Beyond Rates and Fees

When looking for a loan it is common place to only be concerned about how it is going to impact the borrower financially. Unfortunately, there are other aspects in lending that are an after-thought and can be detrimental to the long-term success of your real estate business. 

One example is the repair escrow account. Home flippers usually request lines of credit to do their repairs and the reason for this is twofold: Firstly, to keep more equity and bring less money to closing, and. Secondly, to hold contractors accountable for their work. While the former is obvious, let me elaborate on the latter. Investors outsource some of the work to contractors and only pay for their services after the work is completed. In order for the hard money lender (HML) to authorize the draw from the repair account, the HML has to send a home inspector to make sure the improvements were properly made. In light of this, if the contractor starts hassling the borrower for payment for less than satisfactory or incomplete work, the borrower can shift the blame on the HML and not himself. It is easier to make the HML the “bad guy” as contractors understand that this procedure is standard.

The problem with most repair accounts is that the borrower has limited draws throughout the term of the loan. This is nonsensical because the HML is assuming your rehab will not run into any unforeseen circumstances. Say you budgeted $50K limited to 4 draws – Yet you decide to borrow just 40K in 4 equal instalments thinking that you may have overbudgeted. What would happen if you run into a HVAC issue by the tail end of the project? In this situation, you have three choices:

• a) Ask the HML for an extra draw, for which they will be delighted to agree to as long as you pay a considerable fee and extra charges
• b) Use supplier financing (e.g. a Home Depot card) and increase the overall interest rate of your project
• c) Make up the deficit from your own checking account

Naturally, none of these options should sound appealing to you. Furthermore, this situation should and can be avoided in the first place. Doing business with a lender that gives you the flexibility of an unlimited drawing schedule is highly valuable. Even more so if you can get the HML to charge interest only on the amount outstanding.

Suppose the borrower wants to turn the property into a long-term rental. Several issues may arise. A neglected house will not pass the conventional loan inspection, thus securing a government insured loan at 3.6% from the beginning of the rehab is out of the question. Equally important, private lenders may charge exorbitant rates or demand equity in the project. To mitigate this risk one could seek HML that specializes in both type of loans, short-term and long-term. This flexibility opens the negotiating table for the borrower. When refinancing the original loan the borrower can ask for exclusion of origination and extra fees.

If the lending business was boiled to rates and fees, most industry professionals would be out of a job. It is true that they stand between you and the capital you need, but it would be foolish to think of the loan as a mere commodity. Ultimately you want the lender to be part of your team – For them to win when you win. Thankfully this is not a one-sided affair - and yes! Pricing is still important. However, one must not discount the value that a loan officer provides when he/she performs his duty like a strategist looking out for the sustainability of your business. Seek real estate finance professionals who are willing to educate you, not sell you.

“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know... it is the latter category that tend to be the difficult ones.” Donald Rumsfeld