How to Use “Hard Money” to Flip Houses, BRRRR, or Buy More Deals

Dave:
Hey, everyone. Welcome to The BiggerPockets Podcast. I’m your host today, Dave Meyer, joined by Mr. Henry Washington. Henry, we’re talking today about a topic I know you’re very familiar with, hard money lending.

Henry:
Yeah, man. Hard money lending has been essential to my business. I use it quite a bit, and in most situations when I’m using hard money, it’s to take advantage of a lot of the conveniences of hard money which is why I think investors use it. For myself, I’m using hard money on fix-and-flip deals, and I’m also using hard money on rental properties. But if I’m using it on a rental property, it’s a property that needs a renovation before I can stick a tenant in it. As you know, I tend to buy distressed properties, and a lot of those situations that I’m buying require me to move quickly, and the best benefit for me for hard money is how quickly I can get access to the money. Sometimes in less than a week, and the other benefit to me is the fact that they finance in the renovation, so they’re providing me the renovation money to be able to fix up that property.
I will say before we get down the road of what hard money is, it is a tool that you have in your tool belt, and you got to use it in the right situation. Not every deal makes sense for hard money, and I think we’re going to learn a lot about that as we dive into this show. But for me, fix-and-flips and rentals that need a renovation, and I’m typically looking to get out of the hard money within three to six months, so it’s not a long-term loan for me.

Dave:
Well, clearly, there are a lot of really good benefits to hard money, but it’s not right for every deal. As Henry just said, it’s a tool to be used at the appropriate time. So, today, to help our audience understand when it’s useful, what it is in the first place, how to apply for a hard money loan, we are going to be bringing in an expert hard money lender. His name is Will Heaton. He’s the co-founder and managing principal of Heaton Dainard Real Estate. If that name sounds familiar, it’s because he’s the partner of another person in the BiggerPockets sphere, James Dainard. He co-hosts the On the Market Podcast with Henry and myself. They’ve been business partners for a long time, but Will focuses on the hard money lending part of their business, and we’re going to be talking to Will about the hard money process, the ins and outs so you understand when it might be useful to your portfolio and if you want to get into it, what the best way is to go about that. So, with that, let’s bring on Will Heaton. Will, welcome to the show. Thanks for joining us.

Will:
How are you guys doing?

Dave:
Doing good. Will, you are in a very unique position. You are the business partner of Henry and I’s good friend and co-host on the On the Market Podcast, James Dainard. You guys run a business together. So can you just tell us a little bit about what you do at the Heaton Dainard Real Estate Company and maybe just tell us why you’re better than James generally?

Will:
First of all, I’m quite a bit taller than him, so I think that immediately makes me better in the world of people in height and things like that. No. We’ve been partners almost 20 years now. I think 19 years, and it turns out we… We started out doing what they call today as house hacking. It’s like I bought my first house, and he moved in as my roommate. So, from there, we started knocking on doors and just built what we have here today. He focuses on the real estate brokerage and acquisitions, and the fix-and-flip side of things. I’m on our development, and new construction, and apartment syndication, rehab, apartment rehab side, and then I am the one who runs our hard money company predominantly. We co-run it, but I’m one of the main points of contact for that.

Henry:
So his name is on it, but you do all the work?

Will:
Yeah.

Henry:
So what I’m hearing is that James Dainard was your first tenant?

Will:
Yes, he was.

Henry:
Was James Dainard a good tenant?

Will:
I think he still owes me a damage deposit.

Henry:
Oh, yeah. See? He didn’t get that deposit back. I’m not surprised.

Dave:
You should have a lot of accrued interest on that over the last 15, 20 years.

Will:
And pain and suffering for listening to his alarm clock go off for an hour before he wake up.

Dave:
Well, as tempting as it is to sit here and make fun of James because he’s not even here to defend himself, which would be fun, we have brought you on to talk about a subject you obviously know very well which is hard money. Our goal today is to really just give our audience a primer on hard money, what it is, who should be using it, how to go about it. So could you just help start us off by giving us an overview of what hard money lending is in the first place?

