Some hard money deals are structured in two parts. The first portion of the loan secures the purchase of distressed property and the second portion of the loan covers the cost of renovations. The rehab portion of the loan is often distributed bit by bit as work proceeds, and this has important implications when it comes to the cost of hard money financing. The following examples will show why it is crucial to analyze the terms of any hard money deal.
In the first is instance our prospective house flipper goes to a hard money provider and proposes a two-month rehab project. The cost of closing on the ramshackle home will be eighty thousand, and the cost of renovations will amount to 30,000. Our first borrower takes out a loan, for a total $110,000 with the rehab budget given out in two successive draws totaling $15,000 apiece. The lender offers a standard hard money interest rate of 14 percent. Work proceeds on the house things go smoothly, and our flipper resells their home earning a handsome profit of 55,320.
It seems like things worked out pretty well in this case, or did they?
Another flipper sees a similar property sale block away from our first. They must have been spying on the first borrower because their proposed project is the exactly the same. The purchase price of the house is 80,000, and the rehab budget is thirty thousand. But they approach a different hard money provider. They agree to a loan of 110,000 with a 30 thousand rehab budget distributed over two draws at a 14 percent interest rate.
Suspicions glances are exchanged between the two investors as they pass each on the way to their respective work sites. Let us assume they finish work at the same time, and they resell their properties at the same sales price.
But, for some reason, our second flipper earned a profit of 56,020 while the first earned 55,320. Why? Because the second flipper carefully considered the terms of their deal. What was the critical detail in the term sheet the first flipper missed?
The first lender charged full interest on the total loan amount up front through the whole two month period, the second lender only charged interest on the money as it was given out in draws. This tiny detail saved the second flipper 700 dollars.
This hidden cost of hard money is something that is often overlooked, and it could cost you thousands in unnecessary interest payments. In the context of a house flip, 700 dollars might be a piddly amount of money. But let’s change the situation, what if our first house flipper’s project went on for 6 months and they had to pay that 14 percent interest rate on the full loan amount? They’d pay roughly five thousand additional dollars in unnecessary interest payments. In the context of a flip 5,000 dollars is a lot of money.
Don’t make interest payments on money you don’t have. Carefully analyze the cost structure of your hard money deal. If you don’t receive the full loan amount up front ask your lender will they charge you interest on the entire loan amount or just on the funds you’ve received from them. Analyze the terms of your hard money deal, so you can avoid making unnecessary interest payments.
Level 4 Funding LLC
Hard Money Lender
Hard Money Loans
Hard Money Loan
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis Dahlberg Broker/RI/CEO
NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave | Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.