Mortgages vs. Private Investors for Rehabs

[Mike Rubin]

When people are trying to rehab homes, why do I keep hearing about private investors to fund the projects? Does a conventional mortgage not work?

I just watched my first episode of Rehab Addict and, she too, uses private investors.

Can someone please explain to me why a mortgage from a bank won't work?

[J Scott]

A few thoughts:

- A conventional mortgage is generally going to be cheaper than private money or hard money. Conventional loans these days are going to run about 5%, with maybe a point upfront. Portfolio lenders (small banks that lend their own money) are probably closer to 6.5% on shorter-term loans (3-5 years), private money is going to be in the 8-12% range and then hard money can be anywhere from 12-18% with 2-8 points.

- The lending/underwriting standards are going to go the other way though, with conventional loans requiring the most documentation and the best condition of the property and private/hard money requiring the least documentation and condition of the property.

- As everyone has said above, you're not going to be able to get a conventional loan on a property that isn't move-in ready or that has mechanical (HVAC, electrical, plumbing) issues. Even a broken hot water heater or missing oven can make it difficult to get a conventional or FHA loan.

- If you're not planning to live in the property, I'm a big fan of portfolio loans if you can find them (e.g., for an investment). You pay just a little bit more, but they are generally much more flexible on property condition and their underwriting standards are a *bit* more lenient.

- You mentioned living in the property for a year. If you can commit to a year, an FHA loan is a great way to get into a property VERY inexpensively, but again, you have the issue of property condition. FHA is even more strict than conventional lenders on property condition.

- That said, FHA has a loan program for houses that need some renovation called 203(k):

http://www.forbes.com/2010/06/18/fha-home-repair-loan-personal-finance-203k.html

They're not always easy to get, and they won't let you buy completely destroyed properties, but if you're willing to live in a place for a year while you fix it up, this can be a great option.

- Hard money is a last option in my opinion. The reason being, it's expensive. I'm not saying you shouldn't use it (I have before), but it should be a last resort when you've exhausted all the more inexpensive options. You'll still need to come up with about 20-30% of the costs yourself.

- Private money is a great option once you have a little bit of experience. Private money lenders are going to want to know that you are a safe investment (again, some experience), but once you can prove that you can consistently provide 8-12% returns, you'll find a lot of people are happy to trust you with their money.