Will:
Yeah. So hard money, real hard money versus what people are calling hard money, in my opinion, today are two different things. I think what we have out there is people found it as a buzzword to say, “Oh, get a hard money loan,” and what we’ve seen sprout up is a lot of Wall Street and hedge fund style capital with a lot of federal regulations and oversight coming out and packaging themselves as hard money, but really, it’s a form of a bank or a financial institution that’s really getting you the money. Now, they may have a more aggressive rate, but a lot of the underwriting and requirements associated with that are a lot more stringent than something like what our company, Intrust Funding, is real hard money.
We are a combination of private capital, our capital, and then we do have a credit facility, but it’s not a real estate facility. It’s a business operating facility, so we’re not… There’s no real underwriting associated with how we do it. It’s a loan to us, and then we turn around and lend that money. So we’re able to finance somebody’s real estate transaction. If they’ve got title and escrow set up, I’m the one that makes the final decision on… We’re wiring the money, right? There’s no banks. There’s no third-party approvals. There’s no stringent underwriting, or appraisals, or any of that stuff that you’d get from a traditional loan.

Henry:
So, if I’m hearing you correctly, the difference between some of these other companies calling themselves hard money lenders and what you guys do, it’s institutional funding versus your own business and personal capital. So it’s the source of the funding that determines what types of regulations might go along with the underwriting?

Will:
Exactly. Well, people may have large buckets of money to lend. The access to that is going to come with somebody who’s putting some pretty stringent requirements to have access to it. Right? They want to have all these boxes checked. It’s like, “Hey, we can lend you the money, but we need to check all these boxes.” Right? Bank financing is even more boxes, but when you’re true private capital, hard money, in my personal opinion, we’re going to have some boxes that we’re obviously checking, but we can go outside the box. Right? We built the box. I’m the one, at the end of the day, looking at the final loan and releasing the wire. I look at that as true hard money.

Dave:
So given the fact that you basically… The idea of hard money is you as the company can make decisions about who you’re going to lend to and what. What are some of the trade-offs? Why would someone want to use hard money, and perhaps what are some reasons they may not want to use hard money?

Will:
Yeah. No. That’s a great question. Thinking of a loan that came to us this last week that we’ve already funded this week was a borrower who was buying a house as a rental. They put it under contract, they went to get it appraised and closed, and the bank did the appraisal review, and the house was hammered. Right? There was a bunch of notated repairs on the appraisal, and it said, “We need to have all this stuff repaired before we can fund this loan,” and they go to the seller. The seller is like, “I told you. I’m not fixing anything. You’re buying this as is.” Well, now, they’re in a situation where the bank isn’t… It’s not financeable. Right? So that’s a situation that would line up for a hard money loan.
Another pretty common situation is the most affordable. Maybe it’s affordable because the most strenuous process is getting a loan from Fannie, Freddie, from a bank, from your conventional mortgage. Right? That’s where you can get the most attractive rates, but the mortgage broker, they don’t want you to pay that loan off in four, five, six, seven months. Right? If they hear that you’re going to do it, they’re not going to do the loan. Their whole deal is they’ve got a lot of upfront costs to do that. They don’t want that thing paying off in less than a year or two. Well, your typical fix-and-flipper wants to pay that loan off. Our portfolio currently turns every 166 days. They just won’t finance you. Right? So what we end up with is it doesn’t mean as a hard money… Our typical hard money borrower are a lot of real estate investors. It doesn’t mean that they wouldn’t qualify for a conventional loan. It doesn’t mean that they don’t have the down payment, they don’t have the credit, they don’t have the income. It’s just the property and the situation at which your options are not conventional mortgage due to the condition of the home or the situation with how quick you plan to pay it off.

Henry:
That’s a good point. I use hard money, obviously, quite a bit. Hard money, private money. You draw the line between what you want to call things, but the concept is essentially the same. When I’m using it, I’m using it in situations where either I can’t get traditional financing or it doesn’t make sense to get traditional financing, or I need that money fast.

Will:
Right. Time.

Henry:
Meaning, I need to be able to get the money in the seller’s hand as quickly as possible because if the seller had all the time in the world, they’d list it on the market and get retail value for it. There’s a reason that they’re taking a discounted offer, and a lot of the times, that reason is they can get that money faster from an investor. So I’ll use hard money in situations where I need the money faster, but as with anything and what I’ve learned with hard money is there’s always trade-offs. Right? So there are some differences in hard money and traditional financing in terms of what it costs to the borrower and timeframe. So, yes, you get some time, but it may cost you a little more. So can you talk about what are some of those differences between getting a traditional mortgage or a conventional loan to buy a property versus working with you guys?

