Access Wealth Strategies

In Part 1 we discussed why the market is ripe for hard money lending, now let’s look at why hard money lenders are willing to fund deals traditional lenders reject.

Hard Money Lenders Can Charge Much High Interest Rates

Hard money lenders demand much higher interest rates (10-18% or 2-3 times higher) than banks do because they fund deals that do not conform to bank standards.

Banks have very specific standards because they are highly regulated and need standardized systems to make many loans. In contrast, many hard money lenders are individuals or small groups who are willing to work in narrower markets with niche products.

It’s All About the Asset / Collateral

If you could own an asset (e.g. real estate) that is worth $200,000 for only $100,000 (getting it for half price), would you do it?

Hard money lenders provide short-term loans (usually 6 to 18 months) based primarily on the value of the hard asset (such as real estate) that is collateral for the loan. In contrast a traditional lender bases the loan on the borrower’s ability to repay with the collateral as a secondary factor.

The two best quotes I’ve heard from hard money lenders are:

“Only lend if you’d rather have the asset.”

“Drive by the asset and think: do I want to own this?”

The “asset” referred to above is real estate, typically a single family home. Now think from the hard money lender’s perspective: You’re making a loan based on the asset, so what’s the worst thing that could happen?

Answer: The borrower defaults and does not pay you back.

So what happens when a hard money loan is defaulted upon?

If the hard money lender has properly recorded a first lien on the property / collateral, then the lender can follow the legal procedure to foreclose on the property – i.e. the hard money lender becomes the owner of the property which was the collateral for the loan.

Let’s see how the math works out in an example:

Imagine a new home bought in 2005 for $400,000 (inflated price in the bubble) and is now worth $200,000 (realistic market price today). The home owner who owes more on the home than it is worth today and who lost their job in the recession has stopped paying the mortgage and been foreclosed upon.

A flipper can buy this home at the trustee sale auction for say $120,000. The flipper buyer gets a hard money loan for 80% of the purchase price, or $96,000, and pays the remaining $24,000 cash himself.

So, assuming the home is really worth $200,000 (realistic price a retail buyer would pay today), the hard money lender’s basis in this property ($96,000 loan amount) is roughly 50% of today’s retail price ($200,000)!

That is a VERY secure position for the hard money lender.

So, in the “worst” case where the borrower defaults on the loan, the hard money lender gets to own the asset that’s worth $200,000 today for only $96,000 (ignoring fees and other legal costs).

How to Win Even If You Lose!

Hard money lending in this market is lucrative because you get to “win even if you lose”:

(1) If the borrower pays you back with interest as promised, you’ve received double digit yield on your money in a short period of time (6-18 months). This is an attractive yield compared to 0-3% on bank CDs and not much more for corporate bonds.

(2) If you “lose” and the borrower fails to pay you back, you can take ownership of the collateral property for what amounts to about half the current market value (e.g. $200,000 property for $100,000).

So, as a hard money lender, you can receive a double digit yield in most cases AND have the security of making even more money if the borrower defaults and you get the property at a cost below the REO or trustee sale price.

Do trillions of dollars of failed loans and losses lead to great lending times?

With the recent collapse of the credit markets, the economy, real estate prices, and the stock market, lenders around the world will take massive losses on their loan portfolios. Large lenders such as Washington Mututal, Indymac, and related entities have already failed.

The write downs on collateral and loan values could make most (if not all) lenders insolvent. So doesn’t it seem strange then that lending on real estate assets could deliver both a high yield AND safety (low risk)?

As strange as it sounds, hard money lenders are well positioned in this market cycle to generate the highest income with the most security. Let’s look at why.

Why Are Hard Money Lenders Needed In Today’s Market

In today’s market with a huge inventory of distressed properties such as foreclosed homes and even commercial real estate, investors and “flippers” are buying these properties at a huge discount.

There’s only one problem: These distressed deals usually require a quick close (sometimes as little as 1 day at a trustee sale auction).

Most traditional lenders would not be much help in these scenarios – not that they are willing or able to lend money on real estate purchases these days. Even if they were, it would take too long (45-60 days) and require perfect credit from the borrower.

Of course, deep-pocket buyers could pay all cash to buy the distressed properties all day long if they wanted. But what if they want to buy but don’t have enough cash of their own? Or, they do have the cash to buy one property but want to buy multiple properties at the same time?

For some experienced flippers, the number of properties they can buy at one time can make a huge difference in their bottom line profit.

Enter the hard money lender, who can fund deals quickly and is willing to overlook the borrower’s less than stellar personal credit, as long as the property meets their deal criteria.

