Hard money strategies I'm not accustomed to...

[David Seale]

So the title of this thread is based on the fact that I'm a new investor and it's quite probable that these arent't new strategies. My fiancé and I met with a hard money lender this afternoon and two things came out of it that I have not been exposed to.

1. The lender is essentially guaranteeing a refinance before the rehab even begins. Based on our credit scores, income, cash, arv, etc. they'll be able to lock us in at an estimated 4.25 interest rate before we even get to the point of signing any contracts. 

2. As it relates to funding the rehab process, I've only heard of getting these funds through draw requests throughout the rehab process. This lender, like others, rolls the rehab costs into the loan like everyone else does but makes you pay out of pocket for the repairs and then submit the invoice for it before getting paid back. 

I guess my questions are 1, are either of these standard practice? 2, what is the risk/reward in doing either of these?

Bonus questions, what's everyone's opinion on using your own cash to fund as much of the purchase and rehab versus using hard money? Especially for a first time investment? In our short time learning about investing, you hear a lot about trying to fund deals with as little of your own money as possible but there's this thing called debt and we're kind of afraid of it.

Thank you!

[James C.]

David,

Lets start here: The HML is guaranteeing a refi for you, so they are guaranteeing their exit strategy (i.e. they will get paid). Do you need to use them, or will a pre-qualification or pre-approval letter from another lending institution work? If you go with their exit financing, what do the fees look like, and how is the HML getting paid for the referral? What is the Down Payment for the HML, and what are the HML prepayment fees. The only reason for the HML to do this is either A) they guarantee that they will be made whole, or B) they are making some cash somewhere in the refinance. Or both (most likely).

The hazard of you paying and then getting reimbursed is that you need to be the draw funding closer and make sure that title is good (title date-downs), no mechanics liens, the budget is in order etc. It's not that hard, but it is time consuming and the HML doesn't have the staff to do it. The second hazard is that the HML doesn't reimburse you in a timely manner, and thus you are on the hook for the rehab funds until they do (you could run out of money). Make sure that you get their requirements for giving you money IN WRITING. If they are loosy-goosey about this, I'd look for another HML lender.

It is always cleaner and cheaper to use your own funds for the rehab, but it limits the number and size of the deals you can do. HML money is expensive and short term, so you need to be on your game to make it work. The motto of most HML lenders is "loan to own". They aren't being predatory, or nasty, or even want your property. What they want is their money back. They are going to try to loan in such a way that if you default, they come out financially whole or ahead. With them, the more money you have in a deal, the more likely you are to try to do anything you can to save the property, and the less risk they have.

If you are worried about the debt load, there are a few things you can do. The first is make sure your rehab numbers are ROCK SOLID and you included the cost of your HML for the ENTIRE TERM OF THE LOAN, plus any fees. Make sure you have contingencies built in to your bids (10% +/-). Preserving cash in your bank account will make it easier to pay the HML should the need arise, so you should have enough reserves to fund them for 6 to 12 months, or better for the entire term. You could either acquire the property with your cash or fund the rehab and avoid the bigger debt load. Having your exit numbers (loan amount/payment etc.) along with the potential rent will allow you to develop a proforma that will tell you where you need to be. Follow the "the day you get into it is the day you get out of it" model.

Standard practice with an HML doesn't really exist. They will do and write whatever they can to make sure that they are protected.

Hope that helps.

Good Luck,

Jim