Many home buyers look for properties that provide rehab opportunities. Houses that need work provide incredible potential for anyone willing to give them the TLC they need. One factor that often stumps or even completely discourages potential buyers is raising the cash for repairs.
Whether you want the home to fix up into your dream house or have found the perfect fix-and-flip opportunity, you probably need financing to cover those repairs. After all, what good is purchasing a fix-up opportunity if you have no funds to complete the rehab?
Unless you have tens of thousands of dollars lying around, then paying out of pocket for repair costs just isn’t in the cards. You may be able to imagine what that $200,000 rehab-project house would look like if you had $50,000 to sink into replacing the floors, shutters, windows, and gutting the kitchen and bathrooms, but unless someone offers you a rehab loan, how are you going to make that happen?
Hard money lenders provide the way
Not everybody knows what hard money loans are and how they differ from conventional financing. Before getting into the explanation of the differences, the bottom line is that you can obtain a hard money loan for your rehab project in a matter of days.
The hard money loan provides enough money for you to make the purchase and complete the rehab. It also serves as a bridge loan, allowing you to make the purchase before the competition and get on with the rehab. Once the rehab is complete, you can flip the property and take the profits to the bank, or refinance the property into a long-term mortgage and settle into your dream house.
Why not a conventional loan?
You may already know why conventional loans don’t work. First, a conventional loan takes 30-plus days to process. This often means the property will be gone by the time you line up financing. Real estate investors must compete for the best properties with the best potential. There are always multiple investors interested in a property that is priced to sell.
As an investor, you know pretty quickly which properties offer the profit margin you want, and which ones don’t. Your competition knows this, too. If they have a hard money lender on their side and you are struggling to get conventional-loan approval, they will get the property, and you will be left in the cold. If you want to make it big in real estate investment, you need a hard money lender that can approve your loan before the competition takes the opportunity for themselves.
Even more of an issue, a conventional lender often wants a 20 percent down payment. On a $200,000 property, that means $40,000! After you put down the $40,000, you still need money for the rehab. Unfortunately, from the conventional lender’s perspective, the property’s value stands at $200,000, which means they will only loan you enough to buy it, not enough to rehab it.
Hard money loans are based on the after repaired value
Now imagine you are looking at that great $200,000 rehab deal with a solid hard money lender on your side. First off, you are now the one who beats the competition to the punch. Second, your hard money lender appraises the value of the property at the after repaired value (ARV), which means you get the cash needed for the rehab.
For example, let’s say the house needs $50,000 of work and that the ARV is $300,000. You can then get a hard money loan based on an 80 percent loan to value (LTV) of the $300,000 ARV, instead of the 80 percent LTV the conventional lender gives you on the $200,000 value before repairs. This means the hard money lender gives you a $240,000 loan, based on an 80 percent LTV. Now that makes a lot more sense!
Hard money loans are meant as bridge loans. They are written for a short term, usually one to two years, which makes them ideal for rehab properties. They generally have a balloon payment after the end of the term, so most hard money loan borrowers refinance the loan or sell the property before the term expires.
Lenders pay little attention to credit scores and income when it comes to hard money loans. The loan is based on the value of the property rather than the borrower’s credit rating. Hard money lenders generally charge points. Points are a percentage of the loan amount borrowers are charged in exchange for using the money. Each point represents one percent of the loan value.
Interest rates are higher than conventional loans because of the higher risk; however, since the loans are short term, the actual interest paid is negligible in proportion to the profits and increased equity borrowers enjoy when completing rehab projects with hard money loans.