WHAT IS PRIVATE LENDING?
Private money lenders play a significant role in real estate funding all over the country, especially with financing real estate flips.
So, what exactly is a private money loan? Essentially, it is a loan funded by a non-traditional lender (such as a bank, credit union, etc.) that is secured by real estate. These loans are based on a different set of criteria than a traditionally funded loan. Rather than basing the loan value on the borrower’s credit, it is primarily based on the value of the asset.
Private money lending has many benefits over traditional lending, especially for house flipping:
1. Faster loan quotes
2. Fund in a shorter time period
3. Rely heavily on the value of the property instead of the borrower’s credit
4. Will loan on rehab properties; most banks won’t fund these type of properties
5. Third party appraisals are not always required
6. Shorter approval time, less paperwork, simplified process
7. No maximum exposure limits to one borrower
PRIVATE LENDING & LEVERAGED RETURNS
There are two vital benefits to using private lending that you need to understand to be successful in house flipping: Leveraged Returns and the ability to Grow and Diversify.
The concept of leveraged returns can be intricate but understanding the tremendous benefit of it in house flipping is crucial.
To make it easier to understand, let’s apply & compare two potential deals:
Your flip is expected to cost $200,000 with the purchase price and rehab combined.
You have $200,000 in cash and fund the rehab yourself. If you can sell the house for the projected ‘After Repair Value’ (ARV) of $250,000, you will profit $50,000 on your $200,000 investment.
This gives you a 25% profit margin.
That’s a pretty good investment, right?
Let’s assume the same deal, but this time you get a private money loan for $150,000 and only need to contribute $50,000 of your own money. With the loan fees added in, your new projected costs will increase from $200,000 to, let’s say, $215,000.
If the house sells for the projected ARV of $250,000, after repaying the private money loan, you will profit $35,000.
However, since you only invested $50,000 of your own cash (instead of $200,000), your Return on Investment (ROI) is 70%!
**That’s almost 3 times more than you’d make in the same deal using all cash.
DIVERSIFY YOUR FUNDS & RETURNS
The other vital benefit to using private money loans is that it allows the borrower to diversify their funds & risk allowing their returns to potentially multiply.
You can take that $200,000 and tie it all up in one all-cash flip at a time:
$200,000 = $200,000 project x 1 project
(Flip Time = 6-8 months)
= $50,000 profit
You can use that same money and have 4 projects going simultaneously using private money loans:
$200,000 Investment = $50,000/project X 4 projects
(Flip Time = 6-8 months)
= $35,000 profit/project x 4 projects
Ultimately, using private money lending will allow you to diversify your portfolio and more effectively & efficiently grow your business!
PRIVATE LENDING FOR HOUSE FLIPPING DEALS
The advantageous part of a private money loan is that there is not a “typical” private money loan. Each loan is uniquely based on the individual needs of the loan. Private lenders typically have their own individual set of criteria they look at and use for their lending process including underwriting criteria, borrower requirements, and loan structures. However, most hard money lenders size their loans based on a percentage of the borrower’s After Repair Value (ARV), an independent appraiser’s ARV, in-house ARV, percentage of the purchase price, percentage of As-Is Value, percentage of total costs, and/or any combination thereof.
Most private lenders will loan approximately 80% + of the purchase price or 60-65% + of the AVR of a residential flip. For example:
Let’s say you are buying a home for $275,000 and are planning to spend $60,000 on the rehab. Your lender has looked at your deal and agrees that you should expect to sell it for $400,000 once the work is completed (your ARV). You should plan to see loan quotes ranging between $220,000 and $260,000.
Some private lenders may reserve a portion of the loan funds until certain conditions are met. This is what is referred to as a “holdback”. The borrower can make draws against the loan as the borrower reaches milestones in the rehab, or in a single amount at the end of the rehab. It is important to understand that most lenders will charge interest on the entire loan amount from the initial funding date, regardless of when the holdback funds are disbursed.
FINDING PRIVATE MONEY LENDERS
Incorporating private money loans into your house flipping business model can be a tremendous benefit to your business. It allows you to get started with little money out-of-pocket, attain loans on projects traditional lenders won’t fund – and in shorter periods of time, diversify your funds, increase your margins, and help you grow your business.
Contact Our Team at Vintage Real Estate Fund today to see how you and your project can benefit from leveraging a Private Money Loan.