Across the country I have heard stories of small or new real estate investors who are perhaps buying their first property or might have done a few rehabs with their own funds but challenged with how to finance a property purchase and/or rehab. One option might be a Hard Money Loan but another option can be a 30 year fixed rate rehab mortgage. As a Loan Officer specializing in rehab financing I thought it might be helpful to draw a contrast between Hard Money lenders and present two other rehab loans that may be less known to new investors and rehabbers.
First, I want review what Hard Money lenders may offer for those that are unfamiliar with them:
- Perhaps the most valuable aspect of a Hard Money lender is speed and less documentation than a traditional bank type loan may require. I have heard of Hard Money loans being approved and funded in just days as opposed to a number of weeks from a bank or traditional mortgage source. In a competitive bidding situation, a Hard Money loan may be helpful due to the speed at which funds may become available, enabling a bidder to be successful against others who need time for a traditional loan to process and close.
- Generally property types can be anything from a single family house to a commercial structure to be funded with a Hard Money loan. This would include damaged properties that a traditional bank lender would not be able to lend on due to health and safety hazards present.
- A Hard Money lender can be a company or individual(s) who have money to lend for the purchase and/or renovation of real estate on a short-term basis. They may be especially helpful in fix & flip situations for example, where Hard Money lenders often do business.
- I have had clients use a Hard Money loan to quickly close on a foreclosure property and then take some time to rehab it and lease it out for cash flow. From the point of view of a Seller, a Hard Money loan can be almost the same as cash given the abbreviated time it generally takes to close.
- Since Hard Money loans are for shorter periods, perhaps 6 months to 24 months, the monthly payment is usually interest only rather than reducing principal as in most traditional loans, with full balance due at end of the initial period, often called a Balloon. Meaning the Hard Money lenders want their money and interest returned quickly to make profit and lend to the next individual. They may charge an extension fee if there is a delay in paying off the loan as well.
- These types of loans are more based on the collateral than the borrower’s income or job history. Meaning the property value when repaired and resold or refinanced. A Hard Money lender will be concerned with upside potential given purchase price and any rehab cost involved. Without the potential to see an increase in value it may not make sense to them to be involved. In other words, they may expect the borrower to fail and may not wish to move forward.
- Hard Money lenders may vary in terms of how much they will lend on a given property but usually that limit, called Loan to Value, is based on what the property will be worth when rehabbed, not what is being paid for the property.
- Generally speaking Hard Money lenders will want to see borrowers have funds in reserve in case of increased carrying costs and rehab project time delays prior to resale or refinancing.
- Less emphasis may be put on borrower credit scores but a Hard Money lender will still want to learn if there is a history of defaults or foreclosures on real estate from a borrower. In that context they may want to partner with those who they feel are more likely to be successful.
- A Hard Money lender may want to work with only those who have experience at buying, rehabbing and flipping properties rather than someone who has never done this and has no record of success to check. Hard Money lenders are very focused on their upside profit potential, but a traditional bank lender may not generally be focused on that aspect of a transaction.
- Fees for Hard Money loans can be much higher than for other, more traditional types of mortgages. I have heard of Hard Money lenders charging 2 to 5 percent of the loan amount as an up-front fee. This is part of the business model of Hard Money lenders and where profit is derived apart from collecting interest on the loan amount over the time period it is open.
- Interest rates can generally be much higher than a traditional bank or lender may charge. These can vary around the country due to competition from Hard Money lenders present or not in local markets. But interest rates might vary widely from perhaps 8% to 15% around the country.
- Most Hard Money lenders will want to see what the borrower is proposing to do with the property. For example, a purchase to rehab and then re-sell a property is a typical circumstance that may be appealing to a Hard Money lender. They will want to see the rehab costs and what the After Renovated Value (ARV) will be to determine if it is a good return on investment for them.
- Hard Money lenders will want their money back as soon as is practical, so a next step would be to work with a traditional lender for a longer term, fixed rate, refinance mortgage to pay off the Hard Money lender as quickly as possible to reduce the amount of interest paid if the property is not to be sold or cannot be quickly sold.
In the past I have refinanced clients out of their original Hard Money purchase loans into a long term 15 or 30 year conventional mortgage based on the current value of the property or ARV. They had used the Hard Money loan to quickly close on foreclosed properties that needed repairs and so bought at a discounted price. Then after improvements and repairs a new Appraisal was done enabling them to pay off the Hard Money loan and have the security of a long term, fixed rate, amortizing mortgage reducing principal each month and maximizing cash flow.