Will:
Yeah. The traditional lender with the added level of scrutiny and underwriting required with it. Right? I mean, what they’re doing with all of that, and verifying employment, and getting years of income verification and credit history, they’re determining your credit worthiness and your likelihood of payment based upon some peoples probably smarter than all of us combined have come up with the reasoning for, “Hey, these are the loans that are most likely to pay for X number of years,” and that doesn’t mean that… We have less than a 1% default rate on our time, and our criteria for that is skin in the game. Right? Hey, you put the money down, we find that the glue is holding people to the deal, and we look at the credit because we want to make sure we get our payments, but the reasoning that we see, it’s not just the cost that is, “Hey, this is less expensive, so I want to go this conventional loan rate.” We also have the ability to be a little more creative where we’ve taken… Somebody might say, “I don’t have the cash, but I own this free and clear rental, so can I have you tie that up for consideration for my down payment?”
Then, another big piece that we get that is an advantage for a fix-and-flip or somebody who’s looking to do a BRRRR transaction where they’ve got a large renovation. Usually, it’s the value-add investor, the fix-and-flipper is our primary borrower. Right? They’ve got the purchase price plus a renovation budget. In our market, $80,000 is probably the average. Right? If you went to a conventional bank, you’re going to put down what? 5% to 20%, and then you got to pay that $80,000 out of pocket. Well, the way we look at it as a lender is we look at it as loan to cost. So we’re taking whatever that purchase price is plus your renovation budget, and then we look at the total deal price, and we take a down payment from that anywhere from 15% to 20%, depending on the geographic location of it, credit worthiness of the borrower, history of the borrower, and magnitude of the project.
So they’re able to finance in the construction piece. Right? So they’re putting down… Say, if it’s a $80,000 purchase and a $20,000 rehab, if you went to the conventional bank, you’re going to put, say, 20% down on the purchase which is 16,000 bucks. So then, you got to pay that $20,000 of renovation out of pocket. So they’re $36,000 out of pocket. Now, if they came to us, they say, “All right. You got a $100,000 project because it’s 80 for the purchase, 20 for the rehab. You put down 20% of that,” they’re going to put down $20,000, and then we’re going to fund them back their renovations through the term of the project over draws.

Henry:
That’s cool. So you’re financing in your construction costs which is definitely something that you can’t do on a traditional conventional loan.

Will:
Right, and it gives them higher leverage.

Henry:
One thing I like that you said that I want to clarify is you said you can be a little more creative. You can allow for someone to… If they have another property with equity in it, you said they could turn that over, and I think what you… For those who don’t know what that means is, essentially, they can use the equity in that deal and pledge that equity as their down payment. So you would then go take a second out on that property and hold that until they pay you back, and then you release that second?

Will:
Yeah. We wouldn’t even be a second. We would record our deed of trust over both pieces. So it’d just be one loan, and we would encumber both properties for that entire amount, and the rental that they have or that… whatever the additional collateral is, it doesn’t really get touched in the transaction. They’re just buying, renovating, and selling it, and then we release off both of them, assuming that loan is covering our entire loan amount, and that’s in lieu of a down payment. Right? So they could literally 100% finance that transaction, assuming we’re comfortable with the additional collateral and the primary asset.

Henry:
You don’t want me to pledge my equity in some shack I have on an acre of land out in the middle of Nowhere, Tennessee? Yeah? Yeah.

Will:
Yeah, yeah. We’re not looking for swamp land. I mean, we’re a one-state lender currently. We’re lending in Washington State. This is where I’ve lived my whole life, so we’re familiar with all the different cities and jurisdictions, and have comfort there. That’s what also helps our ability to make quick decisions and move quickly is our comfort in the markets that we lend in.

Dave:
All right. So now that we know what hard money is and why investors might want to use it, how do you access it, and what do investors need to watch out for if they go the hard money route? That and more after the break.

Henry:
All right. Welcome back, everyone. We’re here with Will Heaton, the co-founder and managing principle of Heaton and Dainard Real Estate, and he is demystifying the world of hard money for us.

Dave:
So, Will, it’s very cool that you can go quickly and be creative. That’s obviously very valuable to real estate investors, but I’m guessing you don’t do this out of the goodness of your heart, and this creativity and flexibility does allow you to charge a higher interest rate. Is that right?

