How to Buy a BRRRR With a Hard Money Loan
What does BRRRR mean?
“Buy, Rehab, Rent, Refinance, Repeat,” is a new initialism to describe a classic, real estate investment strategy. Savvy real estate investors have been employing this investment strategy for a very long time, so the concept of BRRRR is nothing new or innovative. But its importance to building a real estate portfolio cannot be understated.
When done correctly, a BRRRR can be an excellent way to build wealth over time from your real estate portfolio. In this article, we’ll explore why funding for a BRRRR is the fastest and easiest when funded with a hard money loan. We will also consider some pitfalls that should be avoided when funding a BRRRR purchase with hard money loans.
To cover the basics super quick here, the initialism, BRRRR, is a method that is described as follows:
Buy: Identify the property you want to purchase and buy it using a hard money loan.
Rehab: Renovate the property as needed .
Rent: Get the property rented.
Refinance: Refinance the hard money loan used for the purchase with a long-term, 30-year mortgage. By refinancing the current loan with a lower interest rate loan, called a “cash-out refinance,” you can take out a slightly larger loan against the property than what is currently owed to the hard money lender. These “cash-out” proceeds from the cash-out refinance loan serve as the down payment used to buy another rental property using a hard money loan.
Repeat: Do it all over again so you can buy more rental properties to add to your real estate portfolio.
Why Buy a BRRRR with Hard Money?
It can be difficult to find a bank loan if you don’t have experience with a BRRRR, in fact, most traditional mortgage companies are unfamiliar with BRRRRs. Using a hard money loan to buy a BRRRR can be a great way to get started in the world of real estate investing if you don’t have the credit, or if you don’t have experience. Many hard money lenders will lend to borrowers with bad credit, some do not require income documentation, and still others will lend to real estate investors with no experience. With a hard money loan, you still may need to bring in a solid downpayment in most cases.
Another challenge that people face is getting a bank loan quick enough to be able to purchase the property. Particularly in a competitive market with lots of investor buyers, a bank loan can be too slow to compete with cash offers. In a sellers market for example, realtors are usually very selective about who they work with and won’t consider offers that are not cash offers.
A hard money lender can get you pre-approved to buy investment properties in advance of making any offers. Because hard money funding is so fast, it is similar to an all cash offer.
How to buy a BRRRR with Hard Money
When it comes to buying a BRRRR investment property with hard money, there are a few things you need to keep in mind. It’s important to note that, even though a hard money lender may not care about poor credit, not everyone will be approved for a loan. Make sure you know what the lender’s requirements are, and make sure you meet those requirements, before you apply. For example, some lenders will require prior real estate investing experience, while other lenders will lend to beginners. Understanding the various requirements of different hard money lenders will help you decide which ones you should pursue for a loan.
Shopping Around for a Lender
There are many, different hard money lenders out there that you can go to for financing, but it’s important to do your research first. Make sure you know which lenders are real and reputable first, by searching for every piece of information you can find about the lenders online and reading each of their online reviews. There are a lot of loan scams in which fake lenders pose as real lenders, just to scam you out of money.
If you can, get recommendations from other people in your target market who have successfully purchased BRRRRs using hard money loans. Make sure you search the lender’s name on search engines, check on sites like Ripoffreport.com and the BBB website, and look for “real” online reviews (it’s pretty easy to spot the fake ones). And then make sure you are comparing “apples to apples” when comparing among hard money lenders. For example, how fast can a lender fund and a lender’s appraisal requirements are two considerations when comparing among hard money lenders.
Hard money lenders differ greatly on what type of documentation each will require in order to fund your deal. Some lenders have almost no documentation, while others require a lot of documentation to get a loan. Do your research and make sure you know what the lender is looking for before you apply. This will make it easier, and much faster, to get the funding you need to purchase a BRRRR property.
What the Lender is Looking for
Lenders want to know that the property you are buying is in a desirable area where potential tenants want to live. All lenders prefer experienced borrowers, but that doesn’t mean that lenders won’t make loans to beginners.
And then there’s the property value. Because the property is the lender’s collateral for the loan, value is a very important consideration for a lender. Is the property worth what you’re paying? Or will you have to increase rents in order to achieve the property valuation you will need to do your refinance?
Many banks require a seasoning period, which is a period of time you must own a property before you can refinance your hard money loan with a long term mortgage. After the seasoning period ends banks require an appraisal to be performed and will only lend you a certain percentage of the appraised value. This is another reason why the property value is such an important consideration for both you and your hard money lender.
And, what if you don’t have a lot of cash to purchase a property? Despite the popular myth that you don’t need your own money to get started in real estate investing, yes, most lenders will require you to bring some money to the table. Even rehab lenders will still want you to show that you have enough liquidity to cover some of the repairs, or at a minimum, show you have enough cash to cover carrying costs.
How much cash does a lender require from a borrower? Some rehab lenders will require minimum borrower cash of 10-20% down of the total project cost if the property needs rehab. While many other lenders will only loan you a percentage of the purchase price for the property, usually between 70% to 90% of the purchase price.
