If hard money is the only thing available to you, and if you have found an unbelievable deal, you may want to use a hard money lender. Before using a hard money lender, however, you may want to approach 4 or 5 investors in your area and see if they would want to be an equity partner with you. This may save you money and reduce some risk.
If you do not have the initial capital to pay cash and refinance, you may want to get a rehab loan. Typically these loans are easier to get from local banks than through national brokers because they want to be close to the property. They will usually require 20% down on the purchase and will lend 75-80% of the after repaired value of the property, holding the rehab money in escrow. They will usually give the cash to rehab the property and will disperse the money at pre-determined landmark events. If you have 20% down for the purchase price, and you need cash to rehab, this may be an ideal means of financing.
Typically the closing costs on these loans will be significantly higher than the equity lines or personal lines of credit. Instead of being between $0 and $500, the costs will typically be between $1,200 and $3,000. Additionally, you do not receive all the cash right away while at the same time, paying interest in the loan as if you had the full loan up front. In other words, if you only receive a loan for $50,000 and the bank is holding back the other $50,000 until certain landmarks; you will still pay interest on the full $100,000.
If you do not have the 20% down, or if you want a cheaper way to borrow money, you may want to find a private lender or financial partner. Many lenders will be happy to get an 8-10% return on their money depending on how you present and how they perceive the risks. Others may require a 12-15% return. This return, however, may be comparable or even better than the rehab loan with $3,000 closing costs and 8.5% interest.
Let’s use an example. If we have a $100,000 loan for a property that we rehab and sell in 8 months. If we pay a private lender 15%, we will pay the lender a total of $10,000. If we pay the bank 8.5% with $3,000 in closing costs, we will pay the bank a total of $8,666. In this scenario we save $1,334 by utilizing a rehab loan, but we have to jump through more hoops and we may have a mortgage in our name and on our credit. It’s tough to say which one is better in this case.
With the private lender, we probably got the full $100,000 up front, while with the rehab loan, we paid interest on money that was not in our account. Another advantage to the private lender in this scenario is that you may or may not have to make monthly payments. I do not make monthly payments to my private lenders.
Let’s say that we sold the property within 6 months instead of 8. In this scenario, we will pay the private lender $7,500 and the bank $7,250. In this scenario, I would say that the benefits of working with the private lender outweigh the $250 saved by using the bank.
In fact, because the lender gave me all the money up front, while the bank kept it in their account until I hit certain milestones, I may have made up that $250 with earned interest in my own checking account.
If we sell the property quicker than 6 months, the advantages are much stronger for using a private lender. As we hold the property longer, the advantages bet better for using a bank. As it is very difficult to know when you will be able to resell the property, it is difficult to know for sure which method to use.
Here is how I would have financed the property. I would have paid cash and gotten a personal line of credit for $100,000 one week after closing – assuming that it appraised high enough. If it didn’t appraise high enough, I may only get $90,000 or so.
I would pay $400 in closing costs, and would get a no payment 6 month note with one option for an extension. I would get this loan for 7.5% interest. I am using this interest rate because I have found this rate to be approximately 1% lower than the rehab loan at different local banks. With this method, if I hold the property for 8 months, I will pay a total of $5,400. This is $4,600 less than the private lender and $3,222 less than the rehab loan. Another advantage to this method is that I can close the loan in my L.L.C.’s name.
If I hold the property for 6 months, I will pay the bank $4,150. This is $3,350 less than the private lender and $3,100 less than the rehab loan. I will use this method as often as possible because it allows me to get my cash back very quickly, and it keeps my overall lending costs down. When it is all done and closed, what really matters is how much money is in the bank account. My method, even though it appears more complicated will put more money into my bank account than the private lender at 15% or the rehab loan. That is why I use it.
See ya the Finish Line...
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