How do Hard Money lenders react to flips going over budget?

Question

Hey BP,

I am currently working on a fix and flip where the budget started at 80k before demo and figuring out what to do (old house with funky floor plan).

Purchase was 80k. House is 3/2 bath 1800 sq ft. Reno budget is now at 170k to finish it. All in position of 250k.

This is my first major rehab and I just didn't know what I was getting into! I have done two other, mostly cosmetic flips before this. Once we started demo, the numbers exploded as I went over each line item that needed upgrading.

Although it was an extremely stressful conversation, my private lender (family friend) has the capital to fund it and is going to help so we can finish the project. Since he funded the purchase and the first 80k in rehab ,  we are both kind of tied together on it. he is nervous about the house not selling for more than 250-275. The comps tell me 300-325.

I am curious how hard money lenders or even private money lenders would react to their rehabber doubling their budget?

Thanks for your feedback!

Jon Holdman · Answer

I've been in this position as lender.  With a hard money lender it would work exactly like @Shawn Ward says.  It would be your problem to come up with the difference.  Further, at most a small increment of the rehab budget would have even been given to you up front.  Perhaps a third of the $80K rehab budget.   You would be paying interest on the full loan amount.  Additional rehab money would only be given to you as the work progressed and was inspected.

So, in your situation you would have reached some point where it was clear you would not be able to finish on budget.  The lender would still be holding some chunk of the rehab funds in escrow.  It would be up to you to come up with additional money to finish the project.  In our case, the person servicing the loan and managing the escrow budget had released the entire rehab budget, but the rehabber was caught by the city doing unpermitted work.  He was out of money.  He ended up giving the house back to us deed-in-lieu of foreclosure.  We put in additional money, finished the rehab and sold the house at a loss.  We believe the rehabber had about $30K of his own cash into the deal.  We ended up with about a $5K loss, though we had $150K tied up for 15 months to generate that $5K loss.

In your case, your lender is willing to put in extra money to finish the project. You're very lucky.  In your shoes I would do everything possible to make this lender whole.  If you sell at $300K, you'll net about $275K after closing costs and commissions.  Sounds like you owe the funder $250 plus interest.  If that total amount is more than what you net on the deal, you should scrape up the money somewhere to pay them everything you own them.

Rick Pozos · Answer

Nobody likes that you went over budget, especially as much as you did. You are in a great position though in that your friend can and will fund you all the way through it. Sometimes you go past what you are thinking and you have to ask for a little more. If you have to ask for a bunch more, this tends to stress the relationship somewhat. Since you are already there, finish it and maybe budget for more on the next deal or dont get into that big a project in the future.

I have gone over budget, but I cover that out of my pocket. I do not like to go back to ask the lender for more. It makes me look bad. I usually get into the deal at 100% financing (purchase and rehab), but I always have some money ready for budget overages. I have some cash and plenty of credit ready for the unexpected.

Shawn Ward · Answer

@Charlie John we've gone over our budget almost every time (we do account for this with our contingency), and it doesn't affect our HML at all.

They only care that:

1. We pay our monthly mortgage payment

2. We pay off the loan in full when we sell it

When you go over budget, you have to pay for it with private funds, since the lender funds on your original plan.

So as long as your sell price is enough to pay them back,  and you stayed current on your mortgage, then you are good.

Onwards!

Manuel Angeles · Answer

Rehab funds are typically held back in escrow and released through fund control . Ideally, you'd want to put in a 10-20% Contingency.

Jacque Fairbourn · Answer

@Charlie John - Can I ask a couple of questions? How many contractor bids did you get on the job before determining that you were going to do the deal? Is this a contractor with which you have experience?

As mentioned above- are these repairs needed in order make it comparable to other houses in the neighborhood?

Because you are using a private lender with which you have a relationship you've been able to secure funding for the increased rehab expenses. In my experience, most hard money lenders will not extend the original loan to cover these types of situations, so you'd need to come up with the money on your own else where. sometimes flippers can use their own funds for unexpected costs, but many turn to gap financing of some kind. You may want to look into have that type of resource in place before you do your next flip.

Let us know about your progress with this one!

How do Hard Money lenders react to flips going over budget?

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