A hard money loan can be used to quickly fund real estate renovations, flips and rental property deals. But how can you refinance a hard money loan you used to purchase the property? We discuss all options in this post.
Refinancing Works Great for Hard Money Loans
Using a hard money loan to renovate and rent properties can be a great way to finance the rehab construction stage. This will allow you to get a more traditional loan from another financial institution when the property matches their condition requirements.
You can go to a bank after the property is out of the high risk category in terms of its physical condition. Traditional lenders are more likely to finance your property when it is ready to be leased.
Hard money loans are a temporary form of financing that is usually 1 year or less for full repayment. Holding a hard money loan beyond that on a rental property not recommended due to the high interest costs. Conventional mortgage loans have lower rates, which will help your cash flow.
Steps to Refinance a Hard Money Loan With a Traditional Mortgage Loan on a Rental Property (BRRR)
- BUY: Get a hard money loan to buy the property
- REHAB: Rehab the property
- RENT: Lease the Property
- REFINANCE: Refinance the hard money loan with a lower rate long term mortgage
- Hard money lender
- Traditional lender
- Title Company
Hard Money Loan to Traditional Mortgage Refinancing
After finishing your typical 60-90 day rehab and securing a renter for your property, it’s time to refinance with a traditional loan.
The new loan will often cover the closing costs along with the previous loan, so the LTV ratio will probably be a bit higher, around 65-75% versus 60-70% for the hard money loan. The renter will provide cash flow for the property which will help secure the new loan.
You should not need a downpayment for the refinancing because that was already provided when you purchased the property using the hard money loan. The new loan will also have a lower interest rate.
Types of Refinance Loans for Hard Money Borrowers
1. Fixed Rate Mortgage
Once your hard money loan is approaching maturity, refinancing using a fixed mortgage is recommended to stabilize your cash flows and avoid high interest payments.
Fixed rate mortgages are a long term option. They are ideal if you intend to hold the property as a cash flow investment for a long time.
Documents needed to get a fixed rate mortgage:
a. Credit History
b. Your Property Sales Contract, including all parties
c. Property Listing Sheet
d. Property deposit verification
e. Names, addresses and telephone numbers of all realtors, builders, insurance agents and attorneys involved
f. Proof of Income
g. Full tax returns for previous two years
h. Year-to-date profit and loss statements, and 2 year pro-forma cash flow projections.
i. Tax forms: IRS Forms K-1 when using S-Corporations, LLC or partnerships for the previous 2 years. Filled out and signed 1065 Federal Partnership and / or 1120 Corporate Income Tax Return with all additional addenda, schedules, and statements.
j. Proof of down payment source of funds (since you are refinancing a hard money loan, this will have already been paid). You can get additional funds from selling other investment properties, using savings, selling stocks or bonds or any other investment/asset you have.
k. Proof of an Earnest Money Deposit
l. Copies of all insurance policies
m. Copy of Title Insurance
n. Documents of further debt or obligations
2. Subprime Loan
The subprime lending market has options available for those with lower than average credit scores (FICO score below 640) and/or high debt to income ratios.
These types of loans are designed for higher risk borrowers and thus offer higher interest rates and shorter maturities. Subprime mortgage lenders cater to real estate investors with less-than-favorable credit scores or risky property cash flows. These loans are often used by borrowers that do not qualify for traditional fixed income real estate loans.
Types of Subprime loans:
- Adjustable-rate mortgages (ARM)
- Fixed-rate mortgages
- Interest-only mortgages
- Dignity subprime loan
Subprime loans undergo much more strict bank compliance and regulatory reviews than traditional fixed rate mortgages. The Consumer Financial Protection Bureau (CFPB) currently oversees subprime mortgages. Recent CFPB regulations have prevented some borrowers from getting subprime loans.
Documents needed to get a subprime loan:
a. Proof of income
b. All relevant bank statements
c. Two to six months of expenses
d. The same documents above for fixed rate mortgages
3. Home Equity Loan
Home Equity Loans are meant for borrowers that have built-up equity in their properties and have a high credit rating and proven cash flows. They work best for individuals who own a couple rental properties.
Home equity loans offer much lower rates than hard money loans and typically have a fixed payment schedule. Banks will often lend up to 90% LTV if the real estate market is strong and the borrower’s credit score is stellar.
These loans are a great option for investors that have invested significant cash into a property and hold a strong equity position with a low LTV on the hard money loan (< 50%). They are ideal for fix and rent investors looking to hold the property for the long term as a rental.
4. Cash Advance
Cash advances are available for all types of borrowers, but come with much higher interest rates than other real estate loans. They also rely heavily on the borrower’s credit rating, which may not exist if the property was purchased under a newly-formed LLC or S-corp.
Cash advances can be granted quickly, usually within 24 hours. This gives a real estate investor the opportunity to move fast.
These can be a great option for paying off a smaller hard money loan that is facing a balloon payment deadline. You can use a cash advance to buy some time and provide liquidity while you search for a buyer or renter.
One of the key factors to consider with cash advances is the ability of the lender to call the loan or cut off further credit quickly. This isn’t always caused by missing a payment, either. Bank policies change along with the economy, and calling in cash advance loans is usually a priority if the market turns down.
