When it comes to getting a hard money loan for your first fix and flip on a property, there are a lot of questions. One of the most common questions we get is "What is the worst case scenario if I get a hard money loan?"
This is a natural question and in today's blog post and video, Ryan answers this question and shows you how to avoid these worst case scenarios.
Watch the video below:
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Hard money loan worst case.
Today we're gonna be talking about what is the worst case scenario if you went and got a hard money loan.
A few days ago, I was talking to somebody and he's like, hey. I really wanna get started in doing this real estate investing, but I really need to know, like, what are all the things that can go wrong? There's so many of them and there's ones I haven't even thought of. But what we have done is over the last twenty two years, we've learned from our mistakes and other people's mistakes to build the system that we have so the mistakes that have been made in the past don't get made again, which is one of the big benefits that we have with our organization is we've systematized the knowledge that has came from lots of different people and the organization itself.
Now let's talk about worst case scenario. So let's say that you go and you get a hard money loan.
There's a couple of different ways this could happen. You go let's say that you're buying a property for a hundred thousand dollars.
Let's say that the this is the purchase, and let's say the rehab's forty thousand. And let's say your interest cost, title fees, and all that, so you're into this a hundred and sixty thousand dollars. Now depending if you got a hundred percent financing loan, which you get for the purchase, the rehab, and the closing costs, then this property would be roughly worth let's just do the math.
Divided by point seven four. So if it was worth, let's just say, two twenty after repaired value, Yeah. That's seventy four percent.
Yeah. So, like, two eighteen ish, but let's just use that number. So so so if the after repaired value is, let's just call it two fifteen, seventy seventy four percent of that, of the after repaired value, would be one sixty, which means the purchase, the rehab, the closing costs, the payments, five months worth of interest, and the title fees, if all of that fits under the hundred and sixty thousand dollars, then you could get financing for that entire hundred and sixty thousand dollars, through our hundred percent financing program, which is very unique, and you won't find anywhere else out there.
But let's say that this one wasn't. Let's say that you needed a hundred and seventy thousand dollars, and the max you could get is a hundred and sixty thousand. Well, we have a lot of strategies, renegotiating, doing other things to come up with that additional ten thousand dollars, other sources of money, you name it. But let's say you've tried all those other sources and in the end, you've gotta come up with ten thousand dollars.
So you come up with ten thousand dollars to close. Well, we're gonna talk about a scenario worst case for both of these where you've put zero money down and also something where you've got ten thousand dollars into the deal yourself.
Now first, I wanna make sure it's important that you realize that most lenders are not out there as loan to own lenders. A loan to own lender is somebody that's doing the loan because they want the property. Like, if you mess up, they're gonna be happy to have the property. And if that's the case, you wanna veer away from those.
For us as an organization, we don't want the property. We want our money back, and we want a return on our money. That's what we're looking for. We're not looking for the properties. We're not doing loans to try and somehow get the property or take it from you or whatever the case is. That is something that you wanna make sure you're dealing with in an organization that is not in it to get properties.
And lots of times when dealing with private lenders, you're gonna run into situations like that where they're doing a loan to own, where they're hoping they're gonna own it.
Assuming that's not the case, you've gotta realize the only mission, the goal of this is to actually make a return on our capital with the lowest amount of risk as possible. That's really what we're going for as a hard money lender. So let's say that we do the loan, and for some reason, you're not able to sell the property.
So let's say that we get the property, and let's say some damage or something happens to the property. Well, that's the reason why we have hazard insurance.
So let's say, you know, the tree falls down and breaks something, then you would go and you'd make a claim against your hazardous insurance. You'll probably have to pay a deductible or something like that, but, normally, that's pretty minor. And then those repairs will get done to the property. So that's one thing that could happen. Second thing that could happen is you could it could have to do with a rehab.
You may find there's additional problems with the property that you weren't anticipating that you couldn't have seen.
Now this is pretty rare because there's a lot of things you can do. You can put a camera down and look at the sewer. You can do pressure tests on the piping itself. You can do a full inspections and get somebody in the roof, in the attic, and everywhere else.
So these should be very, these should be very infrequent when you're running into situations like this where, you're finding some stuff. Now what a lot of people do is they'll just budget. They'll budget ten percent and say, hey. I'm gonna plan an extra four thousand dollars.
