So, you found a perfect property for a flip and have your executed purchase contract in hand. Do you have your funding lined up? Whether you are doing a single-family flip or a larger commercial development, hard money could be the solution to getting your deal funded. These loans are typically outside-the-box type deals and can provide creative financing to help real estate investors fund projects where conventional financing may not be a good fit. Hard money loans are typically fast, flexible, and can go as high as 70% loan-to-value (“LTV”) based on the after-repair-value (“ARV”).
Does a Deal Make Sense?
When a loan request comes in, a hard money lender starts by making sure that the deal makes sense. Generally speaking, three things need to work – (1) the comparable properties (“comps”) used to estimate the subject real estate’s value need to be similar enough to be useful, (2) the renovation budget should be realistic, and (3) there needs to be sufficient “meat on the bones” so that the investor makes ample profit. All three factors need to check-out in order for the lender to move forward with the loan request.
LTV and LTC metrics
Assuming the three points above check out, a lender would next examine the loan-to-value and loan-to-cost metrics. Most lenders lend up to either 65% or 70% of the LTV. So, for example, if the ARV is estimated at $500,000, a lender would likely only lend up to $350,000 (or 70%). The difference between the total cost of the project and the loan amount, is the cash that the investor needs to bring to closing, also referred to as “skin in the game”. In a case where the total costs of acquisition, closing costs, renovation budget, and financing costs add up to $400,000, a hard money lender could issue a loan for $350,000.
Loan-to-cost is another metric that lenders pay attention to. Typically, for a renovation of an existing structure, a lender would lend up to 85% of the total costs. In our example where the total costs are $400,000, a lender could loan up to $340,000. Given that $340,000 is the lower limit between the LTV and LTC metrics, this would be the maximum loan amount that a lender could issue. The $60,000 differential, or the “gap”, is the cash that the investor would need to bring to closing.
Next, a lender would take a look at the character of the borrower. For hard money lenders, getting comfortable with the borrower’s experience and ability to execute are big factors. Here are some questions that the lender is likely to ask:
- Does the client have sufficient experience taking on a particular real estate project? Lenders prefer to deal with clients who have experience, as those without experience come off as high-risk borrowers.
- Does the client have a reasonable credit score? Typically, anyone below a score of 601 would be flagged as a high-risk client. If the client is hoping to refinance their project (with a conventional bank) rather than flip and sell it, the minimum score would need to be at least 650, since that is what many conventional banks typically require.
- Does the borrower come of as reliable and honorable? Most lenders pull judgement searches on a client, so if the investor has outstanding judgements on his record, it could hurt their loan application.
In addition, the lender expects the investor to have some cash reserves in case they would need to “dip into their pockets” to cover unanticipated costs such as construction cost overruns. Having ample liquidity to “plug a possible hole” in a project can go a long way to strengthening a loan application.
Finally, your hard money lender will analyze your ability to get yourself out of the deal. For instance, if the investor has a poor credit score and limited income, their ability to refinance the hard money loan in 6 months through a traditional bank would be questioned. The lender needs assurance that investor will be able to repay the loan – this is absolutely critical for approving a loan request.
In conclusion, before applying for hard money loans, make sure the deal works and you have a good plan for repaying the lender.
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Should you find a great deal and have a need for financing, please consider PSG Lending (www.psglending.com) for helping you financing the transaction. We close in as little as 1 week and finance anything from flips to commercial real estate.