Will:
It is. We’re not getting a prime rate or what you get on your conventional loan. I mean, our draw circle around 11%, 12% is our average interest rate charge. It’s interest only. Payments are due monthly. That’s pretty close to market for lenders that are like us in our market and that I’ve seen also across the nation. Then, the loan fees start at two points based upon the outstanding loan balance. That will get you five months.

Dave:
I think it’s really important for everyone listening to just understand that there are trade-offs with every type of lending. Right?

Will:
Yeah.

Dave:
Just like Henry said, conventional loans might have a lower interest rate, but they take longer, and they are a lot, a lot more structured, and there’s a lot more regulation. Meanwhile, if you’re going to want to do something quickly and you’re going to want to go around some of those regulations, you can use hard money, but you have to understand that that means that the hard money lender is taking on more risk than a traditional bank, and the hard money lender is going to charge you a higher risk premium in the form of a higher interest rate to compensate for that risk that they’re taking on. So it’s not like it’s predatory. There’s just different calculations for a conventional lender as there is for a hard money lender, and that’s why the rates are so different and the fee structures are so different. But given that, well, given that the fee structures are so different, you mentioned you do a lot of value add. Is that the profile of investor, the type of strategies that are most aligned with hard money lending?

Will:
Yeah. I would say 90% plus of our borrowers are your single-family fix-and-flip borrower. It’s the most commonly used transaction that uses hard money. The sellers always want to move quick or there’s… The best deals are, a lot of times, coming in with clash, closing quick, and maybe need a bunch of work. So, again, it doesn’t have anything to do with the borrower not qualifying. Most of the time, it’s the property or the speed at which it needs to transact or the competitiveness of how your offer needs to be with lacking any sort of contingencies. Therefore, the deal is, most of the time, what directs the type of capital you need, and then the borrower coming in is, “Hey, what is your financial situation? Do you have the ability to make payments?” We want to make sure of that too. Like I said, we have a very low default rate, but the fees that are charged, yes, it is more, and we look at… We’ve seen people come into our market and try to charge 7% or 8% for hard money rates. I mean, Henry, you said you borrow hard money. Have you found anybody out there at 7% or 8% anymore?

Henry:
If I did, I wouldn’t tell anybody who they were.

Will:
Because what Dave was talking about is that you have to have the risk factored into it. Right? There’s some risk involved, and so we’ve got to charge what we charge to make sure that we’re here for the long-term, and if you’re not… You can’t run this model and charge really low fees and interest, and operate it because you don’t have enough risk factored into it. When you do have issues with a loan, there needs to be enough meat on the bone in the portfolio to make up for that. With these companies that have tried to practically give the money away, I think that they found out that… “Hey, that didn’t work out.” I know some of the large national lenders sold their portfolios for below what they funded on them.

Henry:
A couple of things to think about here for listeners is this idea is not unlike anything else that we have in a retail space in America. You pay for convenience. Convenience costs you money. If I go to the corner store, the gas station right now and I buy a candy bar, I’ll probably pay about two bucks for that candy bar. If I decide I don’t want that convenience and I’m willing to go and deal with the crowds at Walmart, I can probably get that candy bar for a buck 50, maybe a little less. If I don’t want deal with that and I want to go to a big-box store like a Sam’s Club or a Costco, I can probably get that candy bar for under a dollar. It’s all the same product, but-

Will:
And 50 more of them at the same time.

Henry:
50, yes, and I have to buy 50 of them. Yes, but the convenience is always going to cost you more. Right?

Will:
Yeah. We’re like the popcorn at the movie theater. Right? It’s like that’s some expensive popcorn, but hey, you’re signing up to have a good time, flip some houses, and hopefully, walk out of there with a smile on your face. You don’t think about it when you’re walking out, “Damn, that was some expensive popcorn.” What do you say? “That was a good movie.” Right? You’ve completely forgot about the popcorn.

Dave:
You’re the $12 beer at the Seahawks game that you’re happy to pay for.

Will:
Yeah.

Dave:
That’s such a great point though, Henry. Yeah. It’s so true that you pay for convenience, you pay for things that are willing to work with your strategy, and for flipping, for BRRRR, for renovations, sometimes, very often, conventional loans just don’t work. Banks aren’t set up for that type of lending.

Will:
They don’t like it.

Dave:
That makes sense too. There are different business models just like flippers have a different model than long-term rentals. Different lenders have different business models.

