4 ways you can get screwed with a Hard Money Rehab Loan
When seeking out a rehab loan for your next real estate flip, don’t go into it unless you are aware of the potential risks.
Many of the real estate investor education courses fail to give newbies all of the information.
Real estate investment education programs tend to paint a pretty picture of the “best case scenario” for new investors. For example, many of the costs of doing real estate deals aren’t even mentioned, and forget about any of the risks!
Here are some of the risks of taking out a hard money loan that your real estate investor education may have left out of the curriculum:
1. Real estate prices go down:
What if you can’t sell the property for your target price because the market declines? This is one of the biggest risks that every real estate investor worries about. Sometimes a price decline can occur in a market suddenly and suck out your potential for profit.
2. Someone else lists a similar property for a lower price:
This happens more often than you may think. Here’s a story to illustrate this risk.
One of our borrowers was right in the middle of rehabbing a house when he discovered that a couple down the street had just listed their house. The couple’s house had nice interior finishes, very similar to the updates our borrower was doing in his house.
But the couple had gone a step further and had turned their backyard into an outdoor living masterpiece, to include a flagstone patio with built-in fire pit and gorgeous patio furniture with cozy, strand lighting to boot!
But the best part? The couple was motivated to sell quickly so they listed their house for $25,000 less than the other comparables in the neighborhood. In hoping for a quick sale, this couple instantly destroyed our borrower’s hope to make a profit. This happens more often than you may think!
3. You get hurt or sick and can’t finish the renovation:
This is one of the risks that these “real estate gurus” will never tell you about. If you’re doing the rehab work yourself with “sweat equity,” this is certainly a risk you should be aware of, whether or not you take out a hard money loan.
Here’s a story to illustrate this risk in more detail. This investor was embarking on his second rehab whereby he was doing all of the renovations himself. About a third of the way through the rehab, the borrower injured a disc in his back and was unable to complete the project himself.
After securing several bids from local contractors, the borrower soon realized his profit in the project was dwindling. Should he hire a contractor to finish the project for him, he would have very little in the way of profit when the house sold.
What happened? The borrower actually walked away from the project after one of the contractors discovered a major repair to the house that the borrower had previously overlooked. Once he confirmed the cost to fix the said repair, the borrower actually decided to walk away from the property, and our loan with it. Rather than have to bring in money to sell that property the borrower ended up letting it go altogether and we had to foreclose on it. This is not a happy ending folks!
4. Takes too long to sell the investment property:
When you take out a hard money loan to rehab a property, you pay interest to the lender as you go. For example, if it takes you 3 months to rehab and sell a property, you owe the hard money lender 3 months of interest. If it takes you longer than 3 months to rehab and resell, you continue to pay interest as you go.
As an illustration: If your interest rate is 12% and your loan amount is $100,000, you will be paying $1,000 every month until the house sells. If it takes you 6 months to rehab and resell a property, you will pay $6,000 in interest payments, and that’s $6,000 out of your final profit! In the case where it takes longer than anticipated to resell a property, the interest payments can eat up all of your potential profit. Always calculate your final numbers based on your worst case scenario should a property take longer to sell.
Unfortunately, all of the risks outlined above are simply NOT within your control. But don’t ignore these risks just because they are out of your control. When taking out a hard money rehab loan to flip your next property, make sure you are going into it with your eyes wide open and fully aware of the potential risks involved.
Looking for a rehab loan? Simply fill out the loan form.