Making Your First Hard Money Loan--Loan Structuring & Commitment
Hard Money Lenders make high-interest-rate (10-14%) loans secured by real estate. Let's break Loan Origination down into 8 steps:
1. Marketing for Borrowers
2. Comping Loan Collateral
3. Loan Structuring & Commitment
4. Collateral File Assembly
5. Title Review
6. Drawing Loan Docs
7. Drawing Lender’s Escrow Instructions
8. Funding & Closing
Previously on Hard Money Monday, I discussed Comping Loan Collateral. Today, I’ll discuss Loan Structuring & Commitment. For consistency, I’ll use the same fix and flip loan funding on Welton Dr in Albuquerque. After comping the property, we determined it had the following values:
As is Value: $340,000
ARV (after repair value): $420,000
Our borrower purchased the property for $330,000, but was getting a good deal on the as-is price from a motivated seller. The sale even included a good amount of uninstalled finish materials. We lent him $250,000 or 76% of his purchase price. He didn’t need more funds. But sometimes our borrowers are tighter on money and need to borrow more funds.
Had he wanted more funds, here’s how we would’ve structured the loan to make sure we were protected. When a borrower adds value to a property through renovation, they bridge the gap in value between what they buy a property for and what they will ultimately sell it for.
There are two guardrails you want in place. I typically don’t like to lend more than 80% of the as-is value at close of escrow. I also don’t like to lend more than 65% of the ARV. Sometimes these two numbers are in conflict with one another.
Advice to live by as a lender: when there’s a conflict between underwriting parameters, choose the more conservative of the parameters.
$420,000 ARV X 65% = $273,000. This is my max loan amount. To determine the maximum amount of money I’d fund at purchase based on the ARV, I subtract the rehab estimate of $25,000 to get $248,000. In this case, I rounded up to $250,000. Had I also lent rehab funds, they would not have been released to the borrower at the time of purchase. I set rehab funds aside for our borrower’s benefit and he would draw on them later based on a percent of completion of the rehab.
Typically, I’m comfortable lending up to 80% of purchase price but in this case there’s a conflict between the two loan parameters. 80% of the $330,000 purchase price is $264,000. Had I lent $264,000 plus held back $25,000 for repairs I’d be lending 69% of the ARV, too high of an LTV for my comfort. You might say “but the borrower didn’t need the rehab funds so why not lend him $264,000?” As a lender, I have imagine taking back loan collateral and what it then takes for me to finish renovating a property. Not even considering legal costs and time, had I lent $264,000 up front, I or the next owner who buys based on my credit bid, would be spending another $25,000 to achieve the ARV.
In my next edition of Hard Money Monday, I’ll discuss Collateral File Assembly.