You’ve found the perfect investment opportunity. The price is right, the market is ideal — and you can do all the work yourself. The only problem is, you need the funding.
Many a house-flipper has faced the situation of having one such opportunity before them — but not having the necessary capital to get things rolling. Several reasons could keep you from seeking help from a bank or financial institute, instead seeking out a hard money source. But is it the best option?
What's Hard Money?
In this scenario, you have two options. You either borrow the money from a lender, or your raise it (from a private source).
When you borrow money, you incur a debt. Debts usually require monthly payments, with interest. That interest is income (ROI) for the lender.
On the other hand, raising money refers to sharing equity. Meaning, you pay back an equity partner with a percentage of equity, cash flow or both.
All lenders will require upfront points because they have to pay an origination fee (usually 1% of the loan) to the broker who got the loan. With a hard money loan (because of the higher risk) the upfront points are usually in the 2-5% range with interest rates of 12-20%.
The higher commission of a hard money lender is to pay the loan broker and offset risk and early payoff.
When To Use Hard Money
Obviously, with a 5 point upfront fee and 12-20% interest, you wouldn’t want to carry a hard money loan for very long. So what are the circumstances when hard money fits the bill?
If the loan is for a rehab or reposition and will be repaid quickly.
If you already have long-term bank refinancing committed.
HOT Seller's Market
If bank money flows freely to buyers who are paying top dollar.
Making The Numbers Work
Hard money CAN be useful — PLUS, it’s predictable. You can calculate the cost of the loan and factor it into your ROI/IRR.
Since the duration of the loan is known, as is the cost, if your ROI/IRR says that you can use hard money and still make your investors the targeted return…use it.
However, if hard money won’t allow you to make your investors happy, don’t use it. That’s the time to get creative and explore other financing options.