HOW TO USE PRIVATE MONEY TO FINANCE REAL ESTATE INVESTMENT

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    Novice real estate investors may not be familiar with the term “private money,” but veteran investors have probably tapped into this resource more than once. Sometimes referred to in the investment community as “hard money,” this type of financing is available for properties that don’t quite fit the traditional lending model. These are basically properties that banks won’t touch.

    Private Money Described

    Private money comes from an individual or a group of individuals—even friends and family members—who pool their funds to finance real estate transactions. Private lenders establish their own lending standards, and as long as they apply their guidelines to all applicants without regard to race, sex or any protected class, they can pick and choose when and where to lend.

    Private money is sometimes called “hard money” due to the typical “hard” terms of the note. It’s become such a common term in the investor community that many lenders will market themselves as hard-money lenders. A hard-money loan can have interest rates in the ‘teens, require a down payment of 50% percent or more, and require higher rates and fees compared to traditional forms of financing.

    Private loans are usually issued only for the time needed to buy, repair and sell the property. A typical private loan might require a 40% down payment, balloon in 24 months, and have an interest rate of 14% as well as four or five points. With terms like these, why would anyone ever choose to work with a private lender? Does the private lender make the loan hoping to foreclose? Quite the opposite.

    Hard Choices

    A loan for a real estate investment has two separate approvals—one for the borrower and one for the property. When a property falls into a state of disrepair, it can become so damaged that a bank won’t make a loan to buy it. The borrower may have a credit score of 800, a sizable down payment and single-digit debt ratios, but if the property isn’t up to standards, the loan won’t be approved, regardless of the quality of the borrower.

    Take the example of a foreclosed property that a bank owns but can’t sell. Two major problems need to be fixed before a conventional lender will finance a purchase: The slab foundation is cracked and needs about $20,000 worth of repairs, and the entire roof has to be replaced, including new trusses. In all, the house needs about $35,000 in repairs.

    The home is the bank’s collateral, but it needs to be in good condition before a loan will be issued to a potential buyer. So it just sits there, listed at $100,000.

    A real estate investor sees that property in a bank’s inventory and makes a visit. Along with his contractor, the investor verifies the items that need correcting. He determines that once the property is rehabilitated and prepared for market, it could easily sell for $200,000, based on sales of similar homes in the area. Enter the private lender.

    The investor lays out his plan for the property and provides the private lender with an application and with an itemized list of the needed repairs with their costs. Included is a new appraisal that supports the future value of the property once renovation is completed. The private lender is convinced and makes a $135,000 loan.

    After buying the home, the investor makes the necessary repairs and sells the property for $200,000. Now that the property has been rehabilitated, any qualified buyer can finance it. A simple breakdown is:

    Acquisition price: $100,000

    Repair costs: $ 35,000

    Loan costs (including miscellaneous fees): $ 8,000

    Selling costs (based on a 5% sales commission): $ 10,000

    Final sales price: $200,000

    Net to investor $ 47,000

    The terms of the private note included five points to the lender, loan costs and accrued interest. Still, even with the “hard” terms of the loan, it’s a viable transaction due to the net profit. Without private money, homes could be left in a permanent state of disrepair, leaving fewer homes on the market.

    A private money alternative is AuctionFinance.com, which offers inspection-free lines of credit up to $5 million with no personal collateral. Based solely on a qualified investor’s personal financial statements, this product can be used to fund up to 70% of the purchase price of any residential property in six different states, with immediate funding, at Auction.com’s trustee/foreclosure auction venues. AuctionFinance.com also provides lines of credit for other residential properties that investors are required to fund in cash, including short sales, REO properties, and foreclosures. This allows investors to immediately leverage that cash for other purchases.