October 3, 2018
A principal goal at Bay Mountain Capital is to make the entire loan process as easy for borrowers as possible. As many BMC borrowers are first-time flippers, this glossary hard money lending terms will help them understand industry jargon. For the experienced borrowers, consider the glossary a valuable refresher.
ARV: Stands for “After Repair Value” or “After Rehab Value.” ARV is the whole point of flipping houses; this is where borrowers make their profit. The ARV is the anticipated price increase due to any rehab and repairs flippers complete. For the borrower to make a profit, the estimated ARV must exceed the initial purchase cost plus the rehab budget.
Exit Fee: The exit fee is a percentage of the loan amount paid as part of the pay-off on the loan amount. It’s usually a lower percentage than the origination fee.
Gap loan (aka bridge loan): A gap or bridge loan is a short-term loan. Depending on the nature of the deal, short-term can run anywhere from three to 12 months. Borrowers seek short-term loans if they need to move quickly on a property. Usually, these borrowers don’t have enough time to wait for a conventional mortgage. BMC typically only makes short-term loans on commercial properties where gap loans are needed to close sales contracts before expiry. Gap loans fill the gap where quick cash is needed before the longer-term loan or available capital can be accessed.
Interest: The interest charged on a loan is the cost to the borrower for taking the loan. Interest is always expressed as a percentage.
Interest-only loan: A borrower only makes interest payments on an interest-only loan during the life of the loan, until the entire loan comes due. An interest-only loan contrasts with the more commonly known amortization loan, where the borrower pays both interest and a portion of the principal balance throughout the life the loan. Interest-only loans are used on property rehab projects to limit the cash needed to do such a project. The expectation is that the rehabbed house will get sold before the flipper’s loan comes due. Thus, the flipper only needs cash to pay the loan interest. They later use cash from the resale of the property to pay off the loan balance.
Lien: A creditor, such as contractor, can place a lien on a property for any amount owed to the creditor. A property with a lien filed against it can’t be sold until the creditor has been paid and the lien is lifted.
Loan term: Refers to the length of the loan until the balance comes due. In the case of the typical BMC single-family loan, the term is 12 months. More seasoned flippers with a history with BMC may take a loan with a six-month term.
LTC: Means “loan-to-cost” and is represented as a percentage. The LTC is calculated by dividing the loan amount by the total project cost. On a project where the property costs $100,000 and the rehab budget is $40,000, the total project cost is $140,000. A borrower getting a $120,000 loan on this project has an LTC of 85% (120,000/ 140,000) and has to provide the extra $20,000 to complete the project. In some cases, BMC will offer a 100% LTC if the LTV on the project caps at 70%. What’s LTV? Read on…
LTV: Stands for “loan-to-value” and is also represented as a percentage. LTV is the portion of the loan relative to the resale value of the property. If the loan amount is $140,00 and the estimated resale value or ARV of the rehabbed property is $200,000, the LTV on this deal is 70% (140,000/ 200,000). In most cases, BMC caps LTV on the loans it originates to 70%.
NOO: Means “not owner occupied.” It’s common to see “OO,” which means “owner occupied.” Both NOO and OO refer to whether the borrower who bought the house for rehab is also living in the house. Different financial and legal rules apply if the borrower/owner is living in the house, which is why most hard money lenders including BMC only make loans on NOO properties.
Origination fee: Typically expressed as a percentage of the loan principal, the origination fee is paid by the borrower to the lender to generate the loan. The origination fee is different from a processing fee, which generally refers to the amount paid to the process the loan application.
Points: A point is slang for one percentage point, used primarily in the context of interest and fees. A lender may describe the 12% interest rate on a loan as “12 points.”
Principal Balance: If a borrower’s loan is for $100,000, the principal (or loan amount) at the start of the loan is $100,000. If the terms of the loan require the borrower to make payments on the principal, the principal balance goes down over the life of the loan.
Proof of funds: Is a document that verifies the borrower has sufficient financial resources to complete a transaction. In the case of the borrower who gets a loan on 85% LTC, the borrower has to cover the remaining 15% of project costs from funds other than the loan. The lender will require proof of funds in the necessary amount before agreeing to originate the loan.
Term sheet: A single document that contains all the relevant terms of a loan, such as loan amount, interest rate, loan term, and fees. It also commonly contains certain conditions and due diligence requirements, such as proof of title and title insurance. Borrowers use the term sheets provided by different lenders to compare their loan options.
Title (insurance): Having “title” to property means one owns it free and clear; no one else has a legal claim to it. Borrowers need to buy title insurance to protect themselves and the lenders against the potential that an outside party will claim ownership of the property being sold.
Use of Funds: Borrowers ordinarily need to detail to potential lenders how they will use the borrowed funds. Flippers have to provide hard money lenders a rehab budget that details how they’ll spend their loan.
Did we miss any of the terms of hard money lending? Let us know at info@baymountaincapital.com so we can build it into the list. Interesting in applying for a loan for your next flip? Check out our terms and apply today.