Expert real estate investors will inform you that the financing aspect is the most important. The best deal on the market isn’t worth a thing if you’re unable to afford it. Therefore, real estate investors who are new often ask me how to finance their first real property investment.
Whatever your the investment regardless of investment strategy, the most effective way to finance your initial real property investment is to use a loan that is hard money. These loans are granted by lenders in relation to the property’s hard asset, which is the property. This means that you are able to get the cash-based loan with no outstanding financials.
In the remaining portion of this article, I’ll discuss how hard money loans can aid you in financing an investment property. Particularly, I’ll discuss the following areas:
- The problem with traditional Financing
- Hard Money Loans as an Alternative
- Finance The First Real Estate Investment with hard Money
- Gap Financing to Cover Additional Cash Needs
- Questions to Ask a Hard Money Lender
- Final Thoughts
THE PROBLEM WITH TRADITIONAL FINANCING
To comprehend the best methods in order to fund your very first investment it is helpful to know the basics of the basics of traditional financing. Particularly, investors have to comprehend why this kind of method of financing does not work for properties for investment. Through these types of mortgages, lending institutions, like banks and credit unions offer loans in accordance with two broad requirements:
The Borrower’s “Soft” Assets
This includes the borrower’s overall financial situation. The lender will want to make sure that the credit score as well as debt-to-income ratios, income and cash reserves comply with certain minimum standards. In essence, lenders need the highest level of assurance that the borrower is able to make payments.
This verification of assets softly excludes many real estate investors who are first-time buyers. In essence, many people choose to invest in properties due to the fact that they do not wish to pursue a traditional job. In turn, those same individuals aren’t usually in) building credit scores and B) increasing their cash reserves and C) making long-term track reports of their W-2 income. Without these essential elements the investors will find it extremely difficult to meet traditional lender’s strict underwriting requirements.
The Property Itself
If a borrower is in default on an loan, the lender is still looking for its money to be deposited in the bank. Because of this, lenders must require official appraisals of the home in the mortgage loan closing. They want to ensure that they’re lending you more than what the home is worth. If you do not pay back they will know they have the option to foreclose and sell the house and the proceeds will be used to pay off the balance of the loan. In this way, most traditional lenders do not offer mortgages for homes that are in need of major repairs.
Most residential investing strategies are dependent on the property’s condition. Particularly the two most popular strategies depend on the purchase of a distressed property and one that isn’t likely to be eligible for conventional financing:
Fix and flip
In this method, real estate investors locate an abandoned property, usually at a substantial discount. They then purchase the home and then renovate it to the standard required by the standards of traditional financing. After renovation, the investors then offer the property to a person using traditional mortgages typically a homeowner who is a primary buyer. Investors pocket the difference between this sale price and their acquisition/rehab/holding/transaction costs as profit.
BRRR
The BRRR means rent, buy, rehab or refinance. These investors search for properties that are similar as the one mentioned above, which is an abandoned home that is sold with a huge discount. After that, they go through the rehabilitation process, however they are aiming at refurbish a house for renters, not for owners. After renovations, investors rent out the property to high-quality, long-term tenants. Once the property is leased, investors can refinance their high-interest, short-term hard money loans to long-term conventional mortgages. This means they can earn three ways: 1.) rent-generated cashflow,) appreciation of property and third) amortization of the loan.
Alongside being popular investment methods, all of them above are based on the discovery of distressed properties that require significant repairs. And, if investors cannot utilize traditional mortgages to fund the properties, what can they do?
HARD MONEY LOANS AS AN ALTERNATIVE
Enter hard money loans! No matter whether you go to go with a fix-and-flip and BRRR approach the loans are an opportunity to fund an investment.
An Overview of Hard Money Loans
The more precise definition is that the term “hard money” is a viable alternative to the traditional financial system. And, hard doesn’t mean challenging. Instead, it signifies that the lenders only concern their own “hard” asset, meaning the property.
In the same way conventional lenders must meet minimal standards in borrowing parties “soft” assets. Hard money lenders don’t bother their own business with this. They look at an asset and ask what will the property be? They decide to lend on the estimated after-repair cost (ARV) of the property.
Benefits
This program offers real estate investors with two important advantages. You can first get an unsecured loan in the absence of excellent credit scores (but most lenders will not be able to work with you if you’ve had bankruptcy or judgments in your credit record). In addition, you can take advantage of hard money loans to purchase distressed properties, which makes them perfect for fix and flip as well as BRRR investors.
