Overview
Hard money, DSCR, and new construction loans are the standard financing tools for active real estate investors, but they aren't the only way to fund a deal, and they aren't the right fit for everyone.
Maybe you're just getting started and don't yet have the track record some hard money lenders look for. Maybe you have equity sitting in your primary residence you'd rather tap into than pay hard money interest rates. Or maybe you have a relationship with someone who has capital to invest and would rather negotiate your own terms than go through a lender's underwriting process.
Whatever the reason, there are several funding paths outside the hard money space worth knowing about. Each comes with its own tradeoff between cost, speed, and flexibility.
Key Takeaways
- Local community banks and portfolio lenders offer more affordable rates than hard money, with more flexible underwriting than a conventional bank, but they close slower and still require paperwork and draw inspections.
- Private investors (friends, family, or your network) offer the most negotiable terms and the least underwriting hassle, but mixing personal relationships with business risk requires extra care.
- Real estate crowdfunding platforms pool capital from many investors and offer terms similar to hard money, but usually require a track record of completed projects to qualify.
- Traditional and FHA 203k loans are the cheapest option available, but strict underwriting and owner-occupancy requirements make them a fit for live-in flips only, not standard rehab-and-sell projects.
- HELOCs, PELOCs, and creative financing let you tap into equity you already have or combine multiple funding sources, offering flexibility that hard money and DSCR loans don't.
Local community banks and portfolio lenders are one of the more overlooked funding sources for flippers. Unlike hard money lenders, they generally lend their own money rather than money insured by Fannie Mae, Freddie Mac, or HUD, which gives them more flexibility to lend on local flip projects than a conventional bank, often at a more affordable rate than hard money.
Pros of Local Community Banks
- More Affordable Rates - Rates will likely be more expensive than conventional rates, but more affordable compared to Hard Money Loan rates.
- More Flexible Underwriting than Conventional Lenders - Loans are not government insured, so they do not have to meet strict underwriting requirements which gives them the flexibility to lend on local rehab projects.
- Relationship Based Lending - Local banks are easy to contact and more relationship based than a traditional lender.
Cons of Local Community Banks
- Stricter Underwriting than HML - Although Community Banks are more flexible than Conventional Lenders, they may have stricter underwriting than a HML.
- Slower Closings - Community Banks generally, won't be able to close as fast as a HML, but should be faster than a Conventional Lender.
- Paperwork/Documentation - Similar to HMLs, Community Banks will require additional paperwork/loan documents upfront and require Loan Draw requests during the rehab to get your money.
PRO TIP
Get in-touch with some Local Community Banks and ask if they have a branch that lends on local real estate deals and fix-and-flip projects. Build a relationship with their branch manager and discuss your goals to establish whether their Community Bank can provide funding for your rehab projects.
Private Investors/Private Money Lenders
Private Investors (aka Private Money Lenders) are generally high net worth individuals that you already have a relationship with that are within your social circle that have a high amount of capital or savings that they could invest in funding for your deals. A Private Money Lender could be:
- Family
- Friends
- Neighbors
- Local Millionaires
- Local doctors, lawyers or executives
- Individuals with sizable retirement savings in 401ks or IRAs
- Random investor you meet at a Local REI Networking Event
Using Private Money can provide a win-win situation for both you and your lenders.
Your Private Lenders may not be satisfied with their current portfolio performance in the stock market or they may have a pile of cash sitting in their bank account burning a hole in their pocket. You can offer your Private Lenders an alternative investment opportunity that could net them a 7 to 12% annual return on their investment to help them diversify their investments and put their money back to work.
As a rehabber, working with Private Money Lenders is generally easier and more flexible than working with Hard Money Lenders. The loan terms are completely negotiable so you can generally negotiate more competitive rates for your deals than Hard Money Loans.
Pros of Private Money Lenders
- Relationship-Based/Deal Based Lending - Instead of lending based upon the Borrower's personal financial situation, Private Money Lenders will often lend based upon your relationship, reputation and the numbers of the deal.
- Negotiable Rates & Flexible Loan Terms - The terms of a Private Money Loans are completely negotiable between the borrower and the lender so you can typically negotiate better rates and terms with a PML than you could with a HML.
