Family Loan to Renovate New House -- Refinance?

Question

Hi Everyone,

I will potentially be purchasing a $50k house that requires a decent amount of repairs maybe about $25k.  After repair value would be $110k, plenty for refinance.  The initial loan mortgage would be a 20% down conventional residential mortgage (therefore a $40k mortgage).  If I borrow the $25k amount from parents and use some sort of paper documentation to document the transaction with an interest rate.  Would I be able to refinance the 80% [or $65k whichever is less] of the property value using the after-repair value assuming 1 year has passed using a rate-and-term refinance?  In other words can I refinance such that it includes the $65k mortgage and then I can pay back the loan to the parents.

Would it be possible to refinance prior to 12 months?

The reason I am considering this is because I don't want to pay the high interest rate for hard money loan.

Thanks!
Brandon

Brandon Cao · Answer

First off I want to thank you both for giving your views.  I definitely see merit in both options.  My only reluctance is as you stated finding a lender that would be able to do a cash-out refi after seasoning of 6 months.  If I were able to find said lender, I would consider this option.  That being said, I will have to find someone of this caliber in the Philly area.  As for Bill's response, the parental separate title work seems like extra work, but the payoffs seem pretty worth it.  It's never bad to have Mike's friend could add another game plan to their playbook.

As before, I said I would look into the Wells Fargo Purchase and Renovate loan.  I spoke with a rep and he's running the numbers right now, but here are the perks:

-no prepayment penalty
-requires 25% down
-can do loans starting from $50k and up, anything below $50k will be a HELOC (a no-no for me at this point)
-ONLY ONE CLOSING COST!!
-Works on Investment Properties

Cons:
-Must hire contractors to perform the work
-I haven't heard of anyone doing this yet
-I heard its a little higher interest rate
-Hoping there's no requirement for points...

Right now this is definitely a contender because of the single closing costs and the lack of excessive interest rates from Hard Money Loans.  Simpler and easier on the relationship for that matter, than the parental loan.  Although I won't know until I try it.  I'll keep you guys up to date -- still waiting on the offer response though.

Thanks,

Brandon

Bill Gulley · Answer

It's fine in any forum for pepole to disagree. It might be foolish for others to follow advice simply because someone wrote more about a question as if they are speaking with some authority on the matter.

Okay Mike, lets hear your sound financial reasons as to making the loan from her parents with a note and nothing else.  Your recap.

I knew of a guy who flew to the moon too, doesn't mean it's good advice to tell people they can fly to the moon.

Mention the member who is doing what you claim and let him join the discussion. I have cashed out days after buying, doesn't mean anyone can.

But first, why is it better not to file a second when she needs to refiance later on?

Mike H. · Answer

Actually, I had assumed when I wrote my post that you were talking about a refi of an investment property.

And, yes, cash out is easier to do with a primary but it can still be done with an investment property. Again, another member on here is doing one as we speak and is doing it at 6 months. Cash out on an investment property at 6 months.

And as you can tell from my post, I said that you might not be able to do a cash out in 6 mos but I suggested you refi your hard money loan at 6 mos rate and term and then go back and do the refi cash out after a year - since your concern was not wanting to pay the interest rate for the HML for a full year.

As far as the parental loan being unofficial. I didn't mean to suggest that you should do anything fishy. What I said was instead of making it a second mortgage on the home, you could very easily just take out a personal loan with your parents and not make it secured by the property.  I did say that you should do a promissory note which gives them the security of your personal holdings (i.e they could technically sue you for failure to pay and go after your stuff).

Thats not doing anything wrong at all. Its not bending rules. Its all about whether your parents trust you enough to do a personal loan vs wanting to have that loan secured by a 2nd mortgage on the house.

Personal loans with family via a handshake are done every day. A promissory note, as I suggested, just gives them some additional security.

I do have to comment though on the previous bost. Bill's comment above suggested people were giving bad advice and mine was the only post on here, so I would have to take that as a shot at me.  I still believe my advice is far better than his.

I see no reason to record a second mortgage on the house if your parents/family are the ones giving you the loan. I have to believe they'd be just as willing to do the loan with a promissory note (its a personal loan) since having a 2nd provides very little additional assurance of getting that money back anyway. Once the owner of the 1st mortg starts adding late fees, attorney fees, foreclosure fees, etc, there's nothing left for the 2nd.

And, as you can tell from his post, there is a ton of additional paperwork you have to do if you do put a second on the house. That second may very well become a factor in you being able to do the cash out at all. So why do it? That makes no sense.

After all, even if the house flops, you're going to pay them back regardless aren't you?

I just don't agree with Bill that you should record a 2nd mortgage. And I also know for a fact you can do cash out refi's in 6 mos on investment properties. I'm not saying it will be easy - getting any financing at all never is. But my "advice" is still sound in that it exists if you're willing to do some digging. And I know that for a fact because a member is doing it as we speak.

So, just to summarize.

1) I actually had assumed you were talking about an investment property loan. 
2) Even after noting Bill's advice, I would strongly recommend against creating a 2nd mortg and, instead, doing the loan with your family as a personal loan with a promissory note instead.
3) You can do a cash out after 6 mos on investment property. Just need to look hard enough. But if not, you can definitely do a refi rate and term after 6 mos for the HML and then do the cash out after a year to pay your family back.

