Bouncing Ideas - Hard Money Lender Strategy for Fix and Flip

[Sharon Evans]

Hi there! I'm still in the "information gathering" phase of the deal, but I've spent the last few days educating myself on hard money loans, the costs associated with them, and the problems that people experience in getting the deal done. My first flip in Chicago was financed using a 203(k), which is a drastically different product, so this HML thing is definitely new to me.

Please bear with me, and spare any ridiculous "that's the dumbest thing I've ever heard" comments, LOL. I'm just looking to bounce some ideas around, and make sure that I have a crystal clear understanding of how this works BEFORE I embark on a deal. So this is all hypothetical :). I'm trying to  avoid dipping into emergency funds and savings, so some creativity in this business is definitely in order. 

The idea is to start off SMALL on the first deal. At first, we were looking to do deals on properties in good school districts, which naturally drove up the possible purchase costs. Though this is a good strategy, in general, it doesn't really fit the model for what we're trying to do. I realized that buying in a good school district is more a "buy and hold" strategy than a "fix and flip" one. So, going small to start will reduce upfront costs, and allow us to build necessary relationships with lenders/contractors/agents in order to get better financing and pricing options on the bigger deals that we'll do later.

Here's a good, hypothetical, example. Please let me know if I have a solid understanding:

Looking at a property that's worth $100k, and a HML that will loan 65% LTV, which is $65,000, does this mean that I'll have to bring $35k to closing? No, and here's why...

Most HML base the LTV on the value of the property AFTER it's been rehabbed. So, let's say that the house needs $25k of work, and I'm able to purchase it for $43k. The appraisal comes out to $100k, which means I'll get the $65k from the lender, as described above. This leaves me with $22k for the expenses related to getting the property up to snuff and ready to sell ($65k - $43k). Well, I need $25k to get the job done, which means I'm $3,000 short. I have 2 choices: 1) Pony up the $3,000 out of MY pocket to get the job done (I don't need to bring this money to closing, but I do need to demonstrate to the HML lender that I have the funds to make it happen), or 2) Simply adjust my budget down by $3k.

Let's say that the lender charges the following:

3% origination fee ($65K *.03) = $1,950

Appraisal Fee - $500 

Pro-rated Interest (one month) - $380 

Title Search / Title Insurance - $175 

Pro-rated Property Ins. - $100 

Pro-Rated Taxes - $400 

Settlement Fees - $400 

Recording Fees - $100 

Wholesale fees (if applicable) - $500 

Since "No Money Down" is not an option, I'll will need to pay these fees up-front in order to get my $65,000. So, using this example, I'd need to come to closing with $4,505. Bring this money to closing, the closing agent pays the seller their $43k, and then I get a portion of the $22k in funds to access to begin the renovations. The HML lender will provide additional draws throughout the construction process.

So, here's the tricky part that I'm still working on, which is funding the construction throughout the process to keep the work going, because I don't want to wait on the draws to be reimbursed MY OWN money. I'm considering the following:

1) Work with a large contractor who is familiar with the HML process and has the capital to keep the job going while waiting on the draws. I found that LOWES is now in the GC business, and their pockets are deep, so you can imagine that they are going to pay their subs regardless of the lender draw schedule, which is great fo me. I spoke with a project manager who assures me that they do fix and flips all the time, and they are NOT worried about getting paid so long as there is a contract in place.

2) Use the HML to finance the purchase ONLY ($43K), and work with a contractor that offers financing, preferably at a lower interest rate than you'd get from rolling the rehab into the HML. For example, LOWES will finance the entire rehab at 3.99% APR for 36 months, or 60 months at 5.99% This way, I have guaranteed the work by way of financing. Simply make the monthly payments on the construction line of credit, and pay it off at closing, or continue making the monthly payments and use the money at closing to being another deal.

I'm still vetting this scenario, and as i said, I'm still in the research phase. Any thoughts on this? Did I miss something in the process? What would you do differently?