Traditional lenders need to verify that, in the event of foreclosure an asset, it will pay the loan amount in the present. Hard money lenders are more at risk. They lend according to the amount they think they believe the home could be worth in near future. Although each lender has different conditions and conditions, at Do Hard Money, we will lend as much as 70% the value of the property’s ARV. Therefore, if the borrower fails to repair a property, the hard money lenders must recover their loan balance by selling distressed properties. Also, selling a property during the course of repairs is unlikely to be able to pay off the loan, since the loan was based on the condition the property would be.
Due to the increased risk and the short-term nature of these loans and their higher interest rates, they are more expensive than conventional mortgages. Based on your real estate investment history and the overall quality of the deal you could be able to anticipate to pay rates ranging from 7.99 percent to more than 15 percent. But, investors are able to also close these loans very quickly. The majority of traditional mortgages need between 30 and 45 days to be closed. You can close a money loan within the space of two weeks, or even less.
Lender Criteria
I mentioned it earlier however, hard money lenders have only a few requirements regarding the background of an investor’s loan request:
Not in collection
If you’ve got an outstanding judgment against yourself and you are currently in the collection process, the majority of hard money lenders won’t give you with a loan. The reason is that they are putting too high a chance of being in debt.
There are no bankruptcy filings
If you have an unresolved bankruptcy on your file and you are a bankruptcy victim, you also likely to not be eligible for the hard money loan due to the reasons above.
There is no major criminal record
Hard money lenders are required to conduct a background check for investors. Minor misdemeanors may be waived on a case-by-case basis dependent on what the offence. If you’ve got an arrest for a crime It’s extremely unlikely that the lender will be able to approve the loan with hard money.
In the event that you meet the above requirements The approval for a hard money loan will be based on two factors. First, what loan-to value (LTV) terms can the lender provide. This is the amount of a loan they will offer, based on the property’s ARV. This is directly related to the second aspect that the lenders who make hard money closely examine the property’s ARV.
ARV APPRAISALS
Again Hard cash lenders make their lending on what the property is likely to become worth. However how do you determine the worth of something that’s not yet available? To answer this question the hard money lenders must have the submission of an appraisal of the ARV before they can issue the loan.
In a traditional appraisal appraisers are looking at the most recent sales comps of properties in its present condition. ARV appraisals also contain “as-is” comps and determine an “as-is” value. However they also take into account the planned remodel and the way in which the house will look like when the renovation is completed. An appraiser will look over your contractor bids and locate properties with similar amounts of work and calculate an ARV using those comparable properties.
Although they’re more costly than traditional appraisals, ARV appraisals offer lenders who are in the business of hard money with the information they need to figure out the amount they’ll be willing to lend. When it comes to Do Hard Money, we actually refer to these as “evaluations” because they’re a slightly different from a typical appraisal.
FINANCING YOUR FIRST REAL ESTATE INVESTMENT WITH HARD MONEY
In the preceding sections, I gave the background information about using loan with hard cash to fund the purchase of an investment property. Here, I’ll provide a hypothetical scenario of the way an investor starting out can utilize some of the loans for financing an investment in real estate. In the ideal scenario, this example when combined with the previous information will give you an outline for hard-money financing of real estate investment.
Bargain
Let’s say you come across a fantastic bargain on a distressed property. It’s listed for sale at $120,000 and you believe it’s possible that with the $100,000 improvement and a budget for sale it will be possible to sell it at $310,000. If you do a bit of back-of-napkin math, that’s a good income of $90,000.
As long as you don’t have cash of $220,000 to purchase the property and make repairs You have to seek a hard money loan to pay for these expenses. If you believe you will get $310,000 from the property following the rehabilitation phase however, the lender will require confirmation from an appraisal of ARV. The contractor submits their bids and the appraiser calculates the ARV at $30,000 – $10,000 less than the initial estimate.
With a $300,000 ARV Do Hard Money as a hard money lending institution (assuming 70 percent ARV loan that Do Hard Money offers) will loan to you $210,000 ($300,000 ARV divided by 70 percent). However, your deal budget totals $220,000. So, in order in order to proceed on the deal you’ll need to invest in $10,000 of cash to pay the difference between your $210,000 loan for hard money and the total budget.
If you have cash to pay for this additional $10,000 then you could contribute it to the transaction. If not, other options are available that I’ll explore in the following section.
