Here’s another example of how to use hard money real estate investor loans to make money from foreclosures. In this example, the goal of depositing at least $30,000 into your bank account via reselling a house where a hard money loan was used to finance the 100% of the purchase price and repair costs.
We’re targeting a profit of at least $30,000 per project due to the fact that it takes a long time to get these things done and costs money. Because there are significant risks involved in real estate investing, your returns should leave you in a much stronger position than when you started.
Step 1. Start by setting some profit goals and determining what the opportunities available to you look like.
Assuming that your desire is to increase your checking account by at least $30,000 in the next 6 – 8 months. Lets also assumes that you are willing to use credit based financing to get the job done, but don’t want to have to put down the 20 to 30% that a bank would require for a purchase, nor do you want to wait 35-45 days for the bank to make a decision on funding the deal, which may be gone by then. Let’s also assume you haven’t got a rich uncle or other private lender available to finance your projects and that you have the time needed to make this work.
Being a landlord is out of the question cause you don’t like dealing with tenants, nor do you want to play around in the lease to own/owner financing sides of the business. Your desire is to accomplish this $30,000 goal through buying & rehabbing foreclosure real estate; reselling the fully remodeled property to a home-buyer or investor reasonably close to full market value.
After reviewing your personal finances you see that you have credit scores in the 660-750 range, household income of about $75k and a light monthly debt load where all those payments do not exceed 35% of your total monthly income.
Based on your research, you have determined that on average, the majority of the home buyers in your market can afford and are buying houses were the monthly payment (excluding taxes and insurance) is about $960 a month; average mortgage rates for home buyers with 640 credit scores on a 30 year, fixed mortgage are in the 5.5% range, with a 5% down payment required. All of that translates into a purchase price for your buyer of about $180,000.
There are a decent number of foreclosures available and a decent pool of qualified buyers too. Property values are stable, as the homes in your target market are in good school districts, have low crime rates and are within a 30 minute drive of where higher paying jobs are.
Because there are so many motivated sellers and foreclosed properties for sale out there, you feel that selling your rehabbed houses at market value probably isn’t feasible, so to move it fast you’ll may need to reduce the selling price a bit in order to compete.
With all that in mind, you need to find a couple of foreclosures that have the potential of covering your $30,000 profit goal.
Step 2. Find a potential deal based on your goals and what’s available in your market
Lets assume that after working with a Realtor, you found a foreclosed, 2 flat (duplex) home that when remodeled, your end buyer will not have a hard time qualifying for a home loan on. Sounds promising if only you can get the total costs financed quickly.
This property is in an area where property values are reasonably stable and where banks are not afraid to lend due to excessive foreclosures. This was confirmed with your Realtor and investing lender. It’s a modern home that fits the expectations of the homebuyers in your market, where the end buyer could live on one floor and rent out the other for about $1,200 a month.
The bank is asking $99k for the property, which needs $20k in repairs with an estimated after repair value of around $200k.
Step 3. Evaluate the potential deal to ensure that it can deliver the $30,000 needed to achieve your goals.
Address: 3528 N. Kilbourn Ave, Chicago, Il
Estimated After Repaired Value Of Property (ARV) $200,000
Asking Price -$99,000
Estimated Rehab Costs -$20,000
Potential Gross Profit $81,000
Looks pretty good so far. But before you go and accept the asking price, there are a couple of issues to look in to.
Step 4. Calculate the other expenses
Based on conversations with your contractors and Realtor, you estimate that it’ll take about a month to get the repairs done and 6 to 7 more months to find a qualified buyer. You can get it listed for sale with a flat fee listing agent, but will more than likely have to take care of the buyers’ agent and cover up to 5% of the buyers’ closing costs as well. You will also want to supplement the marketing with ads, signs and other forms of advertising (like craigslist, which is free), plus maintenance on the property each month.