So that I have is a little bit of buffer if something comes up that I wasn't expecting, which is a wise thing to do, Not something that's required, but it's a wise thing to do. So there's that. So if you didn't have the rehab, there may be some additional cash that you'll have to come up with if there's an unanticipated repair that needs to be done. Now one of the things we do is we have a project manager walk the property with your general contractor on a virtual walk through to help identify those types of things and asking questions to try and do our best to not have these unexpected repairs.
The next thing that could happen is your, so this is an unexpected repairs.
The other thing that can happen here is just a cost overrun.
You're end up having to spend more money than was anticipated. Well, what we do is we get agreements with the contractors that includes pricing, and we hold them responsible for those pricing. So that works out really well with the general contractors to earn the business and actually tell us what the pricing so you setting that up appropriately is gonna save you from a lot of those things. So now we're to the point where we're gonna say you've already fixed the property up.
You've got the property, that's all fixed up. Now what you're trying to do is you're either trying to refinance or you're trying to sell. Right? One of those two things.
You're gonna refi into a long term hold and keep it as a rental property, or you're trying to sell the property for a profit. One of those two things is happening.
Let's start with the refinance. Let's say that you, were wanting to do the refinance. Well, before you started this whole process, you should have been preapproved for that so that we've got takeout financing all ready to go. So that means they check your credit and your income and all those things necessary to get a full preapproval.
That's not required for the hard money loan. That's required for the takeout financing.
One of the things people are doing is DSCR, debt service coverage ratio, and that basically, you don't have to have any income qualifications. It's basically based upon the debt service coverage ratio. So you've got your conventional way that's gonna look at your credit to do a takeout financing. Then you've got your DSCR, which is your debt service coverage ratio, which basically is gonna look at the income from the property divided against what the cost will be, and they're gonna wanna make sure that's a one to one, one to one point two ratio, meaning the income is one point two times the debt service or the expenses with the property.
So that's the thing that you can do there. So let's say you were trying to get a traditional loan and that doesn't go through. The next thing you could look at is getting a DSCR loan. Hey.
We'll look at doing something like that. A little bit higher interest rate, but a lot less hassle. If that doesn't work out, then you could move and say, now I'm gonna sell the property, and put the property on the market and list it with an agent, get the property sold. Now your plan may have been that you wanna sell the property and do a fix and flip.
The thing that I find, happening most of the time is people overvaluing their property. So when it comes time to put your property back on the market, what you've gotta do is look at the market and say, what do I realistically think this house is worth? One of the mistakes a lot of people make is I'll list it for whatever and somebody can make an offer. I disagree with that on every single level.
I believe in what's called precision pricing. I think you should list the property within three to five percent of what it really should sell for and give yourself three to five percent negotiating room and and, put the property on the market for that amount. Now, can you get more than that amount? Yes.
But I'd rather have a bidding more than I would have bringing the price down. What a lot of people don't realize is when I first put my property on the multiple listing service, I get the most amount of exposure. And the longer it's on there, the less interest I'm going to get. So I only have one time to do this.
So I'd rather come out with a really good price and get a frenzy and maybe get multiple offers and then go for highest and best and get something that's more than what I was hoping for rather than putting it on a high and over time bringing the price down. We call that chasing the market where you're always a little higher than where the market is and you're always bringing it down. And that takes time. It costs money.
And if you've got a hard money loan, there's expenses to that because interest is not going away. It never sleeps.
Okay. So let's say we're going for the sell. You're hiring an agent. You're doing precision pricing. You've put it on the market, and you still don't have this property sold. The next step that you're going to be doing is regular price reductions.
So every thirty days, you're gonna be looking at this or sooner depending upon the feedback. So what should be happening once your property's on the market?
So your property's on the market. Your agent should be getting feedback of every person that goes and looks at the property. They should be asking a few questions. One of the questions they should be saying is, hey, are you guys considering making an offer on this property?
Is it even one you're thinking about? If so, why? And if not, why? Number two, what did you think of the price of the property?
Number three, what did you think about the condition of the property?
