Does 100% Financing Mean No $’s Needed At The Table?

The purpose of this “Nugget” is to help anyone who is seeking, or has ever considered using, purchase & rehab financing, and has been introduced to 100% financing, to gain a complete understanding of just how the loan product works.

Given the name of the loan product being “100% Financing”, you would think that would be sufficient to understand the product, however it’s a little more complicated than you might think. The loan is commonly used when it involves the purchase and rehab of either single family properties or properties that contain 2 to 4 residential units.

Typically, the loan amount is equal to either 100% of the purchase price and 100% of the rehab budget OR a percentage of the after repaired value (ARV) of the property, whichever is less. In other words, if the purchase and rehab amounts fit within the designated ARV figure, then the borrower has a zero down deal.

The ARV is a crucial figure in the formula

Just what is that golden ARV figure that the purchase and rehab amounts need to fit within? Well, the answer to that depends on the recent experience level of the borrower. Normally the track record of experience is limited to the most recent 2-3 years. The lender seeks to know how many real estate related transactions involving either rehabbing or new construction the borrower has had ownership within over that period of time. This supplies a comfort level of extending leverage (LTV) to the borrower, hence the larger number of transactions completed, the larger the percentage of the ARV.

Example: If a borrower had no experience or had ownership in up to two completed transactions with rehabbing involved within the last 3 years, then the lender could make that golden ARV percentage 65%. If the borrower had 3+ transactions within that time as a track record, then the lender may increase the percentage of ARV to 70%. The days of exceeding 70% of the ARV seem to be in the rear view mirror, or at least for now.

Circling back to the 100% financing formula previously mentioned, the loan amount would equal either 100% of the purchase and 100% of the rehab OR 65-70% of the ARV, depending on borrower experience, whichever is less. If 65-70% of the ARV is a lower figure than 100% of the purchase and rehab total amount, then that lower figure becomes the loan amount, hence 100% financing wouldn’t apply. In order for 100% financing of the purchase and rehab to apply, the total costs (costs = purchase price + rehab amount) must be NO MORE THAN 65-70% of the ARV. If the total costs exceeds 65-70% of the ARV, then the borrower brings the excess to the closing table.

You might be asking yourself, if the ARV is such a crucial figure in this formula, who determines the ARV? Good question. The answer is that it is determined by a licensed appraiser engaged by the lender. The lender will request a 2-part appraisal, Part #1 is the AS IS value (the current value in its current condition) and Part #2 is the future value of the property after the rehab is completed. The appraiser will supply comparable sales (comps) for each value. This appraisal is delivered to the lender and often shared with the borrower by the lender.

Is money needed by the borrower at the table?

If, as mentioned above, the costs do not fit within 65-70% of the ARV, then yes, the borrower will be bringing the difference to the closing table. When the costs are able to fit within 65-70% of the ARV, the borrower still does bring funds to the table. Surprised? Let me explain.

There are fees that the lender typically will NOT finance. Fees such as: the lender origination fee (usually a percentage of the loan amount), the lender fees for processing/underwriting/money wiring/document prep, any prepaid interest or per diem interest being collected, settlement agent fees, local document recording fees, local property title transfer fees, title insurance and property insurance premium.

Even when 100% financing of the purchase and rehab amounts is being financed, there are still costs and funds associated with the transaction that have to be born and are the responsibility of the borrower to be paid. The borrower needs to factor these costs into their figures when doing their due diligence on a targeted project/property purchase. In addition to the funds required at closing by the borrower, they need to also show the lender proof of liquidity to get the rehab of the project started. Why? Because the rehab budgeted funds are placed in escrow with the lender and drawn from as work is completed and inspected. This way the lender is assured that the rehab is taking place to increase the value of the property (their collateral for the loan).

The borrower must have sufficient funds to start the rehab until they request the first rehab draw for work completed. These funds that the borrower needs to show proof of having typically are around 15% of the rehab budget. So, if the rehab budget is $50,000, then the borrower must display proof of 15% of that figure ($7500), with these funds being over and beyond the funds needed by the borrower at the closing table.

If you are seeking a figure that is required in the way of funds needed by the borrower even when 100% financing of the purchase and rehab amounts is used, perhaps it is better to target a percentage of the costs (costs again = purchase price + rehab budget). That percentage, when using 100% financing, could be around 30-35% of the costs. Example: Purchase price of $150K, rehab budget of $50K and ARV of $310K. The costs fit within 65% of the ARV, and if we allocate 30-35% of the costs for funds needed by the borrower that figure would be in this case $60K-70K. Some projects may require less than 30-35% of the costs for borrower funds allocation, as no two transactions, or borrowers are identical.

The use of other people’s money as leverage in real estate investing can be a powerful tool, as it replaces the need for your dollars to be exposed, however that use comes at a cost and it doesn’t mean that you will have none of your funds in the deal, just less of your funds.