All of these holding and selling expenses will have to be accounted for monthly for 6 – 8 months within your cost calculations:
Expenses Excluding Mortgage Payments For 8 Month Holding Period
Holding Expenses Monthly 8 Months
Utilities Monthly $150 $1,200
Monthly Maint/Misc, Staging, etc $150 $1,200
Advertising (newspaper & paid sites, etc) $400 $3,200
Street Signs 200/Month @$4 Each $800 $6,400
Flat Fee Realtor Listing $400 $400
Flyers of Property $50 $400
Direct Mail 500/40 Cent Postcards to renters $200 $1,600
Estimated Monthly Expenses, Excluding Mortgage Payments $2,150 $14,400
Subtracting that $14,400 from the gross potential profit of $81,000 leaves a potential profit of $66,600. Still looks good, doesn’t it? However there are a couple of other costs you have to take into consideration, including the fact that you may have to lower your asking price from full market value and offer other incentives to get it sold fast. You also have to understand how the financing works to make sure that you actually get the deal without using much of your money upfront.
Step 5 Figure out how you are going to finance the deal
Conventional Bank Lenders
Most Conventional lenders (banks) will lend a limited amount to highly qualified buyers of non owner occupied properties, up to a max of about 75% of the purchase price; excluding the repair. So if you are to buy this property at $99K they’ll only lend you up to $75k and expect you to come up with the remaining $25k on your own and the other $20k for repairs, a total of $45k out of pocket.
That really sucks, as your targeted profit ($30,000) is less than the amount of cash that you have to put out. Not only that, but a huge chunk of your cash is tied up into the deal for up to 45 – 60 days before you even make a monthly mortgage payment as banks take forever to decide if you and your project are worthy of their time. Making matter worse, is the fact that after they approve your loan, you still can’t use that money until the place is resold (6 to 8 months), limiting your ability to work on other opportunities .
Not going to work in our case, where your desire to preserve cash on hand is important.
Hard Money Lenders
Hard Money Lenders on the other hand, tend to make it a lot easier to get things done.
Most of the lending decision is based on quality of the property and the discount it’s purchased and rehabbed at. If it is in a highly desirable area that people want to buy and live in and can be purchased and repaired at a deep discount (under 60% of the ARV) it’ll be easier for you to secure funding.
If however, the property is located in a dangerous, crime infested area or is one where most of the recent property sales are foreclosures, then you’ll struggle mightily in securing funding, conventional, hard-money or even private. Most lenders don’t want to lend in areas where property values are extremely low, as they know that the odds of you either refinancing the loan or getting someone else to buy the property from you are really, really low, (A.K.A. it’s probably not going to happen). This is one of the main reasons why you can buy houses for $5,000 in some areas (sellers know that most people can’t secure financing for them, nor can they secure anything against them as well.
Hard money loan terms usually are a bit higher than banks in regards to interest rates and origination fees or points, with the financing period usually only between 6 to 12 months. Most will lend a max of 65% of the total after repaired value of the property to qualified borrowers for the purchase and repair of single and multifamily homes that the investor will not be living in. Some lenders (the ones I recommend that you deal with) require zero down, while other up to 20 percent of the total amount needed; all depending on the strength of the borrower and the deal.
To be honest, today’s hard money lenders do take a really hard look at the borrowers’ credit and finances, as well as their level of experience in rehabbing too; so if you’ve had recent bankruptcies, foreclosures, inconsistent income, limited reserves and bad credit, you are going to have a really hard time qualifying for any type of loan. In that case, you are better off partnering up with a person that can qualify and a working out a profit sharing arrangement in return for your management or marketing services.
On the flip side, if you do have 650+ credit scores, provable income where your monthly debt payments are less than 35% of your paycheck, have at least 15% of the amount that you want to borrow in reserves and have a great deal in a great area, then you are in excellent shape to get the funding needed for achieving your $30,000 goals.
Step 6: Get pre-qualified for a hard money loan
Many hard money lenders use the same credit and income criteria as a conventional lender does. On approval, you’ll have a clear idea of what is actually possible. TO get started, you will need to show the following:
Brief bio of you, which indicates the level of experience that you have
3 months recent bank statements
2 recent paycheck stubs
2 years tax returns, all forms
Personal financial statement
List of properties that you already own. Include rental income and expenses, plus copy of leases.
Credit report (lender will pull)
If you already have a deal negotiated, you’ll also need to show:
Detailed repair list with cost
The exit, either resale or refinance
Contractor contact info
Other info will be needed as questions will arise, so please be prepared to answer them
Step 7: Do the math for your project
Assuming that you decide to accept the banks asking price of $99k and if you qualify, the hard money lender should be able to provide financing that covers 100% of the purchase price and 100% of the total rehab costs. Possibly rolling some of the closing costs into the loan, just as long as it all fits within 65% of the value of the property after all repairs have been made, at an interest rate of between 9.5% to 18%. Of course it all has to fit…
So in our case where the appraised after repair value is $200k, the max the hard money lender could provide is $130k ($200k x 65%), which up would more than cover the purchase price, repairs and some of the closing costs.
