How do I have a hard money loan cover my rehab down payment?

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I am looking to fix and flip my first property in a few months and have been looking at using a hard money lender (HML). For rough numbers I am aiming at 150K for the property and 50K for rehab. With this in mind, I have been saving for 20% down (30K) on the property with the understanding that a HML will finance 80% of the property and 100% of the rehab... however the more I learn about draws for the rehab, the more concerned I have become that I am underestimating the amount that I need to have set aside. To get reimbursed from the lender, they send an inspector to review the work after I request and then Ill get paid 2-5 days later. But if contractors want 25% or more of the project cost up front, how can I get reimbursed if that 25% isn't against a specific line item in the scope of work such that an inspector can sign off on it? Do I need to have more like 42.5K saved up (30K for the property and 12.5K for the rehab)?

Has anyone found a good way to work around this to maximize their leverage and avoid having to use more of their capital for the the rehab on top of the property?

[Alex Breshears]

Hi Henry! The terms you are quoting are pretty typical for hard money lenders. So let me explain the thought process behind it so you can potentially find a work around for it.  When you sign on the dotted line for a mortgage, the lender is taking on the risk of that capital being deployed. In hard money lending, they are lending money on an asset that often needs significant repairs, renovations etc.  That is a much riskier scenario because the property may not be "worth" the amount of capital for the loan at the time of closing. To use your example, the $150k purchase price is the value of that property as it stands (just to keep things easy), but then they are loaning you another $50k to improve it to get it up to a $300k value fully done (again just to keep the numbers easy).  Now imagine you buy the property, they give you the $50k check at closing to go work on the property.  There is nothing stopping you from hopping a flight to Vegas with that money and just having the weekend of your life! Then from the lender's perspective, they now have a $200k loan outstanding for a property that at that moment is only worth $150k.  To avoid this scenario, lenders build in certain performance gates, like you mentioned above, certain portion of the rehab completed, certain aspects of the project completed and inspected etc.  They do this as a way to have some assurances that the money they are providing to you is A) actually going towards real estate renovations and B) going towards the specific property the loan is out on.

Now understanding the lender's thinking, you can see why some of these parameters are in place. Not all lenders will have the same parameters. Some private lenders might actually let you leave closing with $50k because you have built a relationship with them and they trust you and your track record.  I would say that you could start out by investing with a mentor as a partner. Maybe you are the sweat equity side of the house and you bring some funds to the closing table, but you are handling the project management, maybe some of the work etc. In exchange, you are gaining valuable experience from that mentor (assuming you select the right one).  This will decrease the upfront capital required while also offering some experience to help guide you in the process (which could save you thousands!).

In the past, I have heard of active investors that have built relationships with those in their network and they will get an unsecured loan for the renovation costs from that investor, and then once all the rehab is complete they are then refunded by the hard money lender and they pay off that other investor. AGain, more of an advanced strategy and not one I would recommend to a new investor, just merely offering some alternatives to know what is possible out there.

Another option is obtaining some sort of line of credit either on your primary home or maybe a business line of credit. This can help extend your capital, but realize there will be an additional monthly cost to that capital, in addition to potentially putting up your primary residence as collateral on an investment property. You also likely will need to personally guarantee any business line of credit especially with a new business entity, but again it's an option that is out there. 

I hope that helps you some! Just keep talking to lenders and make sure you are very clear on what their draw model is for getting those funds being held back for renovations.