When she first came to me with an investment property she wanted fix up and sell, Doreen Harlsway of Salt Lake City, now retired and 71 years young, had just completed an expensive training course on real estate investing. At first I eyed her with skepticism of course, wondering if she thought this was going to be an easy ride.
She was buying in a neighborhood in Salt Lake City, Utah called “Sugarhouse,” that scores big points the B to C buyers. Her ARV was $145K and she was buying at $94,000. Rehab was $9K. Her partner in the deal was to oversee all of the rehab. The comps for the ARV checked out, as I know this area well, so I was intrigued by the deal. I met with Doreen and her partner, and they seemed like they had the best intentions and the right answers to my questions.
Well, the retired lady Doreen, was nervous as a hen nearly every day after the purchase closed on the house. She had a big chunk of her retirement cash locked up on the deal. But luckily, her partner made sure the rehab was completed in a little over 3 weeks and the property was listed this Spring for $150K. Spring flowers blooming on the little sidewalk out front, and the grass already full and green, Doreen accepted an offer for $145K with only 16 days on the market!!
Doreen has since paid us off, and now she’s celebrating big time. She’s a lot better off on her retirement nest egg on this one, little real estate deal. This is what I call a success story. Congrats Doreen!! She could not have qualified for a traditional bank loan to do this. We provided her with a real estate loan or private money loan, to make the deal happen. Click here to find out how you can become qualified for a real estate loan quickly and easily.
With the tightening up of lending in recent years, it’s tough for some real estate investors to obtain bank loans for investment properties. But, private money loans are within reach for those real estate investors who are seeking financing for their investment properties. Here are 5 commons sense tips when seeking private financing for your investment property purchases:
1. Research Hard Money or Private Money Lenders
Find a hard money / private money lender or a dedicated hard money broker who knows all the real lenders from the bogus lenders. Do you homework on a lender to find out what their criteria for lending are, what types of properties they like, and their loan terms. Make sure the length of the loan you are getting matches your needs. There’s nothing worse than getting into a short-term loan when you have a long term strategy with an investment property. Ask for references and do your homework. There are a lot of fee collectors who will take an upfront fee and never provide a loan.
2. Make Sure You Have a Down Payment or Cash Equity
Most private money lenders require at least 10% cash in from a borrower. The more you can put down, the lower the interest rate in most cases. If the property that you are targeting is in need of rehab, some lenders provide rehab loans. You can also use your bank for a HELOC, use your life insurance policy, and even a home depot credit card to fund the repairs.
3. Check your Credit Report
Private lenders look for judgments, tax liens, and mortgage lates. In today’s market, credit is more scrutinized, even by hard money lenders. Work on getting any derogatory removed from your credit report as soon as possible. Have a Letter of Explanation if there are bad marks on your credit to explain the problem and how you will fix it.
4. Check Your Bank Reserves
Make sure you have enough reserves to carry a property beyond the obvious hard and soft costs in the initial number crunching. Particularly on a rehab loan, some lenders will want to see a reasonable amount of reserves to cover unforeseen expenses.
5. Take Advantage of Seller Financing Options
Many sellers are willing to work with you in today’s market. If they won’t carry the entire purchase price, they may carry a portion. Make sure your lender is ok with a seller carry and find out how much they will allow the seller to carry.
Use these tips as guidelines if you’ve never had a private money loan.
I recently did a survey of all of the hard / private money lenders I know in the industry. I also posted the survey on LinkedIn to get answers from the hard/private money lenders I don’t know. The question I asked these lenders was pretty simple:
“What are the top 3 reasons you decline a real estate deal when the numbers make sense?”
Although I received a lot of different answers to this question, there were 3 top reasons that kept appearing from the majority of the hard money / private money lenders I surveyed.
1. Neighborhood: The property is located in a high crime or extremely distressed area. Sometimes this is where the good rehab properties are found, but if a lender is afraid to get out of his car without a gun when he/she does the site inspection, you most likely won’t get a hard money loan on it.
2. Location: The property is located outside of a major metropolitan area in a rural location where there are no sold comparables within 2 miles of the subject property. Hard money and private money lenders prefer to lend in major metropolitan areas over rural locations. Although a real estate deal in a rural area may look good on paper, if there aren’t sold comps nearby to support value, a hard money lender may turn it down. Also, smaller market, smaller pool of buyers. There are exceptions of course.
3. Borrower’s Cash Reserves: Particularly on a rehab loan, a borrower who seems to be grossly undercapitalized is a sure decline. Lenders want to make sure a borrower can cover any shortages in construction, or in case of a low appraisal for the refinance.
If you are a borrower who has been turned down for a hard money loan on a deal that penciled on paper, please share your experience. If you are a hard money lender reading this, please share your own top reasons for declining a real estate loan where the numbers made sense.
One of the real estate investors we fund loans for came to me with an idea last week. His grandmother has a free and clear mansion in the Hamptons, NY. She offered to get a cash out refinance loan against the property and then use the cash to invest in real estate. She wants to be the cash partner, and wants her grandson, (my client) to be the sweat equity partner. But….does this sound like a good idea?
This real estate investor carefully weighed in all the costs involved in using his grandmother’s money on real estate deals. He uses hard money loans for financing the bulk of the purchases and uses his own money for down payment. Whatever the cost of the loans, he just takes that out of the back-end equity in the deal.
He calculated the numbers based on his grandmother’s cut of the equity, versus the hard money lender’s cut of the equity. Not only would it be more expensive to use his grandmother’s money, he decided that the mental stress of using her money just made the overall costs too high. To use her money on a deal, Grandma wants 65% of the back-end equity. In other words, grandma wants 65% of his profits! Using a hard money loan is definitely a cheaper option for this real estate investor. He pays us interest on the loan and a loan fee for giving him the loan. And we don’t take a cut of his equity like Grandma.
Money from family and friends may have a lower cost of capital than using a private money lender, but it’s important to consider the full costs of involving them in your deals. Whenever you involve a family member or friend in business, there are always intangible costs to consider. Sometimes it’s just cheaper and less stressful to use private or hard money loans to purchase real estate investments rather than involving family or friends.
Any thoughts on this topic? Please share your comments below.