refinancing rental after hard money?

Question

Hello,

My friend is looking to buy property and I told him I'd ask for him. How difficult is it to re-finance at the end of a hard money loan(interest only, 6 months)? He might be paying 34 to 50% cash, the rest a loan. This is for one property only. He'd be rehabbing and renting it out & expecting to buy below market value. Will probley have a loan much less than 70K.

I can't give specifics-   He dosn't have any property in mind yet, although we've looked around.

Thanks, any help appreciated.

Lynn Harrison · Answer

Wow. Thank you everyone, there is a lot of useful information here!

The reason I'm posting is I have more time & consider this a challenge. He considers this part of it a PITA.

"Give us some real numbers and loan terms and we can work through this for you."

Yes, I'm in the process of finding those real numbers. We do not have a particular house in mind although we've looked at about 20 of them. The plan is to buy a rental in an area where we don't live in order to build equity so that he can afford to buy a house where we want to live later on.

"Is he planning to manage the property himself?"

That depends- one area is very cheap but further away and is what I guess is called a "war zone" on this forum. In that case yes, hiring a management company. The other is higher and closer and in that case no.

Is there anything else we should be cautious of with financing. Jon, you saying

"That makes it sound like it has to be repaid in exactly six months. Be VERY VERY sure it can be extended. If an approval is required to extend, assume it will not be approved. Better to get a loan term of nine months or more. I personally would not be comfortable taking out a six month loan right now, just because it is taking so long to close loans.

That hit the nail on the head, that is the biggest worry. I'll be calling the hard money person soon and asking a few questions but we don't really want to meet with him until we are prepared. also the math seems to work out but I'm assuming 4 points on the loan & could be way off. 2 friends of ours borrowed form the hard money lender and did not have to pay in full at 6 months, just had to pay both interest and principle, but it's 10% at 1 or 5 years (don't know which yet). The lender is liberal but he does make good money.

I think the math would work out for any house considered, but what I am worrying about is it seems banks do not like to loan for any reason right now and some of the processes may not be as straightforward as they are presented by them. If it took an additional 6 months he could do it but wouldn't want to.

He will be going for a re-fi with a local credit union so that may help.

The one thing that may throw him is his credit is not so good. An old girlfriend got hold of his credit card & also he moved and didn't get a bill for $12... I think his credit score is 640. The only thing he can do I think is write an explanation on the reports. Is this something that would stop a re-fi cold?

Andy Collins · Answer

on top of what Jon said on making sure it can be renewed, see what the cost is for renewal,,many times if you go past the first term, say 6 months, you have to pay a couple of points for the extension.

Make sure he can qualify for the loan after the fact, you will still have to look at credit score, DTI, etc,,even if he is only financing 50% of the homes value, if he wants a mortgage his personal DTI has to be under 45 or 50%,,,

The biggest problem I have in refinancing a hard money loan is getting a bad appraisal for the refinance,,but since he is only financing 50% or so of the deal that won't be a problem

Jon Holdman · Answer

Is he planning to manage the property himself?  That, take calls from tenants, show it to prospective tenants, screen them, etc?  If so, the banker's formula is pretty close

cash flow = (rent * 75%) - PITI
.  If he's going to use a property manage, a more accurate forumla is:

cash flow = (rent * 50%) - P&I

"*" is multiplication.  I've been doing software so long I assume everyone knows you use * not x for multiplication.

P&I is the principle an interest part of the payment.  The output of the Excel PMT function.  PITI adds in the taxes and insurance.

DTI adds up all your monthly debt payments (real estate, cars, credit cards, student loans, etc) and divides by the monthly income before taxes.  I'm not 100% sure how the rental properties figure into that, but I think as long as the cash flow is positive you don't include either the debt or the rental income into the DTI calculation.

Is he going to be living in this house?  Seems a little unusual to have gift money for a house you're not living in.  Terms for owner occupied loans are easier from conventional lenders. But hard money lenders don't usually do those.  Realize with hard money lenders this is strictly business.  If your friend defaults, the lender will take the property.  There won't be any "forbearance" or "workouts" or "loan modifications".  The lender will expect your friend to quietly and willingly just sign over the house.  Won't matter if your friend has cash invested, that's now a loss on his part.  Your friend should be very sure he can get into this property, then get the refi done in a timely manner.  Sounds like there is a six month pre-payment penalty, but then the loan term is six months.  That makes it sound like it has to be repaid in exactly six months.  Be VERY VERY sure it can be extended.  If an approval is required to extend, assume it will not be approved.  Better to get a loan term of nine months or more.  I personally would not be comfortable taking out a six month loan right now, just because it is taking so long to close loans.

