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If you are an investor looking to make a profit by flipping properties, you cannot rely on conventional financing. Why? Because traditional lenders such as banks and credit unions don’t lend on properties that are in disrepair. Their underwriting guidelines are often too complex, and they move too slow to be competitive. Cash rules but private lending offer the next best thing.
Private loans are designed to accommodate the needs of real estate investors. Because private loans are based on the after-repair value of the property, they offer borrowers unsurpassed leverage not available from anywhere else. Private loans are a unique product, and to make money using them, you need to stick to some core principles.
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Identify the right private lender
Private lenders are companies that issue private loans. They are alternatively referred to as private money lenders or hard money lenders. Choose a private lender that is not a broker and lends it own funds. Real estate is a local business, so a local private lender can advise you better and service your loan more efficiently. Seek a private lender who works closely with their borrowers and treats them well. Take a look at their online reviews and, when possible, ask other investors or your real estate agent for recommendations.
Do your own profitability analysis
As a real estate investor, you might have some experts advising you, but you are the one who will be left high and dry if your deal is not profitable. Don’t delegate the profitability analysis, and don’t be swayed by emotions. Find and learn how to use a good hard money calculator. Do not rely on the numbers provided by your real estate agent. To estimate the future after-repair value of the property, run your own analysis based on the prices of the recently sold homes in your area.
Be a good project manager
As a successful real estate investor, you need to wear many hats. One of them is being a project manager. One of your main tasks is to identify a construction crew that is both affordable and reliable and then manage them well. If you are working with a reputable private lender, you can benefit from their expertise in this area. Many private lenders require the construction funds to be set in an escrow account. They release those funds back to you in draws as you complete different stages of the rehab. “Our construction escrow set up and management forces even an experienced investor think like a weathered rehabber,” says Anastasia Sennott, a partner at New Funding Resources, a private money lender in Maryland. Your private lender will most likely require you to submit a detailed scope of work and develop a reasonable draw schedule that pays all parties involved based on the work accomplished and not promises made.
Have some nest egg to keep up with all the expenses of homeownership
Reputable private money lenders require their borrowers to maintain appropriate levels of reserves. Reserves are your own cash that you can tap to pay numerous expenses associated with owning a home. You will need it to make a monthly payment to your lender. You will need it to pay your property taxes. If your property is a part of a community that has a homeowner’s association, you will need it to pay its fees and assessments. Lastly, you need to have funds to meet unexpected expenses that arise during the rehab process. The last thing you want is to have your project stall since you do not have adequate funds to move it along.
Strive to repay your private loan fast
Private lenders take a substantial risk by making high-LTV loans, and they charge for them accordingly. Each month you are holding a private loan, you will be paying an interest that is substantially higher that comes with regular conventional loans. You don’t want to drag your feet. For example, if your regular monthly payment to your lender is $1,500, flipping the home in 8 months versus twelve months could cause savings of almost $7,000. For a rehabber using private funds, time is money.
Keep your private lender up-to-date
Working with a private lender is not like working with a conventional lender that holds the mortgage on your primary residence. With your primary home, a lender doesn’t need to hear from you (or you from the lender) as long as you’re making timely monthly payments on time. Things are different when you are a rehabber who is using private funds to fix and flip properties. A first-rate private lender will make his support staff and his decision-makers available to service your loan and guide the process. Do your part and keep them informed of the process. If you run into any issues, let your lender know. Together, you can work on a solution that minimizes the risk exposure for all parties involved.