Henry:
I also think what’s important here to mention for the listeners is you’ve got to see different types of lending as tools in your tool belt. Not every type of loan makes sense for every type of deal. There are certain deals that a hard money loan is absolutely perfect for, and there are certain deals that a hard money loan is going to be terrible for. You have to understand what your deal is calling for and what your financial situation will allow for, and select the financing option that meets those two in the middle. If you are trying to buy a property and it doesn’t need a renovation, you’re going to use it as a rental property. It’s going to sit there for 30 years.
Getting a hard money loan for that property is going to present some extra hurdles. You’re going to have to figure out a way. You’re going to have to buy that cheap enough so that you can refinance your hard money lender out of that money down the road, and you’re going to eat up some of your cashflow to do that. But if you’ve got a house that needs a renovation, you don’t want to fund the renovation, the seller is a grumpy old man who needs his money in the next two weeks, and he doesn’t want to deal with anybody in and out of his house and, “Don’t mess with my tenants, and I’ll sell you this. I’ll sell it to you for a good price, but don’t you hassle me about it.” Right? That’s ideal for a hard money lender.

Will:
Yeah. You’re just paying a convenience fee to be able to close that deal. If the deal is right, it’s the cost, and it’s not atrocious. I mean, say, that $100,000 property we’re buying, you’re borrowing a hundred grand. I mean, the loan fee is 2%. It’s $2,000. Right? Your interest rate is 12%. It’s a thousand bucks a month. I mean, let it be a gauge of, “Hey, is this a good enough deal? Does it stand on its own even with paying these costs?” That’s going to tell you, and another thing to add, Henry, to what you were just mentioning. When I see a deal come across my desk and it looks like they should qualify for bank financing, “Hey, they got 60 days to close. The house is clean,” or, “It’s an apartment building, and it’s clean. It’s got good income.” I’m being told the borrowers… all that and a bag of chips, but they want a hard money loan. For me, I’m like, “Why? What am I not being told here? This doesn’t make sense. Why aren’t they going to a bank?” We’re not just trying to lend everybody when something doesn’t seem like they should be getting that hard money loan. I mean, I find there’s usually a reason when I start digging in on those borrowers.

Dave:
So, Will, given the higher interest rates and the typical buyer that you usually work with, what’s the average length of a hard money loan?

Will:
Most of our loans are written at a five-month term. Like I mentioned earlier, our portfolio is averaging about 166 days from funding to payoff, so we’re rate pretty close to in line with that. We do 5, 7, 9, 12, up to 12 months. They’re short-term. Right? 12 months and under is really our strike point. If somebody wants a two-year loan, we don’t typically write that out of the gate. I mean, it’s too long of a period. It’s a fix-and-flip. Why should you need two years? If it’s a buy, renovate, refinance, definitely shouldn’t need two years, so.

Dave:
Got it.

Will:
Then, a few deals where they maybe needed to get them renovated and they might need 12 months of seasoning or 12 months of income on the transaction to qualify for their takeout loan. We’ve had a few transactions like that, and that coming to us with that, “Hey, this is why we need this much time,” that makes sense to us. Unless there’s a specific reason, any of our loans are typically written 12 months or less.

Dave:
All right. So, Will, for our listeners, could you help us walk through, let’s just start at the beginning and the end, what the process looks like for hard money loan? If I, Dave Meyer… I literally have never used a hard money loan. If I were to come to you, what would I need to bring, and what would the application process look like?