Loan Denial for a BRRRR Purchase
In some instances, your loan might be denied by a hard money lender for one or more of the following reasons:
- They don’t like the deal for whatever reason.
- The home might be in a bad location, it may be priced too high, it may require too much work, or maybe the numbers just don’t add up.
- You don’t have enough experience, a solid plan, or enough money.
The Advantages of Buying a BRRRR with a Hard Money Loan
The Ease of the Application Process
Many hard money lenders make applying for a loan very easy. For example, our application process for BRRRR properties consists of a one-page form to fill out. Once we have the one-page form and a few photos of the property we can give you a yes or no answer on your loan request. And because hard money loans are primarily asset-based loans, these loans require far less documentation than a bank loan.
The Fast Turnaround Time on Funding
In competitive markets where good rental properties are in short supply, you need a lender who can fund quickly. This is probably one of the biggest advantages of buying a BRRRR with a hard money loan, which is fast funding. Look for smaller, lending companies because they can typically fund a loan much quicker than larger companies with high loan volume.
Many hard money lenders will use a local broker’s price opinion to determine property value rather than using an appraisal. Because appraisals can often increase the time it takes to close on a property, this is another advantage of using a hard money lender to fund your BRRRR purchase.
Low Cost to Borrow Short-Term
Interest rates can vary from 8- 12% and the rate depends on the lender. As compared with bank loans, these rates seem really high. But if you’re planning to keep the hard money loan in place for a short time until you refinance, this can be your lowest cost financing.
For example, say you purchase a BRRRR using a hard money loan with a 12% annual interest rate. You keep the hard money loan for 5 months and then you refinance into a 30-year loan with a much lower rate. In this example, the hard money loan only costs you 5%, not 12%. This is a small price to pay as compared with the cost of taking on a partner, or the drama that can come from borrowing money from family or friends.
The Disadvantages of Buying a BRRRR with Hard Money
There are far more advantages to using hard money than there are disadvantages. However, there are two important disadvantages that you should be aware of when buying a BRRRR with hard money.
Excessive Junk Fees
All lenders have junk fees associated with funding the loan, and these fees are different from loan fees, or points. Some hard money lenders have excessive junk fees, so make sure you are aware of all of the fees associated with the loan. Especially when selecting one lender over another, use the total fees as a tool for comparison among various lenders. One lender may have a lower interest rate than another, but his junk fees may be higher as compared with a lender with a higher rate and no junk fees.
Not Everyone Will be Quickly Approved for a Refinance Loan
One thing to be aware of when using a hard money loan to purchase a BRRRR is that not everyone will easily qualify for the refinance. This means you may hold the hard money loan longer than you anticipated. Because hard money loans are far easier to qualify for than bank loans, some real estate investors are confronted with a challenge when refinancing. Someone may not be able to refinance because of a low credit score, while others may not qualify from a DSCR perspective.
For example, if the price paid for the property is very high but the rental income is not high enough to cover the mortgage payment on the refinance. A real estate investor may be betting on future appreciation of property value and is willing to take a loss on annual rents. But banks like to see the rental income is enough to cover the mortgage payment, taxes, and insurance. If the rental income doesn’t cover all of these expenses, a bank will look at your personal income to cover the loss. If your personal debt to income ratio is high you may have trouble qualifying for the bank refinance.
If you are unable to refinance quickly, this could leave you stuck paying a higher interest rate on a hard money loan for much longer than you expected. In the worst case, you may need to sell the property if you are unable to refinance out of the hard money loan you used to purchase it.
Some lenders require that you keep the loan for a minimum period of time before you pay it off. Always ask your lender if there is a prepayment penalty on the loan, sometimes this is called a guaranteed interest period. If there is a prepayment penalty, it is usually the sum of the interest from the day you pay off the loan through the lock out date. Some hard money lenders want a minimum of a three month loan term, while some want a minimum of six months.
You’re Approved for a BRRRR from a lender. What’s next?
Once you’ve found a hard money lender that has approved your purchase of a BRRRR property, then what’s next?
-Plan Your Exit Strategy: Make sure you qualify for the refinance to take out your hard money lender. What is the seasoning requirement of your take-out lender? Will the property value be high enough to pay off the loan and cash out for your next purchase? Does your rental income cover your loan payment, taxes, and insurance?
-Start Looking for Properties: Once you’re approved by your hard money lender and you’re 100% certain you can qualify for the refinance, it’s time to start looking for properties. Make sure the properties you are looking at will meet your hard money lender’s requirements. Really understand the property value, look at market comps, look at market rents, make sure you’re not overpaying for the property. And don’t make assumptions about rents, make sure your projections are accurate. And then finally, make sure your projected rents will cover the loan payment on your hard money loan.
Build Wealth Faster with BRRRR Properties
When done correctly, a BRRRR can be an excellent way to build wealth over time from your real estate portfolio. Using a hard money loan to buy a BRRRR can be a great way to get started in real estate investing if you don’t have the credit, or if you don’t have any experience. And by using hard money loans to acquire BRRRR properties, you can scale your real estate portfolio faster, and as a result, you will build your wealth faster.
If you’re looking for a BRRRR loan, reach out to us to discuss your financing options.