New Funding Resources 
As a private money lender, we work with a broad spectrum of borrowers, from first-time investors to those with substantial experience and funds of their own. It’s self-explanatory why someone with only modest savings needs to work with a private lender. However, why would someone use them if they have enough cash of their own? The answer, my friends, is leverage. This article is a continuation of our series on hard money calculators, so if you need a refresher, please read our article on Hard Money Calculator Basics.
Financial Leverage Refers to the Use of Debt to Multiply Profits
To leverage something is to use it to the maximum advantage, and it is by far my favorite financial mechanism. Financial leverage refers to how a person or organization borrows money to invest. Leverage can help finance all sorts of things, like a home (mortgage payment), vehicle (car loan), or college education (student loan). For individuals, paying out-of-pocket for these big-ticket items oftentimes is unrealistic. Thus, leverage might be the only way to afford a home, car, college education, or other major purchases.
Financial leverage refers to the use of debt – aka other people’s money – to acquire additional assets and multiply profits. Any mortgage is technically leverage that allows a borrower to purchase an expensive asset without paying 100% of its price with his or her own money. However, working with private money lenders takes such leverage to a different level.
For fix-and-flippers, hard money lenders provide superior leverage than conventional lenders.
Let’s say you have $40,000 and want to invest it in real estate. If your conventional lender’s downpayment requirements are 10% of a purchase price, it means that you can purchase a property with a price tag not exceeding $400,000. In other words, a conventional lender enables you “to leverage” $40K into buying an asset valued 10 times more.
Specialized programs that were created to promote homeownership offer a more aggressive leverage. For example, with an FHA loan, you can buy a primary residence with as little as 3.5% down. That means a FHA loan allows you to leverage your $40,000 into an asset sold for more than $1.1 million. Of course, such leverage comes with strings attached. FHA loans have strict requirements regarding credit scores, debt ratios, and the property’s condition. Perhaps most importantly, they are not intended for investment properties.
What differentiates the leverage offered by hard money lenders is that it is not based on the purchase price of your property. It is based on the future after-repair value of that property. It’s literally the leverage on steroids. Let me illustrate it with the same $40,000.
Let’s suppose you found a distressed property that is offered for $180K. You estimate it might take another $40K to make it all shiny and new. Once the renovations are completed, it might sell for $300,000. Under this scenario, a private hard money lender like New Funding Resources might extend a loan of $195,000. That’s right, they might potentially provide you with so much leverage that their loan would exceed the purchase price of the property!
Working with Private Money Lenders Maximizes Your Return on Cash
Annualized return on cash is one of the best ways to understand and measure leverage. It measures how much profit is generated in twelve months as a percentage of your initial cash investment. If you put $1,000 into your savings account and end up with $1,015 after twelve months, your annualized return on cash invested is 1.5% ($15 divided by $1,000). Yes, it’s often referred to simply as the interest rate.
Let’s look at the same example we did earlier in this article: you are a real estate investor leveraging $40K in cash to purchase a distressed property for $180,000 and requiring $40K in renovation. If you enter it into our hard money loan calculator, you see that you are slated to generate close to $30K in profits if you sell the property in twelve months and for $300,000. What that means is that by leveraging $40K in cash, you were able to recoup this $40K and then generate $30K in profits. Your annualized return on this transaction is almost 70%!
Leverage Allows You To Diversify Your Real Estate Investments
Using leverage to buy several properties instead of one has other advantages. If you are an experienced investor with a good head on your shoulders, I certainly hope that most of your flips are profitable. A few of them are home runs and a few – let’s be honest – probably fell below your expectations. It’s the nature of the business, and some factors that influence the profitability might be beyond your control. What’s within your control, though, is the ability to hedge your risk by not putting all your eggs in one basket. Just like when investing in the stock market, you want to diversify your assets. The leverage provided by private money allows you to do that.
Working With Private Money Lenders Keeps You Liquid
Of course, you can argue that you would not be able to find seven properties to invest in at the same time. It might be true but consider another factor. Real estate is not necessarily the most liquid asset. Do you want to invest all your money at once in one property? If you could make the same profit by investing only a fraction of your cash and have plenty of money left for other investment opportunities or life emergencies, wouldn’t you rather do that?
Real estate investors in Maryland, Virginia, and Washington, DC, can use leverage to prosper. They won’t ever miss an investment opportunity because they’re low on funds; hard money lenders finance the lion’s share of the property purchase and investment. A hard money loan provides the leverage a borrower needs to purchase an expensive asset like a fixer-upper or buy-and-hold property. First-time investors, rehabbers or landlords with shallow pockets can use what assets they have to maximize their advantage. That’s one way leverage is used in property investment.
Just like a small business owner uses leverage to fund a business expansion, property investors can use leverage to expand their business opportunities. To start flipping houses or to take your existing rehab business to the next level, contact us. As a hard money lender in Maryland, Virginia, and Washington DC, we offer unparalleled leverage to borrowers.
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