Hey real estate investors!
Here's 4 things you need to know BEFORE your next Fix & Flip or real estate investment.
First, check out the interest rate from your hard money lender. Some lenders charge 14, 15, even 18% on their loans! That's insane. Depending upon your investment, we can provide you with a loan for as low as 10%.
Second, you need to know how much your lender is charging for their origination fee. Most charge 3-4% while we only charge 2%. They are charging you 50-100% more!
Third, make sure there are no hidden fees or rate hikes in your contracts. Way too many lenders try to sneak in extra ways to charge you. Not cool.
Fourth, make sure your lender has a successful lending history. Can your hard money lender provide any testimonies or references? You do not want an inexperienced lender funding your next real estate investment.
The perfect hard money lender would help you make AS MUCH money on your investment as possible, have no hidden fees or rate hikes, help you navigate the paperwork, and enjoy helping you make more money on your next property.
Contact us if you are searching for a hard money lender! Our phone number is 210-941-3916. Or you can email us at email@example.com.
Hard money lenders have a bad reputation - and a lot of the time, it is for good reason! These lenders give the rest of us a bad name and can cost their clients tens of thousands of dollars in unnecessary expense on every flip!
We have put together a list of some of the most egregious things to watch out for when shopping for a lender on your next investment project (and maybe these are reasons you should fire your current lender!):
1. Collect money up front
Does your lender charge you money just so they can tell you if they want to lend to you? Watch out for lenders advertising great rates, but requiring an upfront fee before giving you a firm written commitment. Some unscrupulous people make their money on 'due diligence' fees for loans they never intend to underwrite. If your lender can't give you a specific term sheet or letter of intent after asking you a few questions and collecting a few pieces of information, they probably aren't serious about earning your business.
Even something as seemingly legitimate as collecting a processing or appraisal fee should happen after terms have been nailed down and agreed to by the borrower.
2. Thousands in made-up fees
While you're making sure you don't pay any upfront fees, make sure the fees you do pay are legitimate! All lenders have hard costs associated with closing loans, and those are often passed on to the borrower. Common costs include appraisal fees, underwriting costs, and loan document preparation and processing fees. Junk fees that we've seen other lenders charge their borrowers to puff up their bottom line include mailing fees, printing fees, approval fees, delivery fees, lending fees, application fees, reporting fees, filing fees, and even recording fees (your lender doesn't 'record' anything officially - that's the title company's job)!
Before you agree to anything, ask your lender for a breakdown of the fees at closing, and then do the math!
3. Their rate is too good to be true
One of the reasons that lenders charge crazy-high fees is to hide their real costs so they can advertise silly low rates that aren't so low once you calculate the total cost of the loan. For example, if you're shopping for a $100,000 loan and your lender hides $2,500 in fees on the final statement at closing, that's equivalent to paying an extra two-and-a-half points at closing!
If a lender advertises a rate that is slightly lower than the competition, it is probably worth your time to investigate further, ask about other fees, and then evaluate the total cost of the loan. One way that unsavory lenders also mask their high-cost of capital as a low-priced option is with the length of the term on the loan. Most hard money lenders have terms between six and 12 months, but some advertise rates that are significantly lower than anyone else in the industry, only to list a disclaimer in the small print that the rate is only good for a certain portion of the loan.
Here is a nightmare example:
We had a client come to us for a loan, and we quoted him a 10% interest rate. He shopped that around and got a 7% interest rate from another lender. We warned him that that rate seemed too good to be true because we have the lowest rates in Texas, but he went with it anyway. A few months later, he called and told us that the lender who did his loan at 7% interest didn't mention to him that the rate was only for the first 30 days of the loan, and then the rate jumped to 14%!
4. Rates changed at the finish line
Just as you want to make sure there aren't hidden fees or terms that increase your anticipated cost of capital, make sure the rate you are quoted is the rate you end up with!
By far, the most common complaint we hear about other lenders is that their rates or fees get jacked up at closing. I can't count the times that people have shown me term sheets on previous deals that didn't match the HUD statement. Lenders that do this figure that by the time you get to closing, you are so invested in the project that you won't walk away just because they put an extra point or two here or there on your loan.
Not only is this dishonest, but it practically ensures that lender will never get repeat business. You can protect yourself from this type of scam by reading reviews of the lender online and asking other investors to refer you to a lender they have had success with. Chances are, if a lender has treated their clients right, they will be happy to refer them to you.
As with any investment decision, it pays to do your homework. Choosing a lender is no different! Arm yourself with facts, get everything in writing, ask others in the industry, and most importantly,, ask your lender questions! A lender that won't take the time to answer all of your questions is not the lender for you. The more you understand the lender's processes at the beginning, the lower the chances are for disappointment and regret down the road.
Ask if your lender can provide references?
Do they have an office you can visit?
How long do their closings usually take?
How can you be assured your rate won't change?
What is their draw process? Etc., etc.
The more information you have, the better choice you can make with respect to the lender you work with, and the better the experience will be with that lender.