And there are two reasons why you'd want to do two refi's there. One is to avoid paying the interest. I realize you'll pay more in fees. But the second issue is that most HML's won't do loans for a year. If yours does, then you have to weigh the costs of the interest for the additional 6 mos vs the costs of the refi and possibly wait the full year for the cash out refi.

Brandon Cao · Answer

Bill Gulley
Hi Bill, Thanks for your input! There's a heck of a lot of info you provided!  You're right I forgot to mention that this will actually be an investment property.  I was curious since I thought you would have to wait to season a cash-out refinance, but I'm glad I asked since I thought it would be "easy" to get a cash-out refinance after the year term when in fact it could be difficult.

I've heard a lot about the rate-and-term refinance from other investors and thought about pursuing this route.  It definitely made sense to me that I would have to record this as a lien but was unsure how do that.  Thanks to your explanation!  The other path forward that I'm considering is Wells Fargos Purchase & renovate conventional loan program.  Also, I was reading the post from:

http://www.biggerpockets.com/forums/67/topics/56550-how-does-one-get-loan-for-renovating-a-property-for-flip

Bryan A. mentioned: "i think i posted an answer to one of your questions a week or 2 ago about getting smaller loans for rentals...same answer here...small local banks...they will provide rehab financing as well, but you'll have to put down the 25% for the purchase price and 25% of the renovations"

I definitely have some options!  Right now I'm waiting for a response for the offer...  Thanks again Bill!

Mike H.

Hi Mike, thanks for your reply as well!  I think our circumstances might be slightly different since I have an investment property.  Perhaps in a owner occupied investment where the Cash-out refinance is easier, you could go with the parental loan being unofficial and then waiting the year seasoning plus repairs performed.  At that point, according to my understanding, I could cash-out refi with a new appraisal (again assuming if I was owner occupied).

--Brandon

Bill Gulley · Answer

Some advice is getting so bad I'm beginning to think there are a few who attempt to sabotage newbies as some cruel sport.

Brandon C.,yes you are on the right track at one year. You didn't mention if it's an owner occupied or investment property, I assume it's owner occupied. Getting a cash out refi on an investment property can be hard to do. Owner occupied cash out is at 75% LTV.

But, you don't need to work this out as a cash out as owner occupied can be 90% LTV but that may not be the best deal with PMI,so say 80%.

In order to do a "no cash out" loan the liens to be paid off by the refi loan must be over one year old or seasoned for one year.

This means any loan you get must be done with a note and deed of trust and filed as a lien on the property. As a second mortgage.

As to parents, there can be an issue when the name on the note and deed of trust is the same last name as the owner/borrower, a lender may view loans between family as not being at arm's length or valid. To overcome this issue, have the note and deed of trust closed with a title company as you would from any other lender. Have the closer prepare a HUD-1 for the transaction. Have your parents get a copy of thier bank account or source of funds prior to withdrawl of the money. They will need a certified funds check for the loan amount, after getting that have the closer get a copy of that check for your records. Then you will get a check from the closing agent as loan proceeds, copy that check before you deposit the funds. Get a copy of your bank statement showing the funds were deposited in your account. All of these copies provide an audit trail showing that the loan was actually funded and closed, a valid debt. That together with the HUD-1 can show any future lender that you have a valid debt that was perfected and owing. If there are any payments required, make sure you pay on time and the checks are deposited on times, the date deposited is the date payment was made.

Now, a year later you are then ready to rfi without a cash out requirement with valid liens to be paid off.

Your parents need to be as protected as any other lender, they need to be added as lien holders to your insurance policy, without a recorded debt they could be an additional insured but as a lien holder they come before you or your estate is something were to happen.

Next, having the debt is evidence for interest income for thier taxes and yours as to your tax deduction, you'll have one 1099/98 with this arrangement.

Don't know if you are an only child, but if anything were to happen to your parents the recorded note and deed of trust will show the arm's length transaction for any estate issue, the same for you as well.

Since you're doing construction, if you had a disagreement with any labor or material supplier your parent's interest will be ahead of any other liens that could be filed against your property by filing that deed of trust in thier favor.

Other liens can arise from unforseen actions, like a huge sewer bill or lawsuits or tax bills, so putting your parents deed of trust in priority is important.

When you refi, you will need those cancelled checks made for payments, the lender will need both sides of the check showing the date deposited,since you don't need a servicer for this loan.

BTW, this loan is exempt from lending regulations as being between immediate family members.

Follow this! Good luck :)

Mike H. · Answer

I believe you can do a cash out refi after 6 months with some banks. A buddy on BP  (Scott W) is doing one next month and everything looks golden for him to pull it off.

That being said, you might be better off not even recording the 2nd mortgage for your family's lien. There is no benefit to having the second. Its still considered a cash out refi if you're paying off a 2nd mortgage and all the guidelines for a cash out apply.

Your family may only be willing to do the loan if their lien is recorded though so you may not have the choice. But if they'll accept a simple promissory note from you instead, that would definitely help simplify the process - especially if you can't find a bank to do a cash out in the 6 mos and have to wait a year.

Without the 2nd, you could refi the hard money loan out in 6 mos at rate and term and then wait the full year to do the cash out to pay your family back.

Technically, you could still do the refi of the HML in 6 mos even with the 2nd mortgage recorded. But then you have to go through the hassle of explaining it and getting the subordination documentation signed and over to the bank.

Just much cleaner if you can avoid recording the 2nd all the way around. Again, they are going to count the refi of the 2nd as a cash out anyway. And the way these underwriters look for excuses not to do the loans, I would try to avoid recording it if you can.