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Updated over 12 years ago,
Hard Money Details
I have found a HML that will lend up to 70% ARV at 12 percent. The closing costs are 3000 (which includes one point at closing) and there are 2 points due at payoff. Draws for rehab require inspection at a cost of 125/inspection. Now, I have to foot the bill for the rehab costs and the work be inspected before I can get the draw. HML will allow me to do the work on my own. The terms are for up to 6 months with no minimum holding period.
My strategy is to rehab and hold. I can refinance up to 75% ARV with no money out of pocket other than the hard money fees. If the appraisal comes in lower than expected, I am responsible for coming up with the cash to cover the difference. I am trying to visualize the process sequentially in my mind and was hoping that some of you in the BP nation could share some insight as to what to look out for that someone new to hard money might overlook.
Thank you in advance for your help!
Just wanted to add a quick comment that closing costs of 3000 assume a loan of about 70K (could be closer to 26-2700).
Those seem like competitive terms. One observation is that I would get a longer term. 6 months sounds like a long time, but with the craziness of refinancing and the amount of time it can take, I would make sure to at least get 9 months. (It took me an insanely long time to refinance recently.)
Another comment I would make is that make sure it's a reputable lender. You're really counting on them to fund and you don't want them pulling a fast one right before closing and jeopardizing your earnest money.
Also, is it one loan officer who's going to oversee the whole process? That's pretty helpful because they can prequalify you on the front and let you know if there's going to be any trouble refinancing on the back end.
I'd also want to know whether the lender has any sway in choosing the appraiser. The last couple I've done, the lender has been able to makes sure it's the same guy doing the appraisal for HML and for conventional refi. (I have no idea how he pulled this off, but it worked.) The risk that it won't appraise for what you thought is a very real risk. I've been dinged once before (not significant), but it's no fun coming up with more cash.
I think you're looking for a timeline on how this might work.
1) Find a lender or broker who will do the refinance step. Be sure you can get the approval. Be sure to find out the time line. Finding someone who would do the refi based on a new appraisal is a little surprising. Not impossible, just not common. A year would be typical.
2) Find out what happens if you can't refi and pay off the HML in six months. Can you extend? How much does that cost? For how long?
3) Get a preapproval letter from the HML.
4) Make a bunch of offers. Get one accepted.
5) HML does an appraisal and decides if they're really funding the deal or not.
6) Closing. You bring your cash, the HML brings theirs, the closing happens. HML would take back the repair escrow amounts.
7) You do the work. As it progresses, get the inspections and get your draw.
8) Get done and get the final draw.
9) Meanwhile, make those monthly payments to the HML.
10) Get a tenant in the place.
11) Start the refi process. Stand on one hand while slicing open you belly so the lender can examine your entrails. Eventuallly and hopefully get approved.
12) Refi closing. You bring your cash, new lender brings theirs, HML gets paid off, you get a new loan.
John Chapman,
The HML I spoke with was actually one you referred me to, Ron. I still need to contact your other referral. Duly noted about the extension past 6 months. Also, both appraisals being done by the same appraiser is something I should talk to Ron about. Possibly it is worth paying higher fees to someone who can make that happen if Ron cannot? I was able to rehab and rent my first property in just under three months, but I can see unforseen conditions creating time delays and pricing the rent/deposit can take a little time to dial in to get the tenant...
Jon Holdman,
Thank you for the timeline. I was a little foggy on how exacly to have the funding lined up to make an offer. So that helped clear up the deal making process a little.
The lender I spoke with is actually originating the refinance loan, but has a relationship with the HML and advertises hard money lending on his website. So, I don't know the exact relationship between the two, but I am under the impression that it is sort of a "turnkey" HM to refi sort of process as that is how it is presented. I think the first thing I need to do is become as postive as possible about the odds of qualifying for the refi.
Brian Hoyt Sorry, I completely missed the point of your post. Jon Holdman described my recent experience down to a T. Step 5 (HML does appraisal) is where things can get hinky if you're not dealing with someone reputable.
I've heard Ron is good but I'm not sure I would ditch him over the appraisal issue.
Most lenders will usually give you a 3-month extension for a fee. (I usually ask them to waive the fee and have had 50/50 success).
In terms of delay, it took me something like 3.5 months just to recently refinance one property. I was getting nervous I was going to hit the six month mark. (I think I would have been responsible for an extension fee.)