As I mentioned earlier, you’ll also have to plan covering at least 6 to 8 months of holding and selling costs, plus the costs of the incentives needed to make the resale work. Those incentives, include not only Realtor commissions and closing cost assistance to the buyer of up to 5% of the sales price, but also possible sales price reductions.
In today’s market, it is difficult to get a property sold at full market value. Not only are there tons of competing properties out there, but many lenders are also very skeptical on appraised values. That being the case, plus the fact that you want to get the property sold fast, may require you to reduce your asking price by 10 to 15% below full market value; so in our case we drop it by 15% to $170,000, which still allows us to make the $30,000 profit that you are looking to make.
However if we factor that reduction and the other selling incentives in (Realtor and closing cost contributions), we come up a little short when trying to fit all of our costs in.
Target Sales Price @ 85% Of $200k (ARV) $170,000
Max Hard Money Loan @ 65% Of $200k (ARV) -$130,000
Potential Gross Profit $40,000
Target Profit -$30,000
Est. Holding Expenses -$2,400
Fixed Selling Expenses -$12,000
3% Buying Agent Commission -$5,100
5% Contribution To Buyers Closing Costs -$8,500
Hurdle (Target Profit + Selling, Holding Expenses & Incentives) -$58,000
Reduction In Purchase Price Needed -$18,000
The $18,000 reduction in purchase price is needed so that most of the cost of the project is pushed low enough to ensure you reach your $30,000 profit goals while using a 100% financing hard money loan.
Max Hard Money Loan @ 65% Of $200k (ARV) $130,000
Reduction In Purchase Price Needed -$18,000
A. Max Purchase Price $82,000
B. Repair Costs $20,000
C. Prepaid Annual Tax $3,200
D. Prepaid Insurance $1,200
C. Cushion For Closing Costs, Points & Misc. Expenses $10,000
Gross Hard Money Loan $116,400
Hard Money Loan Monthly Payment @ 10% $970
Base Purchase Price $82,000
Less Payments For 8 Month Holding Period -$7,760
Target Purchase Price $74,240
Starting Offer @85% Of Target Purchase Price $63,104
Based on the calculation above, the target purchase price for your project where you want to earn at least $30,000 in net profits is $74,240. This number is based on the total costs of the deal being taken into consideration, including the monthly loan payments.
To get this purchase price, you need to of course start negotiations far enough below that target to enable you to work up to it, that being the case, I would start at about 85% of the target price and work upwards to the target price.
To begin, you will need to prove that you actually have the ability to get the sale closed. This means providing proof of funds in the form of either a bank statement in the amount of your offer or a pre-approval letter from your hard money-lender. It makes sense to get pre-approved prior to searching for a deal.
Step 8: Negotiate the deal to match your goal
Using the number you need to make the deal work, contact a number of sellers and stay engaged til you are able to seal the deal via a signed contract for purchase. Start the negotiations with an amount that is well under the max that you can borrow for purchase and repairs so that you don’t have to come out of pocket.
Keep going back and forth on the negotiations til you get a price that works for you, just as long as it doesn’t exceed your target price. Once you have the signed contract, submit the contract and other info needed to the lender for processing.
Step 9: Close the sale and begin the rehab work. Once the repairs are completed, you may consider working with a full service Realtor to assist in marketing the property for resale.
Step 10: With a good property in the right market and consistent marketing, within 6 to 8 months you should be able to get the property sold to a qualified buyer. Closing the deal depends on the strength of your negotiating skills, incentives to the buyer and your sales price.
The marketing process is a bit more complicated as it’s an art piece, not a math problem to solve; another article .
Step 11. Once you have come to terms with your buyer, you’ll need to actively manage the closing process by staying in contact with their lender, Realtor, closing attorney and buyer to make sure that things run smoothly.
Step 12. After closing, deposit your $30,000 check and repeat process as needed.
Hopefully this helps to explain the situation better. Of course this is just a summary; each case on the purchase and sale is unique, so in most cases the end result and terms may vary depending on your situation and the capabilities of the lender used.