Fix-and-flippers use hard money loans because they can finance both the purchase and renovation of a home in one short-term, interest-only loan. Many short-term investors look for houses in poor condition, that if renovated, could sell for more than their current market value. These houses are typically found at short-sales, foreclosure auctions or lender-owned REO properties.
Using a hard money loan, fix-and-flip investors finance the initial purchase of the house as well as the necessary renovations. Fix-and-flippers typically obtain hard money loans equal to a percentage of a property’s after-repair-value (ARV), which is the expected fair market value after all renovations have been made.
Once a property is purchased with the initial funds from the lender, investors start their renovations, receiving renovation financing from hard money lenders in stipends or “draws,” typically in the form of a line of credit. This means that fix-and-flippers typically have to float rehab costs until they receive funds from the lender.
During renovations, fix-and-flippers pay a hard money lender interest-only payments. At the end of the hard money loan, fix-and-flippers repay the loan through the sale of the house for a profit. If you want to dig deeper into this, read our detailed example of how rehab loans work.
Buy-and-hold investors typically use hard money loans when an investment property isn’t in good enough condition to qualify for a traditional mortgage. This is because traditional lenders won’t issue conventional mortgages for houses in poor condition. Buy-and-hold investors can also use hard money loans to season units before refinancing into a permanent loan.
To circumvent this funding problem, long-term investors use hard money rehab loans to finance the initial purchase and renovations of the asset. Once renovations are made, long-term investors rent out the property, refinance the improved home with a conventional mortgage, and use the loan proceeds to pay off the hard money loan.
Sometimes a buy-and-hold investor who may qualify for permanent financing will need access to the financing right away, like when they’re competing with all-cash buyers at real estate auctions. In these cases, long-term investors rely on hard money loans for a quick approval process and a fast funding time.