I would also say, make sure to pick up a property that requires a ton of repairs. Only time I've had issues is when I did a rehab where repairs were something like $10/foot. Went through a ton of appraisal reviews with the lender when I went to refinance.
John Chapman, I have more knowledge from what you posted (thank you) and I expected varying responses at the question was fairly open ended.
But you bring up another point that I never considered: Get a property that needs lots of repairs - to reduce the risk of appraisal issues? Can you explain how/why having less repairs can be an issues and how having more can be helpful? What is the mentality of the lender? This could very well effect what things I repair and how I repair them. My assumption was that an easy rehab would be better as to avoid construction problems, but based on what you say, the logic behind the rehab strategy could be a little counterintuitive.
From other HML's I have talked to ( I don't do rehabs myself ) they focus a bunch these days on credit and capital for the buyer.
They want to be able to dump you off quickly after rehab if you can't sell for a flip into a refi program so that you don't default and they can churn the money.
When the rehab and loan costs start adding up and the potential margins upon resale goes down the investor starts to give up mentally for expected returns and slows down.
I am wondering what is the average number of defaults for a hard money lender making loans?? I haven't seen that discussed before.
- Joel Owens
- Podcast Guest on Show #47
Brian Hoyt Here's my perspective and it is counter intuitive. It's based on conversations based on lenders, appraisers, and my own personal experience. If you buy a house that needs only paint and carpet, you make those repairs, and then turn around and ask for a new appraisal, the lender is going to look at the appraisal more skeptically. I think the lender's perspective is, "Really, you expect me to believe you found this magical deal, it needed practically no work and now it's worth a ton more." If, however, you buy a house that requires a ton of work (e.g. new roof, hvac, foundation, windows, etc.), I've found that they are less skeptical on the new appraisal. I've had appraisers say, "Oh yeah, I can get you a higher value because of the new HVAC and roof." Intuitively, I think lenders (and by extension appraisers) are more comfortable that you found a deal if you had to put a lot of time and money into it and they are more comfortable giving you a higher value on the appraisal.
I'll second what John Chapman is saying. How many posts have you seen here where someone writes "I have a property under contract for $150K. It needs nothing done to it. Its really worth $200K". Bzzzt. Its worth $150K.
OTOH, consider a junker that has no working baths and the kitchen is wrecked. For most people, this house is worthless. They don't have the time or money to fix it up. So, its worth much less than just the ARV less the cost of repairs. That's why you can justify a much higher value if you do a bunch of work. Minor repairs, especially just lipstick repairs like paint and carpet, aren't going to net you the same kind of value increase. Some owner occupants will walk away, but many can see past messy paint and stained carpets. Further, these repairs are affordable for many homeowners.
John Chapman and Jon Holdman
Okay, so I know this is not likely, but what if I find a property for 55K that needs no repairs, maybe some paint. It appraises for 75K. The HML will finance 70% ARV, 52.5K. So I come to the table with the 3K closing costs (including 1 point up front) plus 2.5K and use the HML to purchase the house. The house needs no work, so I immediately put a tenant in and proceed to refinance and that lender will finance 75% ARV, 56.25K. The closing costs would probably be around 4K including the 2 points paid to the HML upon payoff. So with the 4K closing costs and the 56.5 owed to the HML, I would need to bring 250 bucks to the closing to cover what cannot be rolled into the refi. We will ignore the cost of paint for this example.
In this case, I have paid 5.5K +0.25K = 5.75K and refinanced 56.25K for a total all in of 62K. So I have paid 82.6% ARV, all in. Not the best deal in town, but better than nothing IMO. If it rented for 850-900 and was financed at 5.5% or less, it would be a pretty good rental and would cash flow 100-150/month, a COC return of about 21 to 31 percent. In all reality I would expect to have about 2-3K out of pocket for paint and repairs to get rent ready which would lower the return to something more like 14-20%, which is still not bad.
In this case, there were no major repairs, and both appraisals came back the same. Would I still have a hard time refinancing even though I did not do any repairs? I think what you guys are telling me is that if I want to *increase the appraisal, I would need to do significant repairs. But does there need to be an increase in appraisal to not raise the eyebrows of the refinancing lender?
Also, in the case where you do major repairs, do you provide those reciepts to the appraiser? Or is it only to show the lender why the second appraisal was higher?
Theoretically, it would work exactly like you describe. I think you have a typo in the first paragraph and you owe the HML $52.5K, not $56.5K.
