Real estate investors routinely use short term loans to purchase a property, fix it up, and resell to an end buyer. But just as it is risky to buy distressed properties and fix them for resale, it's a challenge to borrower the money for these projects.
These are frequently hard money loans, based on the value of the project. They are not loans for homeowners, they are commercial loans for house rehabbers. The length is typically 6 months......
What happens if the note is due and the property is not sold? The answer to that depends on who you are dealing with.......
The best way to know the answer to that question is to ask up front, and to try to negotiate that into the commitment from the begining. If we have a good borrower who is making his payments on time, and the project is progressing appropriately (assuming it is a rehab or stabilization project) we typically will extend a loan at the same interest rate for a set amount of time, and the borrower pays additional points.
There are reasons why you may need to extend, such as:
- Building inspector held up the project
- more work needed than expected
- you haven't reached stabilization in a multi yet so you can't refinance with conventional funding yet
- you tried to do all the work yourself and found out that carrying costs more than eat up any savings, etc.
- House didn't sell as quickly as you thought
- House sold but buyer couldn't get financing
As an example - if a borrower was making interest only payments on a $200,000 loan, plus had paid 4 points up front ($8000) to borrow in the first place, then we would typically extend for 2 more points ($4000). Usually only a note modification is necessary, not a mortgage modification, so the legal costs are minimal.
Understand, the lender makes money by turning over the capital and charging points and interest every time. Yes, I know it's expensive, but remember, these are deals that no one else will do. Either the property condition rules out conventional lending, or the borrower's financial state rules it out. The house may have no kitchen, or no septic, or whatever. We don't ask for credit reports unless the exit strategy is to refinance. These are high risk deals that unfortunately run into trouble more frequently than average homeowner loans. (Well, given the number of foreclosures, I may have to re-think that statement.)
Here is why this works for both the borrower and lender:
- The lender also has a borrower who is already paying as agreed, and sometimes will take reduced points (two instead of four) because there is an advantage in having a customer you know.
- The borrower benefits, because refinancing hard money with another hard money loan is even more expensive: Think a whole new set of closing costs plus new points, plus the new lender may be even more expensive.
Of course it is best not to stay in hard money any longer than you have to. We don't want you to stay in the deal, we want you to finish the project, make money, and do another one.
Hope I didn't sugar coat this too much. ;-) But I think knowing what's going on is in everyone's best interest. Know who you are dealing with, and get it in writing. I've also created a page with a way to help determine how much you may be able to borrow. This does not apply to every deal, but it's a starting point.
Your partner in profitable investing,
Ann Bellamy. Buy Now, LLC
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