GAP FINANCING TO COVER ADDITIONAL CASH NEEDS
This example demonstrates the typical situation for loan for hard cash. In other words, you’ll generally require money that are greater than the amount you’re able to borrow from your hard money loan. It’s a bit difficult to locate the kind of deal that an investment in hard money will fully pay for. This is why the majority of investors are able to find other ways to meet their financial needs in addition to the requirements of a loan from a hard money lender. Although it is not a complete list, investors could do the following to fill in the gap between the cost of a hard money loan as well as the deal budgets:
Credit Card Financing
Credit card companies will want your cash. Therefore, if you’re a responsible borrowers, they’ll give you decent personal loans. Imagine you have a $20,000 maximum credit limit for your account but you use only about $2,000 each month, and you always pay it back in time. It’s likely that the credit card company will give you a low-interest personal loan to pay for the difference between the credit you typically use and the limit you have set. This is a fantastic alternative to financing your gap.
Business Partner
Alternately, you could look for an associate in business. Many people A) would like to invest in real estate however B) do not have the knowledge or time to make the investment. If you have money to invest, you could possibly invite them to join as a limited (or “money” – partner. These people contribute the funds, are not involved in the day-to day operations and are paid a percentage of their investment. You’ll have to give up a part of your profits. However, if it is the difference between financing the deal or not, getting an additional partner could be a good alternative.
HELOC
The home equity line of credits, also known as HELOCs, are a excellent gap financing option. Typically, investors tap into the equity of their homes as their primary residence. Assume you own $50,000 in capital in your home. The lender cannot offer an HELOC for the whole amount, but the case that you obtain the $25,000 HELOC it provides you with a huge amount of financing for gaps. Additionally With HELOCs you pay interest on the amount you take. After you have paid off the outstanding balance, you do not have to pay any interest.
Business LOC
In terms of functionality, a business line of credit (LOC) is like it is a HELOC. Instead of securing it against the home the banks will use your company’s operations to obtain the business LOC. This option is only applies to investors who have a business. If you own an extremely successful business, an LOC that is secured by the operation could be a great opportunity to finance a gap.
It’s also the option of getting an unsecure line of credit. This means you’re not using an organization or your residence as collateral. The criteria will be dependent on your reputation as a lender. They will be higher rates of interest, but when they can help you secure an agreement, it might prove worth the cost.
QUESTIONS TO ASK A HARD MONEY LENDER
Before you sign a credit application for a loan, if you are the only lender you meet you must be aware of the possible pitfalls. It is important to conduct your due diligence before signing a contract with the lender you are considering. Particularly, I suggest to ask at a minimum following questions:
Which is your highest LTV you will provide?
Based on the amount of cash you’re willing to put in depending on the amount you’re willing to contribute, this can determine the success or failure of an agreement. In terms of standpoint of return on investment the greater leverage you are able to use to make a deal work and the higher your profit on capital you contribute. (NOTE that a higher leverage also increases the risk of a deal, which is why we stress the importance of thoroughly studying deals before making a decision).
How much is your maximum amount of loan you’ll provide?
This is directly related to the question above. For example, a hard money lender could provide 75 percent LTV loans, which is quite a high-end standard. At first it seems as a good deal, because you could finance a greater portion of the deal than a 60 70% or 70% loan would permit. However, if that lender limits maximum loan amounts at $150,000, you’ve drastically reduced the number of opportunities.
Can you lend money to a specific kind of property?
A lot of hard money lenders concentrate their lending on a specific type of property, usually something they’ve got plenty of knowledge. I was guilty of this as an real estate investor who was new. I discovered what I thought were excellent deals, but I didn’t have a loaner interested in the properties. So I learned by trial and error It’s better to learn about the types of properties lenders will finance prior to you begin to find bargains.
What are your strategies for handling the repayments of loans?
This is an crucial question. Some lenders require monthly payments of interest (or principal and interest payments) after a set period of time. This could seriously impact the flow of cash and disrupt the budget for your deal. Additionally Do Hard Money Do Hard Money we accumulate all interest upfront which means that real estate investors pay off everything in one go at the conclusion of the deal. This reduces the need for budgeting and cash flow process.
FINAL THOUGHTS
As an real estate investor new to the market for the first time, the best option to finance your initial real estate venture is to partner with an institution that lends money to hard-money investors. If you can find a good deal, you will be able to 100 percent finance the entire purchase with loans made from hard money. In the event that the loan isn’t enough to cover all expenses however, you are able to fund all of the investment by using a the right gap financing plan.
