Financing house-flipping projects can be challenging for investors since traditional lenders do not usually provide loans for fix-and-flip properties. The difficulties are compounded for new investors who may have limited resources and no track record of successfully completed projects. One solution to consider when needing to finance your projects is a hard money loan. Let’s look at how it works and whether it’s a good solution for you.
HOME FLIPPING COSTS
If you’re a new or even a seasoned investor, home-flipping costs can be a tricky topic, since no two projects are the same. Here are some funding requirements to consider when planning your project:
Purchasing the property
Closing costs, including inspections, appraisals and traditional real estate settlement costs
Permitting
Contractor fees
Construction supplies and equipment
Marketing and listing expenses
Broker fees that will be incurred when reselling
Time is of the essence when it comes to home-flipping investments because carrying costs accumulate quickly. Once the purchase is complete, investors need to start rehabbing and meet tight deadlines to resell the property as soon as possible.
HARD MONEY LOAN BASICS
Hard money lenders offer unsecured loans that typically have higher interest rates and larger down payment requirements than other sources. Usually, these loans — where approvals are based more on collateral than creditworthiness — are processed faster than traditional loans and carry more flexible terms than conventional loans.
A hard money loan for flippers will typically use real estate as collateral. The collateral property may be the subject of the rehab project or it may be a different property owned by the investor.
These loans differ from traditional mortgage loans in the following ways:
Funds for hard money loans are provided by a pool of private investors while conventional mortgages are funded by banks and credit unions.
Loans are typically available in a few days while traditional lenders may take as much as 30 days to process conventional loan applications.
Loan terms are limited to six to 12 months with extensions possible for up to five years.
Monthly payments based on interest or interest plus principal are required for fix-and-flip loans. A balloon payment is due at the end of the loan term, presumably timed to coincide with asset disposal.
A hard money loan is intended as a short-term arrangement to let investors undertake improvements on the property to maximize its value, which should be realized when the property is resold. A down payment is also required to complete the loan application, but even this amount can be much smaller, typically 10 percent to 15 percent. Lenders may decide to release loan proceeds in phases as a way of managing their exposure while keeping tabs on the project.
HARD LOAN REQUIREMENTS
Lenders use the loan-to-value ratio to determine the total amount and terms of the loan. Rates for a fix-and-flip loan can range from 7 percent to 12 percent, and the borrower is required to make monthly payments to cover interest only. Lenders may charge a fee or points of 1 percent to 10 percent. Interest rates and fees are not tied to bank rates.
QUALIFYING FOR A HARD MONEY LOAN
Applying for a hard-money loan can be as easy as completing an online application form on the lender’s website. You should be prepared to submit the following:
Completed loan application and an application fee
Two to three months of personal bank statements and tax documents
Portfolio of finished projects as proof of your real estate experience
Signed purchase contract that should show amount offered
The address of the property
Contractor bids may be required for beginner investors
Project description including details of planned renovations
WHEN TO USE A HARD-MONEY LOAN
Hard-money loans are typically used by two types of real estate investors:
Fix-and-flippers will benefit from hard-money loans because they are quick and easy to access. These loans are good for short-term projects that will last up to a year from purchase reselling. The business plan should define the project deadline to sometime before the due date for the balloon payment.
Buy-and-hold investors may have to access hard-money loans when the property is not in a condition that would be acceptable to conventional lenders. Proceeds of the hard-money loan would be used to rehab and prepare the property to be suitable as a rental. The investor can apply for a conventional loan when the property is ready and rented, paying off the hard-money loan in the process.