But there are two major flaws in your scenario. One is that you can buy a $55K house that needs no work and is worth $75K. The problem is that, even if there are other comps that support $75K, you are creating a new comp at $55K. The appraiser will have a really hard time justifying the higher value when you did nothing to the property.
The second flaw is timing. You're unlikely to find a lender that will do the refi in the time you're hopeing. Its probably going to be six months or a year before you can refi. Even if you pull it off in six months, you will have six months of interest payments.
Further, in the time between when you buy and when you refi, your new $55K comp will be affecting other valuations. That will in turn become your comps on the refi. So, even if an appraiser comes up with the $75K value up front, the later value may well be lower.
But the basic idea is exactly what you describe. The HML/refi strategy is a way to get into rentals with less cash than a straight buy. I have done exactly this, but not in the last couple of years.
Okay. Let's assume I buy the house from a whole saler and not off the MLS. The purchase price of the property does not get recorded at the county unless you record the price. Usually the price is stated as something like "the sum of $10.00 and other considerations." In this case, how would the first puchase of the house affect the comps of the neighboring properties and the property itself?
Yes, there was a typo on paragraph 1. And true, there would be some months of paying interest payments to the lender - the hope being that I would be recieveing offsetting rents for any of those months past the first three - the first three would be 525*3, another 1575, still not crushing the deal.
But why do you think the refinance would take more than 6 months? It would only be my second mortgage. I refied my personal residence with an FHA streamline and it took about 6 weeks. Would the 2nd refi take longer just because it would take longer for the bank to decide?
Could you do it in less that six months? Perhaps. Anything may be possible. But banks generally have a seasoning requirement that you must own the property for at least six months. The last refi I did like this, which has been several years, I was told that by multiple sources. And I was told it was an FDIC rule, not just something the banks had chosen to do. I did actually managed to get it done in a bit less than six months. Or so I thought. The broker I was using actually makes the loans themselves and then sells them into the secondary market. They could not sell my loan because the process had been started in less than six months. So, we ended up doing a second refi (at their expense) and the second loan was salable.
What your looking for is not impossible. Unlikely and difficult to find such a good deal, but not impossible. You're counting on a lot of stars to line up just right for a deal like this to happen.
Yeah, I am looking for the ideal ideal buy and hold investment (Jarred? lol). Really, the only reason I am looking toward hard money is to get around having to support the entire new mortgage payment with my DTI without being able to use the rental income from said purchase. I don't mind coming out of pocket with less cash, but then again, I don't mind using more cash to offset all the extra complication and risk of using hard money.
This next tax return will be the second year to show income from my first rental house. From what I understand, a conventional lender will allow me to use 75% of the rents for a new purchase to count as income for that purchase. I guess they would use a market average area? I only have 2 months of rental income showing on last year's income tax, so it still may not work well for me - need to keep calling around and do some more research on that since it will probably not be until after I file my next tax return that I am ready to do something even if I go the hard money route.
By the way Jon Holdman, you had once posted a link that showed the dfferent deposit amounts for different banks so I could try to locate smaller banks to speak with, I haven't been able to pull that up searching old threads. Do you still have that info?
Thanks
I think you mean the FDIC institution directory:
The lender for the new loan will probably want the appraisal to include a rent appraisal section.
Net rental income for the new one will be (75%*rent) - PITI. If that's positive it improves your DTI, negative it hurts. For existing ones they will use actuals from your tax returns. As far as I know lenders just want two years showing rental income. But I really don't know if they want a certain number of months on the first one or not.
Sorry for the delay in resonding Brian Hoyt. Here are my thoughts on your questions.
(1) I agree with Jon Holdman that finding at $75 property for $55K is highly unlikely (more likely to find a unicorn)
(2) I've now done four properties in the last year where I've used HML to purchase, rolled repairs in to the closing cost, and then immediately ref'id with into conventional with a new appraisal. Jon Holdman is right that it's tough to find a lender who can do it, but it is possible.
(3) In terms of the cash you bring to closing, I've always found that I've had to bring more to closing than I thought I would need to. (It's always worked out in the end for me but I've found that the HML tends to hold a decent chunk in reserve.) If you want shoot me an e-mail and I can send you HUD-1 on one I did so you can see how it worked for me on one.
(4) On the new appraisal, I've never had my original comp counted against me and drag down the value. If I had to guess, it's because that comp is in a dilapidated state and not indicative of fixed up "retail" value.