Will:
So, for us, and I know a lot of other lenders out there that are like us, a lot of borrowers will get pre-approved. Right? They just want to know like, “Hey, I want to write offers,” or, “I want to get this deal. What do I need to do upfront?” That’s the most important thing to do is get ahead of it. Don’t get your deal tied up, and then figure it out. They’ll come to us ahead of times, and if they’re writing offers on the market, what we need is a credit report, and we pull that, and that doesn’t mean that we’re… We don’t have a minimum credit score, and I could talk more about that in a little bit, and we want to see liquidity statement and asset statement. We want to see that they exist as a human being and that they have the capital required to put down the down payment.
That will get them to the point where they can start writing offers or presenting us as their lender. If they get a purchase and sale agreement, they get something tied up, they’ll submit that to escrow, they send us a copy of it, and we will… Assuming we are good with their plan, they’re, “Hey, we want to see just a rehab budget.” If it’s a large project, we might want to see that detailed. Especially if they’re going to do a rehab loan where they were holding that amount back, we want to see a detailed budget. We’ve got their credit. We’ve got the liquidity. That’s all we need. We’re ready to close.
So we don’t need tax returns. We don’t need financial statements, we don’t need W2s, or we don’t verify employment. If there are some things that come up on a credit report that make us a little bit uncomfortable, we may do a background check. I mean, we had a borrower recently. We’ve had a handful of borrowers. I mean, this guy’s credit this last week was like 440 or something. I was like, “He is trying to not pay his bills.” Right? There was something like 18 delinquent accounts and charge-offs, but we verified. This guy has been flipping houses, and he showed us, “These are the last three deals. These are the entities I borrow in.” Right? We looked at it. He was buying them. He was renovating them. He was selling them. He just doesn’t like to pay his bills. So, a situation like that, we just said, “Hey, let’s have you make three payments upfront. Those will be the last payments. So you make payments, and if you stop, we’re going to use this money.” He was fine. So it doesn’t mean… We’re just trying to get a gauge and understanding of what is the situation with the borrower.
Now, he was also buying a good deal, so we felt comfortable with it because at the end of the day, we’re an asset lender. We look at it. “If we have to take this property back, are we going to recover our money?” We don’t want to. That’s not the business we’re in. We are in the business of loaning money and getting paid off. But as to mitigate risk, we want to make sure that if we are in a situation where they stop making payments or something happens, that we can recover our principal loan amount, and looking at their payment history can give us an inclination of showing us. It’s typically a reflection and it’s why it’s used of, “Hey, are they going to make payments, or are they just going to disappear into the wind?” Now, if I got a borrower with a sketchy deal, it’s really hammered, we don’t like the loan-to-value, and they’ve got bad credit, it’s like, “Okay. We want more down.” It doesn’t mean we won’t do the deal. It’s just we might need 30%, 35% down.

Henry:
Okay. So Mr. Dave on his hypothetical deal here will send you essentially an email that’s got the address of the property, it’s got the plan for what he plans to do renovation and cost-wise, and it’s got whatever his exit strategy potentially is going to be. You evaluate that deal. You evaluate him as a living, breathing human person, and then you decide, “Okay, Dave. We like your deal. We know you’re a real person who likes to pay their bills.”

Dave:
Or not.

Henry:
Or not.

Dave:
Who knew that was even an option like, “Oh, I just don’t like paying bills?” Right? “Not going to do it.” Yeah.

Henry:
So we will fund your deal. You give them an approval, what happens next? How do we go from that stage to they actually get the money?

Will:
So our transaction manager is then going to be coordinating with the escrow company and sending them the loan docs, and whenever the scheduled loan closing date is or property closing date is, the borrower goes into escrow or has a courtesy signer, and they sign the closing docs and the loan docs, and we fund the loan.

Henry:
So what’s the average that takes you to get from that stage to them actually receiving money?

Will:
We’re always ready before everybody else. I mean, we, countless times… I mean, I had a loan submitted yesterday, and it needed to close in three days. It’s like, “Okay. I’ll look at it tomorrow. I’m not even worried.” That was yesterday. I’m going to look at it by the end of the day, approve it. We’ll send docs over. We’ll be ready to close. So if they’ve got title and escrow set up, title and escrow is who we’re waiting on. Right? We can underwrite a deal if it needs to be underwritten in a few hours and give the person approval if we’ve got photos. We don’t go out and view it. We take photographs. That’s another piece that I forgot to mention. We need a link or a bunch of 15, 20, 30 photographs of the property.

Henry:
Okay.

Will:
We see their plan. We see we’re going to have clear title.

Henry:
So there’s a slight correction. You’re a little more picky than we thought. You need the borrower to be a real person, and you need the property to be a real property? Is that what I’m hearing?

Will:
Yes.

Henry:
Okay, okay. Getting picky now. Getting picky now, Will.

Will:
Our underwriter… I look at the photos of every deal too, but he looks at the photos, looks at their budget, and makes a determination like, “Hey, they’ve got an $80,000 budget, and they have a 5,500-square-foot house that they’re going to do a studs-out remodel on.” It’s like, “Okay. Well, this guy doesn’t know what he’s doing.” Right? That’s not going to happen. That’s one of our pieces of underwriting is like, “Does their plan pass the smell test? Do they look like they’ve got an understanding of what they are doing here too?”

