Beating Broke

Personal Finance from the Broke Perspective

What Is Required for a Hard Money Loan?

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When most people buy a house, they take out a loan with a traditional lender.  However, individuals who are interested in buying run down houses to fix them up to then sell or rent rarely qualify for traditional mortgages.  Instead, they seek hard money loans, which have short terms and give the investor more flexibility than a traditional loan.  Before you first enter the home flipping business, it’s important to know what is required for a hard money loan.

What Is Required for a Hard Money Loan?

What Is Required for a Hard Money Loan?

Of course, each lender will have their own requirements, but in general, there are three criteria that are most important when trying to secure this type of loan.  Not surprisingly, many of the requirements circle around cash on hand and experience.

Down Payment

Most banks require a 25 to 30% down payment for residential properties.

In general, a successful hard money loan fit this formula.  Consider the estimated after repairs retail value of the property.  Let say you expect to sell the property for $250,000 when you’re done fixing it up.  Maybe you purchased the property for $100,000.  You expect to complete the repairs for $60,000, and you also want to borrow enough to cover closing costs of, say, $15,000.  Your total comes to $175,000, or 70% of the expected value of the property.  If you use this formula, you will likely qualify for a hard money loan.

Cash Available

What Is Required for a Hard Money Loan?
Photo by Shane on Unsplash

Since hard money loans are inherently risky, the lender will take a close look at your cash reserves.  You will need substantial cash reserves to use during the renovation process to pay for things like HOA dues, interest payments on the hard money loan, insurance on the property, and other expenses.

The more cash you have available, the more likely you are to qualify for the loan.

Exit Strategy

The last thing the bank will consider is your exit strategy.  Most hard money loans only have terms of six to 18 months, so you must have a plan for what to do when the loan term ends.

For private properties, there are two basic exit strategies:

Sell

The most typical option is to immediately sell the property when you’re done renovating it.  You settle the hard money loan, get your profit, and are free to go on to invest in the next property.  Some investors go a step further and get a cash out refinance so they then have even more cash on hand to invest in the next property.

Rent

Another option is to renovate the property, then rent it.  When you rent it, the property is now making money.  You’ll be able to go to a traditional mortgage lender and get a traditional mortgage in place of your hard money loan.

Final Thoughts

If you are considering going into the real estate business, you must first learn what is required for a hard money loan.  When you meet the requirements, you’ll be able to secure your first loan.  After you have amassed more experience and cash, you will find that hard money loans are easier to obtain, and you’ll be able to grow your business.

Cost of Living Makes a Big Difference

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Where you live, and how much it costs to live there can make a huge difference in what your finances look like.  The differences in the cost of living between someplace like Seattle, or San Francisco and where I live, in North Dakota are stark.  Oftentimes, when you see someone using a calculator of some sort for your retirement “number” there are some assumptions that get made.  People simply assume that they are talking to people who have the same economic circumstances.  They also assume that a 20 year old male is going to need the same amount in their retirement account as the next 20 year old male.

Now, let me tell you something that will knock your socks off.  At least, it will if you live in one of those bigger cities.  Me and my family of 4 (+1 dog) do just fine on less than $70,000 a year.  We’re not extremists, living in a small trailer in a campground somewhere, eating only rice and beans all the time either.  Could we survive on less?  I know we could.  We have debt; student loans, car loans, medical bills, a mortgage, and your regular monthly utilities and such.  But, the cost of living here makes it not only doable, but affordable to live on that amount.

There are some things that cost about the same everywhere.  New and used cars, for instance.  A new pickup here still costs about the same $40,000 (depending on model and features, of course).  Other, more universal goods, like books, computers, and pretty much anything you can buy off the internet, still cost about the same.  But, for many of the other standard items, we’re a lot closer to the source.  A pound of hamburger is only about $3.50.  A pack of cigarettes is only about $4.50.  Compare that to the prices in someplace like New York, and you start to see the benefits.

Where the real difference is, is in the local goods.  Property being the big one.  I’ve compared a few times in different markets.  After the real estate crash a few years ago, prices have gotten a little better, but still aren’t all that close.  We own a 2+1 bed, 1 bath, house with no garage on a good sized city lot.  When we bought it, back in 2004, we paid a little over $46,000.  Some of you reading this likely drive cars that you paid more for.  The houses value has gone up some over the years, but the last time we had it valued, which was in 2011, it was worth $57,000.  I truly hope there aren’t too many of you driving cars that you paid more than that for, but I’d bet there’s one or two.  Comparable houses in some of the larger markets usually are priced closer to $250,000.  If I do the quick and dirty math on that, the mortgage payment would be $2,040 more in one of those larger markets.

I don’t have any real way to compare the utilities, but I have the suspicion that we pay less there too.  Our house is older (c. 1950), so it’s not the most energy efficient house out there, but we still only pay about $90 a  month for our electricity, and about $35-$40 for our natural gas a month.  Water, sewage and garbage are lumped together, and usually end up around $50 a month.

