Initial loan with hard money and then refi with conventional???

Question

It was suggested to me that I could use hard money to secure a property and then refinance 3-4 months or so later to a conventional loan.  The idea being that a refinance  is easier to acquire than a standard conventional loan from the beginning; and possibly not require the standard 20%-25% down.  Could someone please clarify this for me?  I have looked into a conventional loan but have been told by one lender that my debt to income is too high since my first rental has not been on my taxes for two years.  Would a hard money loan be easier to secure?

David Beard · Answer

The idea behind going with hard money is:

Advantage at purchase - your offer is almost as good as cash, since the    HML can close in a couple of weeks typically and underwriting is streamlined and much easier.  An offer contingent on financing from a traditional bank is viewed much less favorably, if not just thrown in the trash can.  Not only will that type of loan take 30-60 days to close, the condition of the property may be such that it can't even be financed by a bank, whether you're holding a pre-approval letter or not (that letter from the bank doesn't mean they'll take a distressed property as collateral, they won't!)

You can finance the rehab - most banks won't finance the rehab on 1-4 unit properties.  But by all means if you have one in your area that will, USE THEM!!

You can do a no-cash-out refinance using a new appraisal in a much shorter period of time on a conventional loan (4-6 mths).  Since the HML lent you funds for both purchase and rehab (many will go to 100%  of P+R as long as the ARV is sufficient to keep the LTV below 65%), you are not looking for additional cash from the conventional take-out lender, just a refinance of the total HML loan.

Jerry W. · Answer

@Paul  The one thing I would reccomend is to not get a hard money loan if the property will not at least break even with it.  If you get stuck and cannot refinance you will be in a very bad bind.  Having to have a future event take place in order to cash flow is risky.  If you can carry the property even with the hard money rate it becomes a more acceptable risk.

David Beard · Answer

If your exit strategy is to refinance, the HML will want to make sure that you are pre-approved for the take-out financing before they lend to you.  So before you do anything with a HML, you need to lay out the scenario to your conventional mortgage lender and get a pre-approval letter.

First, you need to find a conventional lender that can do the refinance using a new appraisal after no more than 6 mths from purchase date.  Will they all do it?  No.  But if you call enough, you can find one.  The HML is expensive (10-14% typically), so the faster you can get out of it the better.

Secondly, you need to make sure that the conventional lender will qualify you with whatever your debt ratio will be with the new property.  If you have shown rental income on tax returns for both 2011 and 2012, then you should be able to count the rental income from all your properties (including the new one).  Ask them to explain exactly how they compute the "net cash flow" that will be used in your DTI ratio for each of your properties.  Some want to just use tax returns, others may use a formula such as gross rent * 75% minus PITI. If they want to use straight tax return info for your other properties, make sure that they "gross up" the income for any year in which you only owned the property for part of the year (they should use the "date placed in service" from your Sch. E to get at the # of days you rented the property in a given year, and annualize it).  Hopefully, your Net Cash Flow is positive for all properties and thus helps your DTI ratio.  If you don't have the two years of tax return history yet as a landlord, then you will have to qualify for the new loan while carrying the PITI of ALL loans in the numerator of your DTI ratio.  This can be a show stopper and may hold up your expansion plans until you file the next tax return.

Thirdly, try to find a lender that will do up to 10 loans.  Many lenders will limit you to 4 financed properties, but some will go to 10.  Find these lenders.  Even if you're at just two loans currently, the lenders that will go up to 10 are investor-centric lenders, and they will be better to work with, on this loan and down the road as you do more.

So your current lender may not be the right one.

Also, the following are bonuses you can look for in the lender:

* They're "direct" to Fannie Mae; this means they use Fannie's guidelines for the most part, without applying many of thier own in-house revisions (which are ALWAYS more restrictive for investors)
* Ask them if the underwriter is in-house and local.  Investor loans are notoriously underwriter-intensive, and so a good line of communication between your lender and the underwriter is important.
* Ask them where the appraisers come from and how are they selected.  You want to hear that the appraisers they use work exclusively in your local market where the property is located, and that the lender has a lot of history with the group of appraisers that they use.  The lender still has to rotate among multiple appraisers on a round-robin basis pursuant to appraisal guidelines, but the better lenders have a known group of local appraisers that they use.

In other words, you really need to nail your take-out financing down with a very good lender that knows investor loans.  You need a full pre-approval, where an underwriter has reviewed all your data (tax returns, cash reserves, etc.) and said it's a go.

You do NOT want to get stuck in a hard money loan.

Bill Gulley · Answer

Actually, the nail is bent. Anyone can go look up secondary market underwriting guidelines and put it out as "the guideline" but it is a guideline and can and does vary from one area to another. What can be done in CA will be different than the Midwest for example. Time periods vary, LTV can vary, it depends too if the lender is funding or if they sell, retain servicing or release servicing.

Contracts do not sail through because of a HML is being used, ask Realtors about experience with them, some Rs will try to avoid deals with unknown lenders, it can be faster if they do what they say and not back out at the last minute as some do. Checking local reputation of a HML is necessary. You will always have a stronger loan commitment from an institutional lender like a bank than a small or internet HML.

It's just best to talk to lenders in your area who know the market.

As to appraisers, banks are rotating appraisals with those qualified, much of the "control" has been lost and for good reason, don't count on getting one that pumps your value up. They will (and lenders will) look at the purchase price, costs of materials, hard costs of labor and permits etc. and allow no more than about 20% as a contractor fee/investor profit in shorter term refis.

I agree with Jerry, make sure you can get the take out loan before you take any HML money, that or that you can sell it quickly. :)

Troy Sheets · Answer

@Paul Zofsak How did this work out?

Paul Zofsak · Answer

I recently was turned down for a conventional loan due to my debt to loan ratio being out of proportion.  I recently went to a leading online mortgage site and found a lender that was willing to look at my investment as an investment.  I already have one property that reports positive cash flow.  The lender is looking at my next purchase and using a rent schedule to determine if the property will have positive cash flow; not using my DTI to determine if I can "afford" the property.  It was finally nice to find someone that was going to treat this as an investment and not a primary residence purchase, besides an HML.  A to top things off the fees are very reasonable and no points.

Hans Restuccia · Answer

In South Fla it is impossible to get a contract when you are contingent on conventional like @david  beard said- they throw it in the trash- it is also very hard to get conventional financing here for investment property- most investors are going HML w/ exit stodgy- that is very good plan if the numbers work.

Jameson Wildwood · Answer

Do you know any lenders that do 10 loans?  The person I'm working with now will do 4, but they also seem really good, would love to find a 10-er.

Paul Zofsak · Answer

Thanks for contributing all your experiences, it would appear that an HML is the way to go when financing a rehab plus repair costs since most banks won't.  My question is really more geared towards whether or not the HML would be a good choice if I couldn't qualify for a conventional loan due to two mortgages already.  Would refinancing down the road to a conventional mortgage be easier after already securing the property via an HML?

Bill Gulley · Answer

Banks here do, not just anyone, and it takes 3 to 4 weeks, an HML may take a week, they are quicker. Costs might make you willing to wait a bit. And, if you don't have experience, you may need a contractor, the property is the lender's collateral, they need to know it's done right.

David is correct, you can do a refi sooner, based on costs, or appraised value, which ever is less.

Your goals and use of the property are also factors as Rudy mentioned. :)

Initial loan with hard money and then refi with conventional???

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