Would using hard money/private money be a good first deal?

[Jenna Barnes]

Hey guys!! I am super anxious to go ahead and get my first property. I am sending offers for owner financing and networking as much as my college and work schedule allow. Would using private money or hard money be a good way to get my first deal since my financials aren’t solid enough for normal lending standards?

[Anna Laud]

Hi Jenna! (Warning this is a long reply but it's going to give you a pretty in depth look at working with an HML!) Keep in mind that while you said that you don't have super solid financials just yet - skin in the game from you will be a necessity. One HML that lends here in Indy and a few other states for example requires you to have $16K in an account (in your name) for 3 months. Another thing to keep in mind is that some HML's aren't super keen on the idea of financing a first time flipper- HMLs that will lend to first time flippers do exist obviously, just don't be surprised when this question comes up from one.

So here’s an example deal; (Just trying to make sure you have an example deal to see how working with an HML would work and in my quick typing I may have gotten something wrong so please use just as a basic outline for an idea in concept!)

Deal:

ARV of $143K

Purchase of $75K

Repairs are $25K

Total capital is $100K (70% of ARV remember)

Turn around is 4 months

Draws 8

This is what the Hard money lender terms would look like;

LTC (loan to capital) 80%

Term 6 months

Interest 12%

Points 2%

Misc fees $1500

(add ext fees if extending if not ideal stuff happens for an example ) 2 points for 6 month extension

Inspection fees of $175 each (remember an ‘inspection’ for each draw to make sure you’re doing the work they think you’re doing with hither money)

Now if this flip takes 4 months, here are the total carrying costs;

Total loan amount cost $100K (.8 how much lent ) = $80K

The two points at 1% = $80K x .2 (for two points) = $1600

Interest so the amount lent of $80K x .12 (12% interest) = $9600 in interest (the total ANNUAL interest) so to carry that for a total of four months would be $9600/12 = $800 in the deal for 4 months = $3200 in interest payments

Inspection fees cost (remember 8 @$175 each for each ‘draw’) = $1400

Now if you didn’t exit the deal in 4 months and added the extension of 6 months you’re adding in the points for the extension (avg of 2 points per 6 months)

So points $1600

Misc $1500

Interest $3200

Inspect. $1400

(not including an extension) all fees ‘carrying’ costs of the hard money are $7700

Where does that come from?

Sale $143K

-Purchase of $75K

-Rehab of $25K

-Carrying costs of $7700

-$11.5K of closing (remember you might be paying yourself here as licensed pro if you're a PM in a state that requires you to be a licensed real estate professional)

___________________

Net profit of $23,800

So the ‘cost of capital’ in this case is $7700 to net $23,800

While intimidating in concept, HML (hard money lenders) are a go to source of funding for many flippers. The idea is to be able to have (near) immediate access to funds to close/rehab/sell quickly as the turn around on an HML is much faster than traditional financing. The investment property itself is collateral for the loan. Meaning they aren't funding YOU personally, rather the property being invested in.

Now to minimize the monthly payments there is a deferred payment style fix and flip loan - this would be where the payments are paid back from the ‘exit’ of the deal (sale) this would be where the position of payments is paid on the ‘back end’ (at the sale of the house) of the deal and not ‘over time’ during the ‘term’ (life/period) of the loan.

To be clear on a common misunderstanding is that hard money lenders are ‘loan shark’ kind of lenders while this is more of a commonly used source of capital funding in fix and flips than not. The idea of ‘oh no, this is going to be foreclosed upon’ is taken back to they are funding the property, not you- meaning before a ‘judgment of default’ was to transpire (aka foreclosure) you would sign over the deed of the property to the hard money lender- but realizing before it ever got to that point they want you to be successful because the more success you have, the more times you will come back to them and they will make more money (repeat business for them) . 

Now to prove that you totally mismanaged their funds- it would have to be taken to civil court, they would have to prove that you were not doing everything in your power to sell the property (again, this is where if you think like a hard money lender yourself and ask, "what are they not doing that I would to sell this, or are they doing everything to sell it?" (they don't want it back and to move it themselves, they want you to sell it and come back for more business) Now considering the number of properties funded at any given moment and the ROI these HML's are getting, it would be quite an extraordinary thing to go through this entire process and not having them work with you on this (because the amount of money stood to be lost in these proceedings eats back into the amount derived from things such as an extension on the loan and simply charging you points for doing so) Again, the ‘worse case scenario' here I'm describing.

Having said ALL of this and hopping over to PMI- this really depends on your PMI source- it could be easily assumed that for some people, working with the 'Frist Bank of Mom and Dad' as your PMI would be less complicated and seem less cumbersome (not in all cases and 'mom & dad; could be anyone) Odds are if they aren't related to you the ROI they expect could be much higher than a relative (on avg it seems maybe around 10%+, whereas a family member may ask for prime alone or something like .5%-1% above prime)

My best advice would be to speak with possible PMIs you may already know as well as HMLs and simply become educated on what their requirements are- knowing what you qualify for, or alternatively don't (if you can take HMLs off the table right away knowing before you apply you don't qualify, it's going to save time in working your PMI angle faster)

The single MOST important thing to keep in mind above all else is this; no matter who you work with PMI or HML- keeping lines of communication open is virial to not only the deal, but any future deals you will have with them (as they are financing) - IF anything looks like it's going to go wrong (say missing a payment) let them know so they can work with you and NEVER against you

Hope this helps! Thanks = )