Henry:
Okay. So we got the approval. The docs here at the closing company. We’re getting our money. It’s three days after we got our approval because we’re getting our… Dave is getting this grumpy seller his money as quickly as possible, and so Dave closes on the property. He signs the paperwork. How are payments set up? Are we making principal and interest payments? Is it just interest payments? How frequently are they?

Will:
It’s interest only, due monthly, paid in arrears. You get a statement every month, and they can pay it online.

Dave:
What happens if they don’t pay, Will, or I don’t pay in this scenario?

Henry:
You’re going to try this “I don’t pay my bills” thing?

Dave:
Yeah. Maybe.

Will:
It works for some people. It gets real expensive. Right? So there’s a late fee that gets applied. I think it’s 10% of the payment as a late fee. If you go over 60 days late, you get put into default which your interest rate doubles. So if it’s a 12% interest rate, your loan is now accruing at 24%. It gets real expensive because we just don’t… Like I say, that’s not our business model, and it shouldn’t be any hard money lender’s business model. It should be being a partner to help people buy, renovate, and resell, or just get in it to buy deals. But when you don’t, that payment starts accruing at 24%, and then after 90 days, we file a formal notice of default, and then 30 days later, a notice of trustee sale. 90 days after that, we’re going to hold a trustee sale of foreclosure down at the courthouse steps to auction the property off to the highest bidder.

Dave:
See, this is why I pay my bills. I don’t want to do any of that. That sounds terrible. I quickly decided to just stick with what I’ve been doing.

Henry:
All right. So assuming you do make your payments, are there other pitfalls that investors should watch out for, and what do hard money lenders know that the average investor doesn’t? Stay tuned. We’re going to find out after the break.

Dave:
Welcome back. We are here with Will Heaton, and he has just walked us through exactly how to get a hard money loan.

Henry:
What happens on the reverse? What if Mr. Dave says, “You know what? Paying my bill sounds great. Matter of fact, I’d love to pay them early.” What happens if you wanted to pay off sooner than your term?

Will:
Yeah. We don’t have a prepayment penalty. I don’t know of any of the short-term fix-and-flip lenders that do have any sort of prepayment penalties. We prefer to churn the capital, originate, have you be successful, and pay us off. If you want to make payments early or you want to completely pay the loan off early, there’s no penalty for that. You do this in 30 days or 45 days. I mean, we may even look at discounting the origination point, say, “Hey, you guys, you did that so quickly. You were able to get in and out. We can probably take care of you on the loan fee if you’re that… your anticipation out of the gate and you’re able to do it that quickly.”

Henry:
So one thing we didn’t talk about, Will, was the construction draw process because you did say you were lending money for the renovations. So I’ve borrowed money from all kinds of places, and the draw process has been different at almost every one of them. So how do you handle giving people money for their renovations?

Will:
Yeah. So, the way we handle our draw process. First thing we do is we give you your first draw immediately after closing. So we may ask for a little more money down than maybe the next guy if we’re like 15% or 20% down. But if you’re doing a rehab loan, your first draw is before your project starts. So you’re getting a chunk of that money back to get your project moving. Subsequent draws, we ask for photographs, and if it’s something that’s not on site that’s maybe paid for, to send us some receipts for it, and the way we break those up, say, if it’s a $100,000 project, we’re going to look at that and the borrower, and we’re either going to say, “This is going to be four $25,000 draws or five $20,000 draws.”
We set that up out of the gate. The borrower knows. “Okay. This $60,000 project, we’re going to do three $20,000 draws on this. You’re going to get the first $20,000 at closing, and then the next two are based upon progress that has completed.” You can request those in the same month. It doesn’t have to be done on a monthly basis. This can be done as fast as the project gets moving. You send us photos, we review the photos, and either that day or the following day, we submit a wire into your bank account. So we know we have the most fluid process, and we don’t have any third-party requirement or regulation. I mean, we’re the ones sending the capital.
We’ve seen other lenders who say, “Yeah, you can do a monthly draw. Every dollar spent has to be applied to a specific line item based upon a percent complete, and then we’re going to send out a third-party inspector who’s going to review that work and make sure, yeah, are you 100% wired in?” Like, “Yeah, we are,” and they’ll be like, “Well, we need to see the sign-off on the permit.” They’ll say, “Okay. Once you have the permit sign off, we’ll release that money,” and then you’re waiting for the inspection and the report to send to the lender.
Then, they have it, and they’re going to say, “Okay. We’ll give you 100% of that,” or they’re going to say, “Hey, I know you may have paid the guy $1,200, but you only had $10,000 in your budget here.” You’re like, “Well, I want to take it from this other line item because we’re not going to use that.” They’re going to be like, “Sorry. You need to pay that out of your pocket.” Right? I mean, on a fix-and-flip deal, it’s simple. Right? I mean, we’re looking at roofs, windows, siding, cabinets, counters, flooring, doors, millwork, hardware, appliances. Like, “Let’s not overcomplicate it. Just keep it simple. You need 20 grand. Move this thing along. We’re going to give you the money when you need it so your project can move.”