- No Underwriting Hassles - Traditional Banks & Hard Money Lenders have strict underwriting guidelines, but Private Money Lenders lend based upon their comfort level with you and your due diligence of the deal.
- No Draws or Inspections - Hard Money Lenders & Traditional Banks don't give you all of the money upfront and typically require progress inspections before they will release a draw for the work that has been completed. With PML you can negotiate your own terms to receive all of the funding upfront so you don't have to deal with rehab inspections and draws.
- Unlimited Number of Deals - "You network is your net worth!". The number of deals you can do is limited by the amount of funding you have available for your business. If you have a large network of Private Money Lenders you could have an endless supply of funding that can be used to scale your business.
Cons of Private Money Lenders
- Mixing Business with Pleasure - Rehabbing houses can be a risk and stressful business and working with friends, family or people within your social circle can amplify the drama, so be sure to remain professional.
- No Regulatory Protections - Unlike licensed lenders, private individuals aren't bound by lending regulations, so the same paperwork discipline you'd get from a licensed lender still matters here, even between people who know each other well.
Reality Check
Treat a private money loan with the same formality as a bank loan, promissory note, recorded lien, and clear repayment terms in writing, even if the lender is your uncle. It protects the relationship as much as it protects the money.
Real Estate Crowdfunding Lenders
Crowdfunding is the process of funding projects by raising small amounts of money from a large number of people, a concept often used to raise money for charitable causes or benefits. The concept of 'pooling money' for real estate has existed for decades, but with new legislation in 2012 and new innovations in real estate, crowdfunding platforms have become a popular option for funding fix-and-flip projects and real estate deals.
Real estate crowdfunding platforms raise small amounts of money from a large number of private investors that is pooled together to fund local rehab projects. These platforms provide a connection between private investors who have extra money and local rehabbers who need money to fund their rehab projects.
Real estate crowdfunding platforms generally offer rates and terms similar to hard money lenders, though these will vary depending on the borrower's experience, qualifications, and financials.
Pros of Crowdfunding Lenders
- Easier Underwriting Requirements (than Conventional) - Crowdfunding platforms can lend on fixer-upper properties that traditional lenders typically avoid.
- Investor Friendly Loan Terms - Crowdfunding lenders typically provide short-term, interest-only loans similar in structure to hard money loans.
- Potentially Larger Loan Amounts/Less Money Out of Pocket - Some crowdfunding lenders offer financing for the purchase and rehab combined. In some circumstances you may need very little money out of pocket if the terms are generous.
- Fast Closing - Crowdfunding lenders can close and provide funding within 7 to 10 days of the purchase agreement.
Cons of Crowdfunding Lenders
- Experience/Financial Qualifications - Since Crowdfunding Platforms are lending other investor's money, borrowers typically have to have a track record of successfully completed projects in order to qualify.
- Relatively Expensive - Crowdfunding Loan terms are typically the most expensive loans available on the market at 10 to 16% interest & 2 to 3% points upfront.
- Paperwork/Documentation - Relative to Cash closings, Crowd Funding Lenders will require additional paperwork upfront for closing and project documentation during the rehab.
- Loan Draws - Unfortunately, Crowd Funding Lenders do not give you all of the money upfront. Your HML will require you to submit a Loan Draw request that includes Contractor Invoices, Lien Releases & Proof of Completed Work in order to receive your Loan Draw.
Traditional Loans/FHA 203k Loans
Traditional loans or mortgages are the most common and cheapest loan type home buyers use to purchase their personal residence. Unfortunately, traditional lenders have strict underwriting standards established by FHA, FNMA & HUD that prevent them from lending on fixer-upper properties that are not in livable condition. For this reason, you may have trouble finding a conventional lender to underwrite a loan for a fixer-upper property that needs substantial repairs.
With that said, FHA offers a loan product called the FHA 203k loan which can be used for both the purchase and rehab costs, but unfortunately the loans are only available to owner-occupied buyers.
This could be a decent option if you are interested in doing a 'live-in' flip where you rehab your own personal residence and then sell the property after a few years of ownership.