Late last year, a new client was referred to us by one of our repeat borrowers. The client was having a hard time finding a property for his first flip.
Recently, a client introduced me to a friend of theirs who is actively flipping 3-5 properties a month. We walked a property together, and she asked what our rate would be for a loan to purchase and rehab the property. I told her our rate was 10% and 2 points. She said it was more expensive than her private investors that only require an 8% return. I asked her to clarify the rate of return she was giving her investors; specifically, was it an annualized rate of return? She said it wasn’t: if she borrowed $100,000, she repaid her investor $108,000. I then asked her how long she usually held her flips – never more than 6 months, and usually only 3.
I didn’t realize it until later, but her cost of capital was higher at 8% than it would have been at 10% plus 2 points. Since the 10% loan is at an annual interest rate, the annual cost of capital is about 12% (adding in the points). This 10% loan, however, if paid back within 6 months, has a cost of capital equal to 7%. The money lent at an 8% rate of return on the other hand, has a consistent 8% cost of capital.
Looking at the graph below, it is easy to see the actual dollar amount paid for each of the two financing options.
While the 8% return ends up being less expensive at the end of 12 months, the 10% loan actually costs less if the holding period is 7 months or less.
For this investor, the actual numbers were the most telling. The property we were looking at was for sale for $250,000 and the rehab was $30,000. She ended up purchasing it that day with funds from her private investor. She sold it 110 days later. This cost her $22,400 to finance the deal. Had she gone with the 10% loan, her total financing expense would have been $14,038 ($8,438 interest + $5,600 points). By going with the lower number, it cost this investor over $8,000 of profit, increasing the total cost of the project by nearly 3%. When it comes to calculating the cost of capital, there are a lot of moving parts – it pays to know your numbers!
In the business of lending to professional real estate investors, we are often told by an investor that they aren't interested in our loan products because they are a 'cash-buyer.' This is how I used to think too. When I started in real estate investing, I used a small amount of money, bought my first house and used the profit I made off of it to buy the second, then third. I continued this process, buying in cash, then using the profits to buy more properties. This strategy worked well, except that it took time. After a few years, I turned a small investment into a small portfolio of rental properties. This was great, however, looking back I realized how much bigger my portfolio could have been had I leveraged my capital in the beginning.
Take, for example, a typical $100,000 single-family house in San Antonio. After $20,000 in rehab and expenses, on a good flip, the house should be worth at least $150,000. That $30,000 in profit equates to a Return on Investment of 20%. Say that the investor in this example had $120,000 in cash at the beginning of this flip. After three months (if all goes to plan), the investor will get their money back and have an extra $30,000 in the bank. If they then put their original investment back into another flip, they could do four houses a year and make a total of $120,000 in profit - an annual ROI of 100%! Not a bad return for an active real estate investment.
But what if in that same year, the investor had decided to leverage his original capital? That $120,000 could have been used as a 20% down-payment on five $100,000 houses that needed $20,000 in rehab. The return on each of those flips would have been slightly lower as the financing would have cost around $4,000, but would have still been a healthy $26,000, or 17.3%. However, since the investor was able to do this five times thanks to leverage, their profits would have been $130,000. If they were able to replicate that three more times in the year, as in the example of the cash buyer, they would net $520,000 for the year. Simply by using leverage to buy more houses, the investor would be able to increase their ROI to 433% annually!
The above examples make an interesting point about how investors should think about ROI. We often see investors that put too much emphasis on the cost of capital and how it affects the ROI of a project - in the previous examples, they would say the cash deal is better because it yields a 20% return instead of a 17.3% return - and they are absolutely right: the cash deal is better. However, what they often times fail to consider is that without unlimited funds at their disposal, it is important for a disciplined investor to look at the Return on Cash, a measurement of how hard your money is working. In the examples above, the cash buyer's ROC is the same as their ROI - 20%. However, for the leveraged buyer, they only invested $24,000 of their own cash, so their ROC on the deal with a slightly lower ROI would be 108.3%. To put it another way, the cash buyer turned $120,000 into a $30,000 profit, whereas the leveraged buyer turned $24,000 into a $26,000 profit.
And the benefits don't stop there. Our clients that use this strategy are able to buy more houses and aren't forced to wait for the 'homerun' deals. Their volumes allow them to take deals that the investor who only has enough capital to do three or four deals a year is forced to pass on. There are so many more of the 15-30% ROI deals out there that if you look in the right places and have the financing in place, you'll never have a gap between deals again. In addition, the leveraged investor who is rehabbing 20 houses a year can demand a lot more from the people on their team than the cash investor doing four houses a year can. These economies of scale can result in contractors giving your jobs priority and increasing their incentive to stick to their bid, realtors that cut their commissions and make sure your paperwork is never forgotten about, and lenders that will bend over backwards to fund a deal in 48 hours. Oftentimes we've found that the savings that are a result of deal volume can actually more than cover the cost of financing.
If you're a cash investor or an investor who has been taking advantage of leverage, we invite you to contact us about your next project, let us give you a financing quote, and see for yourself if using leverage can help you grow your business.