When he does the refi, the bank will determine a value, then loan, at most, 75% of that.  There will be costs.  Three to four percent of the new loan amount would be a good guess, but that's just a guess.  Hopefully he will have to bring little cash to the table, but its possible.  I did a streamlined refi recently and had to put in about $50.  When I originally refi'ed that same house out of a hard money loan, I had to put in about $1000 on a new $88K loan.  Regardless of the values involved, he's not likely to walk away with any cash.

When he buys with hard money, there will be costs, too. About 1% or a little more for the closing transactions, plus the hard money points.

Give us some real numbers and loan terms and we can work through this for  you.

Why isn't your friend posting?

Nathan Emmert · Answer

PITI = Principle, Interest, Taxes (Property), and Insurance (Fire/Dwelling).  If you escrow your taxes & insurance, this is your monthly mortgage payment

DTI = Debt to Income.  This is a ratio banks will use to determine if you can handle more debt.

Rent x .75 is exactly how it looks.  Rent times .75.  Banks will use 3/4 of the rent, 75% or .75, in determining the income it generates.

If it rents for $1,000 and your PITI is 600 the banks will look at $1,000 * 75% = $750 - $600 = $150... the property is helping you.

In reality, most of us strive for a 3:1 mortgage (payment + interest only) to rent ratio (or better).  If the rent is $1,000, you'd want your mortgage payment around $300 without taxes and your homeowners.

Lynn Harrison · Answer

Oh, and he is only going to buy one property. Maybe after that though... you never know :)

Lynn Harrison · Answer

Thanks Jon and Carl!

It's late and I'm having a hard time concentrating, So I will look over this again tomorrow.

"For income, banks figure rent * 0.75, then they subtract the PITI payment. If that's positive, it helps your DTI. If negative, it hurts (and, the property is probably truly cash flow negative). "

What are PITI, DTI and what is *0.75? Is that "x" .075?

It shouldn't be cash flow negative. We are being careful looking and he has experience in construction estimates. We rehabbed a mobile home last year that was a nightmare but it ended up OK financially.

The loan I believe cannot be refinanced for 6 months and is interst only for 6 months. He's not applying for the loan until he has 35 to 50% cash in the bank. Most is gift or earned from a sale so doesn't need to be paid back.

So, I think refinancing should be on 30 to 50% of the value of the property. We are looking at REO's and waiting for a few to hopefully come down in price.

Curt Davis · Answer

IT all comes down to the mortgage companies policy on rate & term refi's.  We only use companies that have no seasoning requirements and if its hard money for a rental you should only need a 90 day term.  If you need anymore then that your rehab is too great or taking too long, one or the other.

Jon Holdman · Answer

He may need to wait six months or maybe even a year to refinance.  But, I've heard of refi loans getting closed quicker than that.  I assume you want to use a new appraisal rather than the price you paid.  That's where the waiting - "seasoning" - comes into play.  If you just want to refi based on the price paid, you should be able to do that quickly.

No cash out.  Just rate and term.  So, if anyone is wanting money back (i.e., family who has loaned him money), it should be done with a deed of trust secured by the property.  Then the refi loan can pay it off.

The borrower will need to qualify for the loan.  That means income to support the loan, good credit, and cash reserves.  For the first four mortgaged properties (primary residence does count), LTV can go up to 75%.  Over four, up to ten, limited to 70%.  Need middle score of 660 or better for the first four, 720 after that.  DTI under about 50%.  Cash reserves of six months PITIA (A = anything else, like HOA) for the property being refi-ed.  For the first four, needs two months for any other properties.  Over four, needs six months for all properties.

For income, banks figure rent * 0.75, then they subtract the PITI payment.  If that's positive, it helps your DTI.  If negative, it hurts (and, the property is probably truly cash flow negative).  Some lenders may allow you to consider the new property.  Many won't until you've had rental properties show up on two years tax returns.

Realize that lenders are all over the place.  These are terms given to me recently by a broker.  They appear to be on the more liberal side to me, but are pretty close to basic Fannie/Freddie guidelines.  Some banks apply their own overlays that add more restrictions.  Don't give up if the first, second, or tenth bank says "no".  An investor friendly broker will be a real asset.

Lynn Harrison · Answer

thanks Ron. I believe the loan will be fixed and open to refinancing after 6 months. I'm wondering how hard it is to refinance with banks.

What he should end up with is a rental that should be repaired and rented by 6 months and at least breaking even including all expenses at that point. But family has contributed to a fund to buy a property. His income by itself would not be enough for a bank mortgage to buy the house. IF a property is paying for itself and 50 - 65% is paid off- would it be easy to get refinancing for it? Lets say it would pass a bank's physical inspection. And should be worth the amount owed on it if not more. Should that be an easy thing or what else should he be prepared to deal with? It just seems like every time we pass one hurdle another one pops up that we hadn't thought of.

Rob Gillespie · Answer

My personal advice is to stay away from a 6 month balloon, it comes too quick. I would do no less than 24 months. 
As far as a refi, lotta factors to determine if it is possible.

Good luck!!