you’ll receive a call with something that meets your criteria.

Jeff

Luc M. · Answer

Guys,

Thanks for all the replies.  I am NOT doing this loan.  I took a drive by the "house" to see if it would be worth doing the additional due diligence and I decided against it.  The house sits on a very hilly street and the site itself is a big hill, leaving whatever residence would occuply it with no useable outdoor space, not even a driveway for a car.  Not ideal for a family and not very suitable for a second home (it does overlook a little lake though).  Anyway, I called the broker who shot over this request and asked him some additional questions - why would an accountant undertake a BIG rehab project like this for his first project, does he have a GC that is going to do the work, etc., etc.  Well, it turns out that the home was going to be for the guys fiance - thus the low 9% + 2 pts (CT usury laws state 12% is max for a residential loan).  I told the broker I was not pleased by this tactic and that I wasn't interested in making residential loans.

Guess the lesson is to always watch your back and if something doesn't smell right it probably isn't.  Thanks again guys.

Raymond B. · Answer

I live in Ct.

At the ctreia meeting is a HML, who lends at 10%, 3 points, only for a SFH.

Another one lends at 12% and 3 points.

Raymond

Joel Owens · Answer

Everyone quotes 15% rates.

Look at it from a purchasers perspective as well.The HML is trying to mitigate risk.

The buyer is trying to get a loan that won't eat them alive in points and interest rate.I don't think 9 or 10% is bad for a HML if the buyer is experienced.This comes down to after making a track record getting closer to private money rates.

If you look around you can find private money willing to lend at great rates.They simply aren't getting any returns from their stocks,cd's,etc.,

If you don't know the buyer,the property,or the area then you have to build in the risk.Big HML's have higher rates that lend in multiple states or nationwide.

Many HML's lend only locally and many were rehabbers before just loaning out money.They know which areas to stay away from.I would not loan on that property if I was a HML because of the numbers provided.

Jeff S. · Answer

I suppose the most common alternative is to play the field and selectively loan to those who apply, adjusting rates by the perceived risk.  Nothing wrong with this either.  It’s just not our model.  Plus, I’m not sure how appropriate it would be for someone like Luc, who hasn’t done enough deals to average out the risk.

You could charge more I suppose, but no amount of extra interest will prevent a default. Yet another difference in our business models.

Jeff

Greg Sharp · Answer

In California you woudln't get the loan financed at 9%/2 points. Typically it will be 9% - 12% and 3-4 points,

I agree about the rehab. $70K on a $178K house is a lot of work and you have to have some serious problems. Many people won't like that because you have crossed the bridge from rehab to construction and increased the risk to the lender.

What Price for This Loan?

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