Typical Hard Money Loan Terms

• Short term: 6 to 18 months
• Application or due diligence fee around $500 to $1000
• Origination points 0% to 5%
• Interest rates 10% to 18%
• Prepayment fee (if the loan is paid off earlier than expected)
• Recorded first trust deed (lender has first lien on the property)
• LTV of 60% to 80%

Why would hard money lenders fund deals that traditional lenders reject? We’ll discuss the 2 main reasons in Part 2. Meanwhile, please add your comments and questions below.

A couple of weeks ago, our business partners picked up a home in North Scottsdale at the trustee sale auction. Since we live nearby, we took a video of us driving by the house and the neighborhood, which is a very nice gated community.

The house is currently occupied by tenants – that’s why we didn’t go inside – who signed a lease before/while the last owner was going through the foreclosure process.

There are several things to note here:

1. There are some nice neighborhoods where you can pick up homes at the trustee sale, if you do the proper research beforehand and go through the right channels.
2. Tenant occupied homes bought at the trustee sale create more complications for rehabbing and flipping the house.  You could offer “cash for keys” but sometimes it could turn into a lengthy process regardless.
3. Not having a “move-in ready” house decreases the potential buyer pool and we’ll probably have to offer additional incentives (reduced price and/or credit at closing) to get the house sold quickly “as is” (with some minor exterior work).
4. If you’re a tenant looking to rent in areas where foreclosure rates are high, beware of the financial conditions of the owner.  For example, having your security deposit held in a real estate broker’s trust account is better than giving that money directly to the owner, in case they go through foreclosure and you’re forced to leave the property earlier than expected.

Please add your comment below and let me know what you think.

We all know that our financial decisions today affect us far into the future and significantly impact our retirement lifestyle.

Perhaps you’ve heard about the tax law change for 2010 that affects retirement accounts such as IRAs but were wondering what this means for you and how you can take advantage of it.

Our friend Kaaren Hall at uDirect IRA referred to this as “taxes on sale” – so you don’t want to miss it!

Keeping up to date on IRS rules and tax laws is something that most of us don’t enjoy. That’s why there are professional tax planners who do this for us.

Listen below to my interview with Amanda Han, CPA and tax planning strategist at Keystone CPA, as we discuss this recent and significant IRA rule change called TIPRA (Tax Increase Prevention and Reconciliation Act), and advanced tax planing strategies due to this change.

In this interview, you’ll find:

• Why is 2010 a special year for Roth IRA conversion?
• Differences between traditional and Roth IRA accounts and how you can take advantage of both in your retirement planning
• How do self directed retirement accounts fit into all this?
• Reasons you may want to convert your traditional IRA to a Roth IRA in 2010 (or maybe even 2009!)
• What are advanced tax planning strategies and how can they help you?
• And more…

Be sure to check out the members’ library area at Keystone CPA’s web site for some helpful articles and tax planning strategies.

Of course, individual financial circumstances vary, so you will want to consult with your tax advisor before implementing any tax strategy.

In just the past 2 years, the real estate market has fallen nationally more than during the Great Depression and more than our most esteemed economists predicted.

Many real estate investors are looking to purchase distressed homes for LESS than the current market price. There are two main options, a bank REO or a trustee sale property.

Foreclosed homes (except through bankruptcy or judicial foreclosure) are sold at auction on the courthouse steps in most jurisdictions.

Why are homes sold at the trustee auction?

This is the legal process to transfer title from the delinquent home owner (borrower) to the mortgagee (lender ).  The lender sets the minimum bid and in most cases wins the auction – the foreclosed home then officially becomes part of the bank’s REO portfolio.  However, sometimes an investor can outbid the lender (the bank) and acquire a home at a discount to the current market price.

Why would buying a home at the trustee sale auction make sense for the real estate investor?

If there is a large enough discount between the price bid at auction compared to the current market price (i.e. comparable sales prices on MLS), then the investor can flip the property for a capital gain or in some cases rent it out for cash flow.

Video Tours of Trustee Sale Homes

Watch this video tour of a home purchased at the Phoenix trustee sale auction to see a home before it is fixed up.

In this second video, we tour a different home that is fully fixed up and on the market. Since the home looks better than new and was well priced (at a discount to current market price), it received multiple offers during the first week of listing on MLS.

You might also like…

Jim Kingle’s video More Around Town, for a look at the San Diego trustee auction in live progress.

My previous posts about trustee sales:

• Real Estate Investors Making a Killing at Trustee Sales
• High Flipper Ratio at Trustee Sale
• Bargain Homes for Sale

Please comment below and let us know if you like this post and what information you would like to hear more about.