House flipping isn’t as popular as it was 20 years ago. Still, it represents a solid investment strategy for people who know a thing or two about home remodeling. Sometimes, the trickiest thing about it is arranging financing. Hard money is one option. But is it a good option?
Should you fund a fix-and-flip with hard money? There is no right or wrong answer. It really depends on your circumstances and goals. It might also depend on your ability to find a cooperative hard money lender. Some lenders are more than happy to work with house flippers. Others, not so much.
Lending Based on Collateral
Salt Lake City’s Actium Partners is one firm that tends to shy away from house flipping deals. They do not have anything against house flipping, it is just that they prefer to put their money into larger projects. Nonetheless, they say hard money lending is largely based on collateral. The collateral you have to offer influences nearly every aspect of any loan you might obtain.
As a house flipper, you are most likely going to offer the property being acquired. The lender must look at how much you want to borrow weighed against two things:
- the current value of the property; and
- the property’s future value after you complete renovations.
Remember that the lender has to consider the possibility that you will default, forcing them to assume ownership of the property and find a way to dispose of it. That means the lender has to consider any additional investment that might be necessary to fully recover the amount you borrowed.
What a Typical Loan Looks Like
There are no hard and fast rules dictating how a hard money loan must be structured. This is one of the reasons hard money lenders can be more flexible than banks and credit unions. They have a lot more room to structure loans in ways that make everybody happy. That notwithstanding, a typical fix-and-flip loan follows a basic pattern.
The investor finds a property to add to his portfolio. He looks to acquire that property for as little as possible. Going to a hard money lender, he is going to offer that property as collateral on a loan that will fund both acquisition and remodeling costs. Then he has one of two options as an exit strategy:
- Sales Proceeds – The first option is to rely on sales proceeds to repay the lender. This assumes that the investor will be able to complete renovations and sell the home within the loan’s stipulated terms.
- Traditional Financing – A second option is to secure traditional financing as soon as renovations are complete. That traditional financing pays off the original loan and gives the investor a bit more time to decide what to do next. He may still decide to sell the property, but he might also decide to rent it instead.
Note that lenders look long and hard at exit strategies. In fact, a borrower’s exit strategy is second only to his collateral in terms of importance. Lenders want to see a solid exit strategy before they are willing to lend.
One of the primary benefits of hard money to house flippers is the ease at which loans can be obtained. Hard money lenders do not care all that much about a borrower’s credit history or credit score. They do not look at the borrower’s income and assets. As long as the collateral and exit strategy are there, loans can be made. That’s why hard money is such an appealing way to get into house flipping as a new investor.