When it comes to Investment Properties, one of the most important factors to consider is the financing. There are mainly four different ways to purchase a property: Ask a bank for money (Conventional Financing), have the current owner finance it for you (Seller Financing), pay Cash or get a loan from a private investor (Hard Money).
Here are my high level thoughts on the four different options:
– Conventional Financing: Potentially the lowest interest rate but high down payment and quite stringent on getting approved.
– Seller Financing: Could be a great option but most sellers will not be willing to act as a bank.
– Cash: Could be a good option if you have it but there is no leverage and sometimes yields a lower Cash on Cash Return.
– Hard Money Loan: Easier to get approved than a conventional bank, tend to have a higher interest rates and fees but could also have more flexible terms.
Most new investors I work with tend to be skeptical about Hard Money Loans. This post’s goal is to explain why Hard Money could be a great and sometimes the best option to purchase your next investment property. To provide some context, my first single family rental property purchased in 2010 was financed via an interest only Hard Money Loan which was refinanced into a Conventional Loan within 60 days. Please note that not all Hard Money Lenders are created equal but I will make my case in order for you to consider hard money in the future.
Why go Hard Money?
During one of my first Real Estate Investment seminars, they focused on showing us how to purchase properties with the least amount of cash out of pocket and earn monthly Free Cash Flow. The easiest way to buy with the least amount is to purchase with a Hard Money Loan and then refinance into a Conventional Loan. Here is an oversimplified but real life example in which I estimated any financing and re-financing fees. *Please also keep in mind that re-financing rules and regulations can change regularly and you should check with your loan officer before taking out a loan that you plan to re-finance in the short term.*
Property After Repair Value (ARV): $114,000
Purchase Price: $78,000
Repairs: $7,000
Hard Money Loan Down Payment (10%): $7,800
Financing Fees (4.5%): $3,510
Repairs: $7,000
Total Cash out of Pocket: $18,310
Refinanced Amount (80% of ARV): $91,200
Original Loan Payoff: $70,200
Re-financing Fees (3.5%): $3,192
Cash back from re-finance: $17,808
NET CASH OUT OF POCKET: $502
Please note that the re-financed loan balance is now $91,200 (conventional) vs. the original $70,200 Hard Money Loan that was used to purchase the property. The new loan balance is quite a bit higher but the interest rate probably dropped by about 4%. I am not going into the Cash Flow details in this post but if you could cash flow on a property and be out only $502 after repairs, you got yourself a HOME RUN! This is not your everyday deal but if you keep an eye out and work with talented realtors and/or wholesalers, you will find a deal similar to this example, especially in a market like El Paso TX.
What to look out for!
Here is a list of things to look out for or contemplate when shopping for your next Hard Money loan.
– Interest rates usually vary from 8% (lowest I have seen) – 15%
– Down payments can vary from 0%-25% depending on how good of an investment the property is and the Hard Money Lender’s appetite.
– WATCH OUT for Pre-Payment Penalties (PPP)! Most, but not all Hard Money Lenders I work with will include a PPP up to 3 years and sometimes also include a balloon payment shorter than the loan amortization. I have been able to negotiate the removal of the PPP for a slight increase in interest rate. Run your numbers and see what works best for you depending on when you plan to re-finance or sell the property.
– Origination or Funding fees: Most Hard Money Lenders will have fees that can be higher compared to a conventional loan. Keep an eye out for fees and make sure the deal makes sense for you. Fees can be higher if you are working with a Hard Money Broker vs. the lender themselves.
– Term/Length of Loan: Some conventional banks only finance investment properties for 15 years. If I am taking out a Hard Money Loan with a higher interest rate, I am going to want to amortize the loan for the longest period they are willing to approve (30 years if possible).
In Summary
I personally like Hard Money Loans for the reasons I mentioned above along with the fact that conventional banks can be hard for investors to work with. As an example, a conventional bank will most likely not loan you money on a house that needs heavy repairs. On top of that, the current market (at least in El Paso) is very hot for investment properties and the seller will choose a Hard Money offer over a Conventional Loan offer simply because the Hard Money Lender will be less strict with approving the loan and they are able to close on the deal much faster (at least a couple of weeks sooner).
Before you go out and get a Hard Money Loan for your next property, make sure that it makes sense based on what you are trying to do. If the property is a buy and hold, make sure that you are going to be able to re-finance the loan within an acceptable time period for you. If you have more specific questions on the loan terms and details, I would be more than happy to introduce you to my Hard Money Brokers and Conventional Loan Officers that can assist you. Not to mention, if you or someone you know is looking to buy/sell/invest in Real Estate, please have them give me a ring at 915-222-6666!
With much appreciation,
Rafael