How to Structure a Deal Using Both Hard Money and Private Money (Without Conflict)?

Question

Hey everyone,

I’m working on structuring my first few fix and flip deals, and I’m a bit confused about how to properly combine Hard Money Lenders (HMLs) and Private Money Lenders (PMLs).

From what I understand, most HMLs want to be in first position and don’t allow any second position liens. But at the same time, many PMLs want to be secured by a promissory note and lien on the property.

So how are experienced investors actually doing it when they say they use both HML and PML money to fund deals with “no money out of pocket”?

Are PMLs just providing unsecured gap funding, or is there a legitimate way to structure it where everyone’s protected and the HML stays comfortable?

Appreciate any clarification or real-world examples from those who’ve been through it.

Thanks in advance!

Patrick Roberts · Answer

Hard money is private money in most cases. Most people colloquially refer to friends and family loans as "private money". People who are not professional lenders have no business lending money in second position or offering unsecured funding on a fix and flip. On the flipside, most professional lenders are not going to do this because it's extremely high risk.

100% financing is a myth. You will have to bring equity capital to the table.

Chris Seveney · Answer

Typically they are not doing both as neither one typically allows it. For those that do do it, just be warned, financing at that leverage is approx10x more likely to go into default (look at traditional default rates compared to FHA loans). If you have never done a deal and someone gives you 100% financing then those in the lending space would call that person a sucker. The only time you see it from lenders is when they can cross collateralize against the other assets and the borrower has significant net worth to cover the losses.

Jeff S. · Answer

I appreciate your initiative, @Kwok Wong, but instead of attempting a few fix-and-flip deals at a time with no money, which is not going to happen, why don’t you save enough cash for a sensible down payment and reserves on one property first?  Lenders will take you more seriously, and you’ll have a better chance of success.  Right now, you have no experience and are asking a lender to take all the risk.  Why would anyone do that?

Many lenders are making 80% to 90% LTV plus 100% rehab loans, and some will work with newbies.  Surely you can save enough to do one, can’t you?  Plus, you’ll want a cushion to account for the inevitable overages that even experienced rehabbers face.

Second, as you mentioned, many lenders include a clause in their loan documents giving them the ability to call the loan due if you take out a subordinate loan (i.e., a 2nd lien or lower).  It’s called a Due on Encumbrance clause, and the intent is to keep you from overleveraging yourself.  For 1 to 4 unit properties, these have been unenforceable since 1983.  Some lenders use the same loan docs for both residential and commercial loans and know this.  Others use this clause to intimidate the unknowledgeable, which appears to work.

A lender doesn’t have to make a loan if they know your plan is to borrow additional funds, but they can’t stop you once you have their loan.

Doug Smith · Answer

Hi Kwok, sorry I'm just seeing this a month later. I think I could have added value. Oh well. I think clarifying your definition of HML and PML is important. I see HML as focusing on the collateral only while PML is just a non-institutional lender. Do we see that the same? I've been a lender for 35 years and own an NMLS-Licensed mortgage company that does both consumer and commercial lending. We do fund a lot of flippers, investors, and builders. Typically, most lenders aren't going to allow subordinate financing (2nd position gap funding), but if you do just make sure you're disclosing it up front. Most lenders are going to want to "source" the down payment, closing costs, and perhaps some reserves (rainy day money that will be left over in your bank account after closing). The default rates on those that put little or nothing into the deal are astronomically higher than those that have skin in the game. That's why lenders don't like gap funding. After I was lending for several years, we decided to jump into investing as well, but we didn't personally have a lot of $ to do so. We ended up partnering with an experienced investor with capital for the first handul of deals until our experience and capital warchest was built up a bit. I know it's likely not the answer you were looking for, but that's how most legit lenders are going to view subordinate or gap funding. Let me know if you want to chat. I'm happy to offer advice.

How to Structure a Deal Using Both Hard Money and Private Money (Without Conflict)?

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