Financing Your Rehab

A READER ASKS, “How do I finance my project? Do lenders finance a board up?”

Securing bank financing to purchase and rehabilitate a property best described as a ‘board up’ is sometimes challenging. Conventional lenders are often reluctant to accept as collateral for their loan a property seriously depreciated by neglect or vandalism. Such properties are often subject to pending Court actions due to outstanding code violations or even demolition orders. In the event the borrower fails to remedy these serious conditions in a timely manner, the bank in the event of foreclosure is in danger of being left with problems it is ill equipped to remedy.

Professional rehabbers, on the other hand, actively seek out such distressed properties. Evidence of conspicuous deferred maintenance and the likely existence of code violations often drive down the price at which the property may be purchased, in fact creating the opportunity for profit for the savvy rehabber. Given conventional lenders’ lack of interest in such properties, the rehabber needs other sources of financing in order to go forward.

Those just starting out in the business may do well to consider the so-called "203K purchase/renovation loan." As the name implies, this government guaranteed FHA loan program is intended to facilitate both the purchase and improvement of owner occupied one- to four-family residential properties. Up to 97% of the purchase price and improvements may be financed at reasonably competitive rates (currently 5-8% depending on the property and the credit worthiness of the borrower). After the initial purchase, construction monies are disbursed incrementally–usually in 3-5 payments or ‘draws’–as work is completed. Upon completion, there is no need to secure long term financing; the 203K incorporates the end loan which may have a 15- or 30-year term. Both fixed and variable or adjustable rate terms are available.

According to Wells Fargo mortgage consultant and renovation specialist Jo E. Thomas, there are conventional loan products available to investors and rehabbers that will fund up to 75% of market value upon completion. Like the 203K program, these loans will fund both acquisition and rehab and generally require a down payment equivalent to ten percent of the total project cost.

Professional production rehabbers seldom utilize the FHA-backed 203K program or similar conventional products. Unless carefully monitored, these loans may very well take six or even eight weeks to document and close, an unacceptably long time for the professional’s fast paced business. Indeed, the terms of the rehabber’s purchase agreement will often stipulate no more than 2-3 weeks to close and specifically exclude a financing contingency. The professional needs to have either sufficient cash on hand to close the deal, or access to ‘specialty’ mortgage lenders prepared to document and close quickly.

Experienced rehabbers work with a relative handful of so-called hard money lenders who, in most cases, will loan up to 65% of a property’s value upon completion. These lenders are deemed "hard money" by virtue of fee structure and interest rate: In addition to the application and appraisal fees routinely assessed, the hard money lender will charge four percent or more of the amount of the loan and an annualized percentage rate of 12% or more. Such loans are short term only, generally six months. It is assumed the property will be refinanced by others or sold upon completion.

Professionals in the business work with hard money lenders because of these lenders’ willingness to finance admittedly difficult deals. Their loan programs are designed to facilitate the fast turnaround nature of the rehab business. A prequalified borrower is generally able to close a typical deal in ten days to two weeks from securing the signed purchase contract. The loan, at 65% of end value, is often sufficient to both purchase the property and fund planned improvements. Upon completion and final payoff, if all has gone as agreed, the borrower generally is considered pre-approved to proceed with another deal under comparable terms and conditions.