Because of the high interest rates and lack of committment to a fixed maturity by the lender, cash advances should be one of the last resorts. They should be approached with caution when refinancing a hard money loan.
Documents needed to get a cash advance:
a. Business revenue, expenses, cash flows and balance sheet
b. Proof of legal business ownership
c. Copies of recent tax returns
d. Copies of any credit card processing statements
e. Drivers licenses of the manager / owners and a voided check
f. Documents that show any UCC liens against the business
g. Business invoices and rental receipts as proof of income
5. Hard Money Bridge Loan
If a borrower faces a due date on their original hard money loan and cannot secure a traditional real estate loan, they may be able to refinance using another hard money bridge loan.
Your rehab and rent steps in the BRRR (Buy, Rehab, Rent, Refinance) process should normally allow you to get traditional refinancing. But occasionally it does not work out this way.
A hard money bridge loan will allow you to refinance and extend your due date without any risk to your personal credit. It’s “hard money” and therefore secured by the property and other collateral you put up.
Reasons for Refinancing with a Second Hard Money Bridge Loan
- The rehab project may have taken longer than expected
- The property rehab cost much more than expected
- You might not have gotten a renter (or enough of them in a multi-unit property) to provide sufficient cash flow to qualify for a fixed mortgage.
- A mechanic’s lien put a mark on the property title
- Delayed building or rental permits
- Contractors did not complete the project fully
- Family issues or a major life event delayed the project
Bridge Loans are Still Expensive
Financing with a hard money bridge loan is an expensive option compared to refinancing with a fixed rate mortgage. However, you will probably pay far less in interest on the bridge loan than the original hard money loan. This is because the property is in much better shape after renovation.
Your property is probably worth significantly more, bringing the LTV down. Since the property is now valued “after renovation” or “after repair” this reduces lender risk. This justifies a lower interest rate.
Bridge Loans Are NOT Cash Out Refinancing
You should expect a bridge loan to be limited to 65-75% of the LTV of the property. These loans are not good for cash-out refinancing because the lender will always value the property conservatively. They will not take into account your credit rating or ability to repay the loan beyond the collateral value.
Switching Hard Money Lenders is a Red Flag
A hard money bridge loan with a different lender than the first hard money loan requires going through the entire approval process again. This may be viewed as a red flag — why wouldn’t the borrower just go back to the original lender who stands to lose much more if they don’t refinance and extend the loan? As a result, refinancing one hard money loan with another hard money loan is not that common.
If the property has sat on the market for under 200 days the original hard money lender may be more inclined to refinance it with a new bridge loan.
6. Private Money Loan
If you are struggling to refinance your hard money loan, a private money lender may be willing to give you funding. The private lender may want a portion of the sale value of the property, and may get directly involved in the property renovation project or marketing the property.
There is a lot more flexibility available with private money loans. These lenders can come to the rescue when other options are not available, but you can assume they will take their “pound of flesh”.
Lenders That Refinance Hard Money Loans
Below are a selection of lenders who will refinance a hard money loan.
Hard Money Bridge Lenders
Banks and Mortgage Lenders
Additional Information on Refinacing Hard Money Loans
Refinancing is NOT a Cash-Out Opportunity
Refinancing a hard money loan on an investment property is not usually an opportunity to pull cash out. Most refinancing loans are limited to only paying off the hard money loan balance and closing costs. Typically, you are borrowing just enough to repay and prevent a default on the hard money loan.
Refinancing Loan Maturity
Conventional fixed rate mortgage loans provide borrowers with long repayment timeframes from 10 to 30 years. A long maturity loan provides you with time to build up equity in the property, using renters to pay off the mortgage.
With a long maturity loan you can incrementally improve he property as well. Your initial hard money loan is usually used to fix major issues and make the property marketable to buyers and renters. But these initial rehab projects usually meet the minimum marketability requirements. Your property may be “Plain Jane” when you first get it on the market. If you have a lot more time to work with, you can enhance the property and move it upscale.
Normal mortgage loans are often used to finance 90% of a property. In some cases they can cover close to 100% financing.
In comparison, hard money loans are generally limited to 60-75% of the loan to value. Higher than 70% LTV is rare, and above 75% is exceptionally rare and only in hot real estate markets where the flipper has a long history of success.
Key Terms You Should Know
This is total debt divided by total income.
Traditional borrowers will usually require 45% or less. Other qualifications may increase or lower this rate depending on the borrower’s risk level.
This is total loan value divided by current property market value.
Traditional mortgages can reach 90% LTV or even higher. Hard money loans are usually 65-75% LTV.
High LTV loans are considered high risk and thus come with higher interest rates and stronger terms. Also, LTVs that are very high may require the borrower to carry mortgage insurance to qualify for a refi loan.
There are a Range of Options to Refinance a Hard Money Loan
The options presented here provide strategies for hard money loan borrowers to refinance their loan. Refinancing a hard money loan is best for longer term real estate investment projects, and to avoid defaulting on the hard money loan when it matures. Once your hard money loan is refinanced, you can begin making lower payments and hopefully pocket significant profits!