A major challenge facing most fix-and-flip investors is securing financing for their projects. Before rehabbers can begin renovating a home for eventual sale or rental, they must first secure the capital necessary to acquire the property, pay contractors, cover listing fees, and other expenses. The majority of fix-and flip investors rely on hard money loans to fund their projects. Hard money lenders specialize in serving the fix-and-flip community and typically offer quicker turnaround and more financing options than are available through traditional banks. If you are a rehabber applying for a hard money loan, here are the five things you need to know:
The terms on hard money loans vary from one lender to the next. However, a rule of thumb is that these types of loans have significantly shorter terms than traditional bank mortgages, with maturities often ranging from one to three years. Lenders anticipate that rehabbers can complete renovation work and re-sell properties before loans come due and use the sale proceeds to pay back loans. The loans are structured with the idea that monthly interest payments are made during renovation and principal becomes due after the home is sold. Because of shorter terms, hard money loans tend to have higher interest rates than conventional mortgages. Interest rates typically vary from 8-16%. The amount for hard money loans can range from less than $50,000 to well over $1 million.
When compared to conventional bank financing, a major advantage of hard money loans is much faster access to capital. Hard money loans are processed quickly, with some lenders providing same day loan approvals. Funds are also dispersed rapidly, often within days of the approval. Fast turnaround on loans gives fix-and-flip investors a distinct advantage when competing with other buyers for desirable properties. Another advantage of hard money loans is that lenders focus mostly on the value of the property, not the wealth of the borrower. A rehabber with proven skills seeking to finance a desirable property may still qualify for a hard money loan despite having a less than prefect credit score or a past foreclosure or bankruptcy.
A third advantage of hard money loans is versatility. These loans are made on a variety of properties, ranging from single-family homes to multi-family dwellings and commercial buildings. By covering more types of properties, hard money loans amplify profit opportunities for fix-and-flip investors.
Different hard money lenders have individual criteria regarding borrower credit scores, debt-to-income ratios and financial histories. Rehabbers can increase their chances of securing a hard money loan by providing lenders with a detailed breakdown of anticipated renovations costs and analysis of property after repair value (ARV). The basic paperwork rehabbers must submit when applying for a hard money loan includes a sales contract for the property, property appraisal, repair estimates and recent tax returns and bank statements for the rehabber’s business.
The amount of financing offered by the hard money lender will be determined by the specific characteristics of the property and the financial qualifications of the borrower. In general, most hard money lenders limit loan amounts to no greater than 65-70% of the property’s estimated After Repair Value (ARV). By lending less than the full value of the property, lenders create a safety cushion that covers their costs if the borrower defaults and the property must be foreclosed and sold to repay the loan.
Consider the example of a rehabber who pays $300k for a property, makes $100k worth of upgrades and repairs and sells the renovated property for $450k. In this scenario, most hard money lenders would finance up to $315k (70% of ARV) for this project. The rehabber is responsible for funding $85k of the budget. First-time fix-and-flippers may receive considerably less than $315k since lenders usually require inexperienced rehabbers to assume more risk. In addition, the lender may require a personal guarantee from the borrower. This involves the borrower pledging personal assets as collateral against the loan.
Hard money lenders often require borrowers to retain a good-sized financial stake in the project and some may require rehabbers to commit as much as 30% of their own capital to the project. Most professional rehabbers rely on business credit cards to cover out-of-pocket expenses. If credit cards are used as a source of financing, rehabbers should look for credit cards that offer cash back or similar rewards programs.
Cost overruns occur frequently in fix-and-flip projects so rehabbers should include some contingency funds in their renovation budget. Experienced rehabbers usually set aside 10-15% of the budget for unforeseen repairs. Other common rehabber mistakes that can erode at fix-and-flip profits include over-estimating the property’s post-renovation value, installing premium features in a house that buyers aren’t willing to pay for or under-estimating the time needed to complete the project.
There are many hard money lenders to choose from. Often the best way to find the right lender is through recommendations from contractors and real estate brokers. Before applying for a loan, rehabbers should research the lenders that best suit their needs. Socotra Capital has provided hard money loans for California fix-and-flip investors for over a decade. Rehabbers can contact us directly at (855) 889-7626 or apply for a loan on-line at www.socotracapital.com.