Now I would like to present two alternative mortgages to a Hard Money Lender loan that include funds to renovate a property. Both below loan types are subject to current, conventional loan limits by county across the country. Neither has any pre-payment penalty.
One is called HomeStyle® renovation loan by Fannie Mae for Investor single family homes, condominiums and townhouses. Basically 1 unit type properties needing rehab investors can purchase or refinance. This loan can be used by a first time investor or repeat investor with a 20% down payment. The 20% down is calculated off the sum of purchase price and rehab funds needed. A Hard Money lender may not be willing to work with first time investor with no record of successful transactions.
- HomeStyle® does have a limit of allowing 4 currently financed properties to each borrower as it is designed for a new or small investor to have access to rehab funds. That means an investor can cycle through fixing and selling properties to stay to the 4 financed or mortgaged property limit at any given time.
- Loan size is based on After Renovated Value (ARV) much like a Hard Money loan might be. Or basically 80% loan to value. Meaning the borrower puts in a 20% down payment to purchase or if done as a refinance the owner will have 20% equity in the property.
- One rule is the amount of dollars in the HomeStyle® loan designated for rehab cannot exceed 75% of the After Renovated Value (ARV). This is to be sure it is not a situation where the property is being over improved and may not appraise out. This is also a safeguard to be sure a rehab project makes sense financially for the lender and borrower.
- Unlike a Hard Money loan there must be a reserve fund established as part of the rehab loan equal to 10% to 20% of the rehab budget to handle any cost overruns or surprise repairs not forecasted up front. This protects both the borrower and lender to be sure the rehab can be completed under circumstances where extra funds are needed not originally in the repair budget. This aspect of HomeStyle is part of the reason why it is open to a first time investor/rehabber.
- Fees for HomeStyle® usually involve upfront costs typically much less than what a Hard Money lender would charge.
- Interest rates are based on borrowers’ credit score and credit history using current long term amortizing mortgage rates. Hard Money lender rates as stated above would be expected to far exceed HomeStyle® interest rates under most circumstances since those loans are collecting interest only each month and not funds to reduce principal as HomeStyle® mortgages do each month. Additionally, the Hard Money lender wants a quick turn around on investment to repeat the process with their next client.
- A HomeStyle® loan can be kept for up to 30 years and each month some portion of the payment funds go to reduce principal loan balance until the loan is paid to zero in 30 years. A Hard Money loan is required to be paid off usually in 6 to 24 months, in full.
Overall HomeStyle® is a great option for first time investors and small investors with no more than 4 mortgaged properties at any given time. It provides safeguards in that there is an emergency reserve of funds from 10% to 20% of the base rehab budget and limits the rehab amount to 75% of After Improved Value. Additionally, there is the security of a fixed interest rate amortized for up to 30 years.
Another loan option for rehab investors is called EZ “C”onventional. This is a similar loan to HomeStyle® but for multi-unit apartment buildings from 2 to 4 units.
- This loan is intended for updates or repairs that are not major or structural in nature. Repairs can range from updating kitchens & baths to new plumbing or electrical, flooring, HVAC, etc.
- These properties cam be mortgaged to no more than 75% of value.
- This loan can be used by a first time investor or repeat investor with a 25% down payment. The 25% down is calculated off the sum of purchase price and rehab funds needed. A Hard Money lender may not be willing to work with first time investor with no record of successful transactions on multi-unit properties.
- The maximum dollars for renovation defaults to $35,000 but can increased by approved exception.
- An example would be an Investor purchasing a 4 unit property for $400,000 needing $100,000 in renovation. The down payment would be calculated off the total of these, or $400,000 plus $100,000 = $500,000. A 25% down payment is then $100,000 in this example.
- Unlike a Hard Money loan there must be a reserve fund established as part of the rehab loan equal to 10% to 20% of the rehab budget to handle any cost overruns or surprise repairs not forecasted up front. This protects both the borrower and lender to be sure the rehab can be completed under circumstances where extra funds are needed not originally in the repair budget. This aspect of EZ “C”onventional is part of the reason why it is open to a first time investor/rehabber.
- This loan offers the security of a 30 year, fixed rate, amortizing mortgage in contrast to a Hard Money loan that is usually interest only each month and for a short period of time.
In this Blog I wanted to present these two alternatives to Hard Money lenders for those exploring rehab loans and investing in properties.
I hope this post has been helpful and encouraging to those that may have thought a Renovation project was too complex or beyond their ability to manage. My intent is always to inform, educate, and generate discussion. Please call me or email me directly or visit my website for more information on renovation loans. I welcome your comments and questions!