One of the biggest worries of new house flippers is what happens when they can’t sell their flips.
It’s a legitimate fear…but one you don’t need to have if you just take a few precautionary steps with your lenders ahead of time.
To do this though, it largely depends what KIND of loan you have on the house.
Here are two scenarios that you may come face to face with and how to deal with them.
1. Private Lender Lenders
When you’re working with a private money lender – this could be a family member, a friend or a business acquaintance, you’re the one who’s setting the terms.
So when you write that promissory note, you’re going to personally guarantee the loan. I do this on all my note holders; I personally guarantee them, depending on the situation.
If it’s an equity deal, then it’s a little different – but on a pure note we usually personally promise them. It’s really important to me to make sure my lenders are well protected.
I do this because I don’t want to be in a position where I can’t pay off that note only because it went beyond the 12 months. So what we typically add in a stipulation our promissory note that includes a “when the property sells” provision.
The idea is not to make you lazy or give you a false sense of security, but to protect you in case hings go wrong.
Never forget that in house flipping, time is money and you never want to be in a property longer than six months.
This provision just gives you a little extra layer of protection to know that you’re not going to be foreclosed on hard by your lender.
2. Hard Money Lenders
If you’re in a deal with a hard money lender, then the rules are completely different…so this section is a bit more lengthy.
When you borrow hard money, the hard money lender creates the rules, they’re professional lenders just like bank and most of them really know their stuff.
Some house flippers, eager to get their first deal funded with a hard money lender, get too aggressive and set their terms for six months.
Big mistake…
Never, ever, ever get into a six-month loan with a hard money lender. I don’t recommend them; its just not enough time, especially when you’re first starting out flipping.
Its completely plausible that you could buy a property and it could take you 60-plus days just to rehab it. Not that you want to take that long on a rehab, but it can happen.
If the rehab takes 60 days, thats two full months into it and only after that, you can list it and start the selling process.
But lets say its towards the end of the year and it took a couple of months for the selling season to come. Or perhaps you could sell it right away. Regardless, it will still take you 30 to 60 days to close.
See how six months can just go by quickly?
The Most Important Question to Ask a Hard Money Lender Is…
For a hard money loan, always go longer than a six month term. Always try to get at least 12 months out of your hard money lenders.
Then in doing so, ask this important question first:
“Mr. Hard Money Lender, I want to close this deal very quickly – in four or five months or sooner. However, if I run into some complications or maybe some cost overruns, what’s going to happen if in 12 months I don’t sell it?”
Of words to that effect…
You really want to know what he thinks will happen if at the twelve month mark it doesn’t sell.
What does he do at that point?
See what they say by asking that question and then closing your mouth to see what they say.
The hard money lender might say they’ll foreclose. If that’s the case, you’ve got to be very cautious with this lender
Or they might say:
“We like you. We don’t want to see you fail. We make damn good money lending you money. We will look at the deal at that point and we would talk about an extension.”
Sounds more promising…but get it in writing just to be sure.
Quite honestly, with one of my hard money lenders, I don’t think I have this anywhere in our documents. But I know he’s not going to foreclose on me. He has no interest in doing that. He would be killing the goose that lays the golden eggs, so to speak.
With this hard money lender, I trust him and we have a strong relationship that works and has worked on dozens of flips.
But you may not know with your lender. If that’s the case, you need to look him in the eye and ask the question above and see what the reaction is. This needs to be done live, in person, face to face.
The 12-Month Extension Clause
Do whatever you can to get in a clause that allows the extension of that 12-month note. When it comes to these things, it’s far better to be proactive than reactive.
Knowing these strategies, having these conversations with your lenders, letting them understand what possibly could happen is critical to your success as a house flipper.
I always like to under-promise and over-deliver as a general rule to all my customers – as well as be as transparent as possible at all times. Do the same with your lenders so they know all the potential pitfalls of what could happen.
And this is especially true with the hard money guys who really know the game. They know what can happen when things go wrong house flipping…and some might try to take advantage of that, so beware.
One of the best things you can do to prevent this from happening is making sure you ask them what they’ll do if things get extended. Its one fail-safe way of protecting yourself in the unlikely event that things go wrong with your flip.
Read original article here: https://www.biggerpockets.com/blog/2014-03-02-house-flips-when-they-dont-sell