15 Important Lessons I Learned Using a Hard Money Loan in Real Estate
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I purchased an investment property and used a hard money loan to rehab. I am going to share with you eleven lessons I learned using a hard money loan.
The “Resurrection House” Before
I can name a million reasons why I love real estate, but one of my favorite reasons is borrowing money. When you are doing rehab projects such as flipping real estate you can borrow money to buy the house, soft, and hard costs to improve the property.
Once the property is rehabbed you can sell at market value and keep all profit to yourself, and not split any profit with the bank. So I decided to flip the "Resurrection House" and use hard money lending to finance my hard and soft costs.
House flipping is considered short-term real estate investing. It is when real estate investors purchase a property at 20% or more below value. Then renovates the property which increases its value of the property. The exit strategy is to then sell and make a profit by selling at the new appraised price.
Courtesy of Milton Miller Interiors
In my last flip, I decided to use a hard money lender to finance my rehab. I purchased the house in cash. I researched several lenders before I finally made my decision on who I would partner with for my deal for rehab. My strategy was to flip and hold. I earned some scars from this flip but it was worth it.
If you're looking for a property that would be a great rehab to flip or hold for your portfolio you need a hard money lender to finance the deal. The goal is to keep as much money in your pocket as you can and use someone else's money.
#1 All hard money isn’t the same
If you do not plan to live in your property, and it needs repairs to make the property habitable there are two types of loans you can use to finance your deal: private money loans and professional loans. I consider professional loans real “hard money” lending.
Private Lending is borrowing money from people who have money in their bank accounts and they want to use their money to finance your deal, so they can make more money through interest, and/or monthly interest-only payments. Private lenders are typically made of family members or individual investors who put their money together and want to be limited equity partners. They don't want to be hands-on in the projects but they know real estate can make their money work for them.
Then you have professional lenders who are also called, “the hard money” lenders that finance through debt holding. Hard money lending is basically a loan to purchase the property and pay for rehab costs. You repay the loan once you sell the property or refinance.
At the time I purchased this property, I did have private investors that wanted to finance my rehab. I weighed the pros and cons of using private equity and decided to go with hard money lending.
So for newbie investors that have heard that using hard money is easy- it is. But there are some terms you should know before partnering with a hard money lender.
#2 Hard money loans have higher interest rates
I start the application process of getting my hard money loan thinking my rate would be similar to buying your primary residence using a traditional loan (FHA and Conventional loan). Traditional lenders determine our rate based on our credit report and the borrower's credit score and our debt-to-income ratio. However, the hard money lenders told me upfront they have high interest rates because your rate is based on your personal credit and on your experience. The more experience you have as an investor, you get a lower interest rate.
If you did not have any experience as a real estate investor the terms from a hard money lender make sense: the higher the risk you are, the higher the rate. So if you have poor credit you can expect to be offered a high interest rate. My first rate was 7%. with a 700 credit score. When I showed proof of recent real estate transactions of investment properties through my LLC, my rate dropped to 6%. They do offer loan options such as using discount points to buy down your rate. Honestly, I did not care so much about the rate. My biggest concern was making my interest-only payments, my budget, and having a team that would create the after-repair value I need to make my desired profit. This is what made a great deal for me.
#3 Hard money financing vs traditional financing
I literally thought hard money financing loan terms were for thirty years just like an FHA and conventional mortgages and I sold the property when I finished the property. What I learned was that hard money loans are pretty much identical to construction loans used in commercial real estate. You have a short period of time to be financed.
When your developing or rehabbing commercial properties you cannot get a traditional loan with thirty-year terms. You have to a loan called a "bridge loan". This loan gives you a loan only for the time it will take you to develop or rehab. Once this period is over you must refinance the loan to hold the property for a certain time frame and then sell. With residential properties, once the property is rehabbed house flippers do not wait for a certain period, they sell immediately to pay back the hard money lender. The hard money lender will determine the short rehab period you have in which they will finance the project.
#4 You have the get the loan in your business name and not your name.
This is the part that was confusing to me because they determine how much risk the deal is by evaluating your personal credit. This made me think the loan would be in my name. However, it’s the opposite. It’s a requirement that the loan is borrowed by a business. The business has an active and licensed with the state and also have an acting operating agreement. (I made mine in less than 10 minutes using Law Depot.) Your agreement must disclose all members and their shares of the business.
#5 You don't get hard cash at the closing table.
This is one common misconception. Because you're getting a loan for a hundred thousand and the house cost 40,000 you think it closing and you'll be getting 60,000 cash to rehab the house. This is not what happens at closing. It will be a fast close because it doesn't work like that. When you purchase the house using a hard money loan at the closing table you will sign a legal agreement and you are using the property as collateral in order to get funding for your rehab. If you default on the loan the lender will obtain the property.
