Some starting capital is essential to qualify for a hard money loan. This is a topic that we discussed at length in our previous articles (see our blogs on Why No Money Down Hard Money Loans are a Pipe Dream and Why Private Mortgage Lenders Want You to Invest in Your Deal). The reason for it is simple: the lack of seed capital is the primary challenge for many new real estate investors. However, as with everything else, where there is a will there is a way.
Among the many benefits of working with a local hard money lender like us is the flexibility of our underwriting. Our hard money loans are not credit-score driven, and we don’t verify our borrowers’ income. When it comes to borrower’s contribution to the transaction, we accept a more diverse variety of sources than traditional lenders. There are many creative ways to raise funds to qualify for a hard money loan. In other words, not having a chunk of money sitting in your savings account does not automatically disqualify you from being a real estate investor. You need to think creatively and look for sources of funds that might not be obvious. To help you do it, we’ve put together a list of sources you can tap to make a sufficient contribution to your hard money loan transaction.
Six Ways to Get The Capital for Your Hard Money Loan
Partner With Another Rehabber:
Many new investors find themselves in the same situation. They have boundless enthusiasm for the fix-and-flip business. Some have already participated in one or more rehabs indirectly – either by being a real estate agent representing a more seasoned real estate investor or by being a part of a renovation crew. Others might have spent considerable amounts of time and money attending real estate investment seminars and courses. These hard-working folks have some savings, but not quite enough to strike out on their own.
If this is your situation, consider partnering with a like-minded aspiring investor who has some money and energy to contribute to your flip’s success. What you can’t do alone, you can do in a partnership with the right person. Between you and your partner, you might have just enough seed capital for a hard money loan. Another advantage of a reliable partner is having someone to share the daily grind of managing your rehab. Chances are you are keeping your day job – at least for now. Sharing responsibilities for your fledgling business with someone you can trust will make the process faster and smoother.
A choice of partner is paramount to the success of your venture. Make sure you and your partner have the same expectations and the same risk tolerance. Put as much of it in writing as possible. Form an LLC to protect your personal assets from any liabilities incurred by your partner in the past or the future. Keep the number of partners to a minimum. Read our previous blog of What Not to Do When Having Partners.
Find A Money Partner:
A money partner is someone who can provide you with the required seed capital for a hard money loan. The lion’s share of your fix-and-flip will be bankrolled by a hard money lender to whom you will pay an interest rate. A smaller share will be supplied by your money partner who will likely ask for a percentage of your profits. You will contribute your time and expertise to manage the renovation and the sale of the property successfully.
The first place to look for a money partner is your circle of friends and family. You need to identify the folks that have some money and some entrepreneurial spirit. They might not have the time or expertise to manage the project themselves. Instead, they will rely on your determination, skill, and honesty to safeguard and grow their money.
Tap Home Equity Line to Contribute to Your Hard Money Loan Transaction:
For those who prefer to maintain sole control over the transaction, tapping the equity in their primary residence offers a great alternative. If you have a decent mortgage payment history, check in with your current mortgage lender. Many lenders offer home equity lines of credit up to 95% or even 100% of the current market value of your home. This amount is likely to be more than enough to make a required contribution to your hard money loan transaction and set some money aside for reserves.
Cross-Collateralize with Another Property:
I must admit that this scenario doesn’t come up too often, but we do see it at least a couple of time per year. If you have a property that is free and clear, a hard money lender like us can tap this property by cross-collateralizing against it. What it means is that we put a lien on both your existing free and clear property and a new rehab property you are purchasing using a hard money loan. The equity in your existing property effectively serves as your contribution to the transaction. Once you repay your hard money loan, both liens – the one against your existing free and clear property and the one against your fix-and-flip property – are removed.
Defer Taxes with Self-Directed Retirement Plans:
Using self-directed retirement plans to invest in real estate is arguably the most effective way to build long-term wealth. The ability to harvest real estate profits without immediately triggering taxes allows your nest egg to grow faster than when you invest with traditional non-tax deferred funds such as cash or savings. The most common vehicle for buying real estate with retirement funds is the self-directed IRA. As a hard money lender, I see more and more of our borrowers taking control over their retirement by converting their existing IRAs or old 401K plans to self-directed plans. While a self-directed IRA account is relatively easy to set up, you must be aware of specific rules to avoid trouble with IRS. Self-directed IRAs is an exciting topic, and I’ll talk more about them in our future blog.
Get Your Hard Money Loan Contribution by Borrowing Against Retirement Plans:
If you are not quite ready to switch your current retirement plan to a self-directed IRA or are unable to do it for any reason, you can consider borrowing against it. You need to consult both your plan administrator and your accountant on the repayment terms and tax consequences of doing so. Any profits you make using those funds will not be tax-deferred. However, they might provide you with a great way to get you started in the rehab business.