Another huge way that our cost of living is different is in travel costs.  I don’t mean vacations.  For most of that, we’re far enough from a major travel hub that it is usually a little more expensive.  What I’m talking about is commuting costs.  Last week, I slept through my alarm.  I’m supposed to be at work at 8.  I woke up at 7:55.  I skipped the shower, but I was able to get up at 7:55, get dressed, quickly help get the kids started getting dressed, and still made it to work at 8:15.  How many of you would just call in sick because you’d have missed the whole first half of the work day?  When I time my drive to work, it’s somewhere around 5-10 minutes depending on traffic.  And, when I talk about traffic, what I really mean is if there’s anyone coming when I have to make a turn onto a  street and I have to wait ’til they pass. I usually have to fill my 12 gallon tank with gas about once a month.  Sometimes I stretch it to 5 or 6 weeks.  And then there’s the savings on wear and tear on the vehicle.  I rarely put more than 12,000 miles on a car in a year.  That makes it really easy to keep a car for 10 or more years!

Now, I’m not telling you all of this just to boast about how cheaply I can live here.  Really, I just wanted to make you aware of the differences.  What you perceive as “normal” sometimes isn’t.  The same is true for me.  What is a good paying job here, would be considered a poorly paying job in a big city.  People who live in those big cities usually have a lot of amenities that come along with those extra costs.  Choices in movie theaters.  Professional sports teams.  Entertainment venues that can hold more than 30,000 or so people.  They pay for those extra amenities in extra costs that aren’t always monetary.  Crime rates, crowding, and more competition for jobs to name a few.

How does your cost of living compare?  How big is the city that you live in?  (for reference, the city I live in is about 15,000 people.)

img credit: afiler, on Flickr

Making an Offer on a House

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In my opinion, buying a house is a lot more complicated than it really should be.  Making an offer on a house plays it’s part in that complication.  You’d think that making an offer on a house you want to buy would be as simple as telling the owner that you offer $xxx,xxx amount and they either accept or reject that offer.  But, if it were that simple, I wouldn’t feel the need to write this article, now, would I?

Depending on your situation, the offer you make can take on many forms.  When we finally found the house we wanted to buy, and decided that we were going to make an offer, we found that there are a few questions that we had to ask ourselves.

How much will you offer?

How much you offer on the house depends alot on your local market.  In some places, the market is pretty depressed, so making an offer that is way below the asking price is pretty common.  In other places, like here in North Dakota, the market has been pretty stable, so offering way below the price could be construed as an insult to the owner.  The house we wanted was originally listed at $138,000 when we first looked at it.  It had been on the market since June, and a week later, when we went to look at it a second time, the owners had just dropped the price down to $130,000.  We knew that we could probably afford the $130,000, but didn’t want to jump at the asking price.  We did that with our first house, and regretted it.  After discussing it with our real estate agent, we decided that offering $125,000 was well within our range, and wouldn’t be so low that it would insult the sellers.

Contingencies to the offer (Only ifs)

New money.One thing that you likely won’t think about, is the contingencies on the offer.  One of these was pretty simple for us.  We already owned a house, and would need to sell that house before we could afford a new one.  So, one of our contingencies was that our house had to sell before we could close on the new one.  If you’re going to have a home inspector inspect the house (I recommend you do), your offer should be contingent on the house passing the home inspection.  There might be appliances that aren’t explicitly stated as remaining with the house.  If you’d like those appliances, you can make the offer contingent on them remaining after the sellers have moved out.  There might be repairs that you think should be done before you move in.  You can make the offer contingent on those being completed.  Think of the contingencies as negotiation factors.  You’re saying “We’ll pay you this much for the house, only if you do this.”

Counter Offers

Once you’ve made the offer, the real estate agent will take it to the sellers of the house for them to approve, reject, or counter.  If the seller makes a counter offer, they may accept all the contingencies, but ask for a higher price.  Or, maybe they’ll accept the price, but want some of the contingencies removed.  It’s all part of the negotiation.

Accepting the Offer/Counter Offer

If the seller accepts the offer the first time, then it’s on to the rest.  If they counter, you’ll have to accept, reject, or counter offer their counter offer.  Again, it’s part of negotiation, so be sure you understand what it is that has changed and what it is that you’re asking for.  At this point, you’ll likely have a bit more paperwork to sign.

What’s next? (After the offer is accepted)

After an sales agreement has been agreed upon, several things will happen.  You’ll want to start the work necessary to secure your loan.  The sellers will start doing any repairs or other changes that you requested in the contingencies.  If you chose to have a home inspection, you’ll want to get a list of home inspectors in your area and contact one as soon as possible to get the inspection scheduled.  All of these things will have a time frame that they will have to be completed within.  In our case, we wanted to have a home inspection done.  We had 5 business days after the offer was accepted to schedule and have the home inspection done.  Once the home inspection was done, we then had 3 additional business days to decide if there were any repairs that would need to be done to the house in order for it to have passed the home inspection.  If there are repairs, you’ll have to request the fixes through your real estate agent who will deliver them to the seller.  The seller can then decide whether they want to make those fixes, or not.  If they choose to not do the repairs, and you don’t want to go through with the purchase, that effectively kills the deal.  If you still want to go through with the purchase, you might be able to have the sellers put the funds for the repair into a repair escrow account for your use later in making the repairs.  If the seller doesn’t want to make the repairs, and doesn’t want to pay for them either, you have the choice of killing the deal, or removing the home inspection contingency on the offer.

Once all the repairs are made (or negotiated out), and all the other contingencies are made, you’ll move onto the financing and closing portions of your home purchase.  Be prepared.  The closing process is drawn out by regulation and can sometimes take up to 90 days or longer.

photo credit: Neil Armstrong2