#6 You are spending your own money first.
This means that you do not get any payouts from the lender until after each stage of the work is complete according to your scope of work. According to project manager, Monique Williams, It is a good idea to have at least 15% to 20% of the rehab cost available in your business bank account to pay your contractors in purchasing materials.
#7 Don’t spend all of your hard money. Leverage other people’s money.
If this is your first deal, you are going to face some bumps and bruises and possibly go over budget. My general contractor suggested a good option for saving my money. He told me to not use all of the hard money for materials. One strategy you can use is purchasing your materials using credit cards or establishing business credit with Home Depot or Lowe's credit card.
Once you sell the house or cash out refinance, you can pay off the card’s balance. It was the best advice so I opened a Home Depot Credit card. Once we finished the rehab I was under budget and didn’t use all of my hard money. So I decided to pay off the Home Depot card with my hard money.
#8 The inspector approves your work to get payouts.
For you to get your payouts from your hard money loan you contact the lender. The lender then hires the inspector. In a matter of days, the inspector will come out. It's important to pay attention to how long it takes from your call to the lender to when the inspector comes. So when it's time to make another draw you can call days before you are ready. It is the inspector's job to make sure the work is complete before the lender deposits cash into your account. When approved, the lender then reimburses you for the work and material you paid out-of-pocket. There's an inspector fee that you will pay each time the inspector comes out which ranges from $150 to $300 for each visit. It’s important to ask your hard money lender in the beginning stages how much your inspections will cost.
#9 Inspector works on behalf of the hard money lender.
There's a difference between working with your home inspector and working with the inspector for the lender. this was one mistake I learned from my last flip. The was one mistake I learned from my last flip. The inspector for the hard money lender was not checking behind the work of my contractors. The inspector was counting doors, windows, and doorknobs, making sure that the repairs you want to get reimbursed, according to your scope of work are complete. This is when you need your personal property inspector to check behind the work of your contractors.
#10 You can not continuously change the scope of work with hard money lenders
There's a limited number of times you can change the scope of work. With my hard money lender, I was only allowed to change the scope of work one time. The biggest lesson to learn in rehab to expect and plan for the unexpected.
It's going to be difficult if you're rehabbing a property and unexpected problems occur and you need to change your scope of work. If your lender does not allow you to change the scope of work be prepared to pay out of pocket for repairs that need to be done. This is a definite question to ask your hard money lender before getting a loan.
#11 Do not ignore emails or calls from your lender.
Always respond within 24 hours. We are business owners we can't ignore calls from the lender. No matter how bad the deal is going. Be honest, they are partnering with you for success. They can offer options and advice to keep the rehab project going. Develop a relationship with your lender representative and their inspector. The lender's responsibility and goal is the make sure they are getting a return on their investment and you complete the project. Check in via email with the progress as you reach different milestones. This is not a requirement but it does make it easier to get approved with another loan because this deal can show you are consistent, good with communication, and trustworthy with your money.
#12 Make payments on time.
If you work with a hard money lender that requires monthly payments until the property is sold or refinanced, make sure you know all of your fees and set your payments up on automatic payment. If you are a day late they will attach late fees plus added interest. This is money taken away from your profit.
#13 Time is of the essence.
Make sure you can rehab this home within the time frame of the loan. You are under a small time frame to complete the project. Do not take your days for granted, consider what must be done on your scope of work. Also, consider weather and seasonal contingencies like rain and snow that may halt rehab days. If you feel you can not rehab and complete the project within the time frame the lender wants, have a plan B.
#14 Do not change the game in the 9th inning.
If you have studied your competition using the real estate agents on your team. You know your real estate market value in your property's area. You have a good scope of work, and a team, already picked out your colors, flooring, doors, etc. at the beginning of the flip- do not make changes. Make a decision and keep moving forward. Sudden changes can end up being costly and unnecessary and your lender will not give you more money because you have decided to upgrade the lighting. Stick to your plan. If you must upgrade you will sacrifice something else in the project to make it work. Worst case scenario you will pay out of pocket.
#15 If your plan changes, talk to your lender about your options.
I was getting several nudges from the universe that I needed to consider holding this property instead of selling it. A month before we were almost complete God told me to keep the property and not sell. At that time my ARV was $135K and I was all in 80K. Which meant I could get around 50K in profit which was good, but I decided to hold. I called my lender rep and he was excited it made the decision to hold the property because I did a great job on the project and he knew if I held for a longer period I could make a greater profit. So I decided to cash out refinance. It was the best decision because now my property is worth $215K.
So if I had to do it all again would I use a hard money lender? Yep. In a heartbeat. Using this “hard” money was easy. This post was all about my experience using a hard money loan for the first time.
If you’ve used hard money before let me know about your experience in the comments.
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