Number four, what other properties are you looking at? So it helps me understand competition. And number five, is there anything we could do that would make you want to make an offer on this property? This is a very important question because if they say, you know what, if you guys would just tear down the gazebo in the backyard, we'd be really interested in it.
Or if you would lower your price ten thousand dollars, my people would be very interested in that. Now I'm not necessarily gonna do that based upon the response of one, but once I have multiple responses, then I'm gonna take this information and I'm gonna make a decision. And the decision is I can lower the price to compensate for some of these things, or I can spend some additional money to fix it. If I'm having multiple people saying the fence is terrible, I would never buy a house like that, and that's the majority of the comments that I'm getting, I probably wanna fix the fence.
The choice is lower the price and let the new buyer fix the fence or go and get the fence fixed up because I'm hearing that over time. Now with that information, if I'm constantly getting feedback, there's one of two things happening here. If I'm not getting enough showings, it means I'm priced too high. If I'm getting showings but I'm not getting offers, it has to do with either the condition or the price.
So I can change the condition, and I don't wanna change that condition until I get feedback from the agents that have showed this property. But every thirty days, I wanna be relooking at this at a minimum to look at the feedback coming from this, analyze that feedback. What am I hearing? Do I wanna lower the price or do I wanna fix the condition?
And then based upon that, I'll make an adjustment on the property and on the price. Alright. So let's say that you've been doing this and you've been making your adjustments, and for whatever reason, you're not getting offers. Now I can tell you this is not very common.
If you've done the rehab and you've done on the time frame and you've been in the budget and you've done the steps we've talked about, this is a very rare situation that we're talking about here. Usually, what happens is the rehab doesn't get done like it's supposed to, doesn't get on time, it doesn't get listed like it's supposed to. All the things we've talked about to this point have not happened.
So when we get to this point, it's pretty rare. But here's the situation. You're lowering the price, You have done everything that we've talked about this far, and you're still not able to get rid or sell this property, and maybe you're getting to the point where there isn't gonna be any profit for you. Well, there's a couple of things that you can do.
Number one is you wanna be communicating with your hard money lender, letting them know what's going on. You wanna be telling them, hey. This is what's going on. You wanna be cooperating with them.
You do not want to be hiding with them. But what's gonna happen is you can come and say, hey. What are your guys' thoughts if doing any type of a short sale? A short sale is where the lender takes less than what they're owed at this time.
Now a lender is not gonna do that if you're not making if you're making money, the lender is not gonna do that. So you're basically gonna have to say goodbye to the ten thousand dollars you put up. If you put up that ten thousand dollars or if you didn't put up any, then you don't have anything to lose there.
And so then it's working with the lender, giving the lender offers. The lender would approve those offers, and decide if it makes sense to sell that property for those prices.
The other thing that you can look at is what's called a deed in lieu.
A deed in lieu is you basically go to the lender and say, lender, I will deed you the property. You don't have to foreclose. You don't have to do any of those things. You take it over, and you deal with it, and I'm gonna walk away.
That's called a deed in lieu of foreclosure. The short tail is I'm gonna work with the agent. I'm gonna work to get the property sold and do those things. I wanna make right on this, but I'm asking if you can make some modifications on that price.
I'm walking away from the money that I've put into the deal and I wanna do that because I wanna do right by you as the lender and get this property sold for the most we can. But the market has changed or something's changed and let's get it sold for, what we can and and I'll cooperate and be the boots on the ground to help you. So, again, communication's everything.
The third thing that's gonna happen, if you're not working on these and you haven't got the property sold, the next thing that has to happen is the lender, the hard money lender is going to have to start a foreclosure process. They're gonna have to go through taking the property back because that's the way that they're gonna get their money back is by taking the property, selling that property, and recouping as much money as they can. Now the lender may choose to sell it as is or the lender may choose to sell that after repairs and putting more money into the property and doing those repairs.
The moral of the story here is hard money loan worst case really isn't that bad. It comes to having a plan, moving on that plan, doing things within a time frame, making sure you're doing your due diligence upfront, and moving through this process and not getting behind solves the majority of the problems that you may be running into when it has to do with a hard money loan worst case. Now, if you're interested in avoiding all these problems, you can give us a call. We've got a step by step system that will help you, walk you through, and help you avoid these hard money worst case scenarios.
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