Pros of Traditional Loans
- Cheap - Generally, traditional loans provide the cheapest interest rates available to purchase real estate.
- Small Down Payment - Down payments will vary depending on the loan product, but FHA loan down payments can be as little as 3.5%.
- Live-In Flips - If the property is in good enough condition and is 'under-writable', conventional loans can be a good option for 'live-in' flips of your own personal residence.
Cons of Traditional Loans
- Strict Underwriting - Strict underwriting requirements make it difficult for flip projects to qualify.
- Problems with the House - Traditional Lenders will not lend for properties that are not in 'livable condition'.
- Need Strong Credit - Most Traditional Lenders require you to have strong credit to get approved for the loan.
- Income Requirements - Traditional Lenders will also evaluate how much your earn compared to your monthly loan payments to calculate your debt to income ratio.
- Loan Limits - Traditional Lenders generally only lend up to 80% of the property value, which means you have to cover the other 20% down payment, as well as the repair costs & other costs out-of-pocket.
- Slow Closing - Closing typically takes 30 to 60 days which can be a deal-killer for sellers that want to close quickly.
HELOCs
If you are a homeowner with equity in your property, you could use a Home Equity Line of Credit to 'tap in' to that equity and get a line of credit that can be used to fund your house flipping business.
A HELOC is similar to a Home Equity Loan, but instead of receiving a lump sum of cash, you receive a 'credit account' secured by your property. With your HELOC you can borrow cash up to the approved credit limit and only pay interest on the amount you borrow.
Pros of HELOCs
- Leverage Non-Performing Assets - HELOCs allow you to cash out existing equity in a non-performing asset that isn't providing a return, and reinvest it into a performing asset that can generate one.
- Low Interest Rates - HELOC rates are often among the most competitive rates available and are typically in line with conventional mortgage rates.
- No Closing Costs - If you have good credit, you typically won't have to pay an application fee or any closing/appraisal costs.
- Pay Off Whenever - HELOCs offer the flexibility to pay off your loan whenever you wish. Note: some HELOCs charge a fee if you pay off the loan too early or don't maintain a minimum draw balance per year.
- Use It for Anything - Unlike other funding options, you don't have to justify your plans for the money with a HELOC, so you can use it to fund your rehabs.
- No Project Documentation/Rehab Draws - Hard Money Lenders & Community Banks require documentation, inspections & proof of work completed before funds are released. With HELOCs you can draw as much money as you need, and when you need it without the hassle of draws.
Cons of HELOCs
- Decreasing Home Values - If your home decreases in value, you could end up underwater on your home loans, owing more on your mortgage and HELOC combined than your home is worth.
- Rising Interest Rates - HELOCs are generally adjustable-rate loans, so as interest rates rise, so will your rate.
- Hidden Fees - Beware of hidden fees such as early termination fees or minimum loan balance fees.
- Your Home Is the Collateral - Unlike a hard money loan secured by the investment property itself, a HELOC puts your personal residence at risk if a flip goes badly.
PELOCs (Portfolio Line of Credit)
If you are an investor with a portfolio of properties, you could use a PELOC to 'tap in' to the equity across your real estate portfolio.
Similar to a HELOC, a Portfolio Equity Line of Credit lets you take out a line of credit against your portfolio that you can use to fund additional purchases and rehab expenses.
Creative Financing Options
Sometimes you have to get creative to fund your projects, using a combination of the options above.
For example, some investors will use a hard money lender to fund the purchase of the property, and use their own cash to finance the repairs and other project costs. Other investors with little to no money may need to structure financing that gets them close to 100% financing for the project by layering a private money loan on top of a hard money loan, or combining a HELOC with a smaller hard money position.
Still Deciding?
If none of these feel like quite the right fit, or your project is a standard rehab-and-sell flip or BRRRR, it's worth taking a look at
Hard Money, DSCR & New Construction Loans, the investor-specific loan products most active flippers end up using.
And whichever route you take, private investors and crowdfunding platforms included, always
verify who you're working with before sending any money. The verification habits in that lesson apply just as much to an unfamiliar crowdfunding platform as they do to a hard money lender.