Henry:
This is a great point here, guys, is you have to ask your lender about the draw process because it can be tedious. It can be a situation where you’re like, “Hey. Yes, I have a lender who’s going to fund my renovation.” But then, the draw process really is you funding your own renovation, and then hopefully getting that back through a series of checks and balances which… If you’re not capitalized to do that on your own, you could find yourself in a world of hurt. It could delay your project which increases your holding costs. So have the conversation on the front side with your lender before you sign that paperwork and then realize your draw process is going to kill your deal. That’s great information. Thank you so much.

Dave:
Awesome. Will, that was a really good explanation, and hopefully, everyone listening to this now understand how this works. Will, before you get out of here, I need to ask you a little bit of a selfish question. I don’t flip houses. I have no aspiration to, but I am very interested in becoming a hard money lender because it just seems like something I could potentially be good at, and it’s the kind of real estate investing I like to do. Who should consider becoming a lender, and how difficult is it?

Will:
It’s probably easier to do it than you would think, but to do it safely and successfully, that’s where the challenge comes in. Right? You could loan anybody money at the end of the day, but are you going to get paid back? Right? Is the collateral that you’re lending on sufficient enough to where if something happens to the borrower and you’ve got to accelerate that loan, are you going to recover your principal? Right? That’s where we look at it. It’s like we want to be in this business for years to come, so we want to make sure the loans we do are good loans, not just because we want to make money, but because we want to preserve the principal and then obviously, make some profit.
So the first thing is going to want to be able to have a clear understanding of what it is you’re going to loan on and get somebody or a resource lined up where you’re able to determine the true value of that collateral, and that’s the as is value. What we look at too is, “Hey, once they buy this property, and they go in there, and they strip it and demo it, and if…” That’s our riskiest point in the deal, right? They’ve demoed that thing, and if they walk away at that point, where are we sitting out on our debt, and then once it’s fully repaired? Right? So there’s three points at which we analyze the value, and that middle point really relies on the borrower. What is their ability to execute on their plan, and is it realistic? Are they going to have enough money to get this house to the finish line? Right?
It doesn’t mean just because, “Oh, yeah. We think we can get it done for 80 grand,” and it looks like a $250,000 remodel. We’re not going to go, “Okay. Let’s do it.” It’s like that plan is unrealistic, and it’s not only unrealistic for them, it’s risky for us to put that money out there. So you’ve got to have a thorough understanding of the asset, the value, the cost of construction, understanding the borrower’s willingness and ability. The willingness is really coming out of their credit report. The ability is coming out of their history in real estate experience or who it is that they have on their team to help them execute on it. Then, we get into the legal documentation. You’ve got to have an attorney who is there to draw the documents up or you have had a set of documents put together that are going to be put in front of the borrower and abide by all of the laws and whatever sort of regulatory agency is involved in your state or your municipality that you’re working in, and then a way to service the debt. Right? Sending in invoices and a source of capital.

Henry:
I was going to say I think you need money, but-

Will:
Yeah.

Dave:
You need money.

Will:
Right. Money, that’s a whole-

Dave:
That thing.

Will:
So this becomes, “Hey, we can operate the lending side of the business, but where’s the capital coming from?” Right? So that’s where I feel like it’s a whole another business is capital raising, and capital management, and liquidity management.

Dave:
Yeah. Got it. Well, that might be a whole other show. I’m very curious about learning more about it and buying hard money notes. All sorts of stuff, so.

Will:
Yeah. It’s a great business. It can be lucrative if done safely.

Dave:
All right. Well, Will Heaton, thank you so much for joining us and sharing your information, your knowledge about hard money with us. We really appreciate your time.

Will:
Hey. Thank you, guys. I appreciate it, Dave and Henry.

Henry:
Thank you, buddy.