Flow of funds Example
THE “HOW’s and WHY’s” of LOAN AMOUNTS & DISBURSEMENTS
As a private lender, we experience confusion from some Borrower’s on how much, when, and why private money loaned funds are determined and distributed.
As a result, we felt it may be helpful to go through the steps of a “standard” fix and flip loan and how funds are disbursed, and related priorities.
EXAMPLE OF A STANDARD 6-MONTH “FIX AND FLIP” LOAN AMOUNTS & DISBURSEMENTS:
ARV = $300,000 PURCHASE PRICE = $125,000 (amount paid for the property)
REPAIRS = $100,000 PURCHASE CLOSING COSTS = $4,500 (taxes, insurance, etc)
Based on this particular example, minimum Borrower’s funds needed total $41,500:
$29,500 minimum funds needed to purchase and improve the property
$12,000 needed for 6 months of monthly 12% (average rate) interest payments
1) Most importantly, a loan request is made on a property that has a market value of $300,000, AFTER the repairs to the property are made “ARV” (After Repair Value). A lender typically lends 65%-75% of the ARV (collateral of the loan). Therefore, the loan amount is determined to be $200,000 (~65% of $300,000).
2) Next, it is determined how much funds will be required by the Borrower, based on their experience, property location and condition, etc (risks) to be involved in the project, exclusive of interest payments needed. Typically, this ranges from 10% to 20% of the Purchase Price of the property. Let’s use 15%, in this example, which means the Borrower needs to have $18,750 ($125,000 * 15%) available to purchase the property and the Lender will provide the remaining funds needed at closing. Notice that the Borrower DOES need to have UPFRONT funds to purchase the property and show proof of those funds available to do so. This is also called “skin-in-the-game”.
3) At closing of purchasing the property, the funds required from Borrower, total $129,500 ($125,000 purchase price PLUS closing costs of $4,500). Of which, the Borrower will bring their upfront funds of $18,750, and the lender will provide the balance owed of $110,750 ($129,500 less the Borrower’s skin in game of $18,750).
4) At closing, the lender TYPICALLY will retain the remaining unused loaned funds. In this case, this equals $89,250 ($200,000 loan amount LESS $110,750) of loaned funds retained by the Lender for future repairs (aka “Repair Funds” withheld) to the project. NOTICE, these funds are retained for future repairs that are to be made by the borrower and NOT advanced to the Borrower.
5) At closing, the Lender will require a Repairs Reimbursement Agreement with the Borrower, based on the Borrower’s disclosed, and agreed upon, repair budget of $100,000. This Agreement specifies when, and how much, of the repairs made will be reimbursed to the Borrower. Oftentimes, Lenders will require a minimum of at least $10,000 of funds to be spent on the repairs, by the Borrower, BEFORE the Lender will reimburse the Borrower. The Lender will not reimburse the Borrower until PROOF (photos & receipts) of the repairs have been completed to the property. Remember, there are $100,000 of repairs needed, but the Lender only has $89,250 held back for those repairs, so the Borrower still needs at least $10,750 of available funds to complete the repairs.
6) As the repairs are made (in increments of at least $10,000) and approved by Lender, the Lender will reimburse the Borrower until the Lender reaches their “holdback funds” threshold. Lender’s Holdback Funds are NOT disbursed to Borrower until the property is 100% completed and marketed for sale. Holdback funds typically are 5%-10% of the total repair budget, which equals approximately $7,500 in this scenario (~7.5% x $100,000). This is the Lender’s protection that the property will be completed ENTIRELY and requires the Borrower to use any of the Borrower’s funds to cover any repair cost overages PRIOR to receiving the final funds from the Lender, should the original repair budget not be sufficient.
7) Assuming the property is improved and sold at the 6-month maturity date of loan, the Borrower would incur additional selling and closing costs, usually estimated at 5% of the Sold/ARV price of $300,000, which equals $15,000. This $15,000 is deducted from the sales price, at closing, and are not funds needed by the Borrower during the project.
8) At closing, the Lender would be paid back their $200,000 loaned funds PRIOR to Borrower receiving any proceeds from the sale of the property. Then, the Borrower would receive $85,000 ($300,000 LESS $200,000 loan LESS $15,000 selling/closing costs) at closing.
9) Finally, for the efforts of the Borrower’s risk and time, they will PROFIT $43,500 on this project. This profit amount is derived from the $85,000 received at closing LESS the $12,000 interest expense paid by Borrower during the loan and LESS $29,500 for reimbursing the Borrower’s skin-in-the game funds for purchase price and repairs. In mathematical summary, see the following:
Sales Price $300,000
Less:
Loan Payoff ($200,000)
Closing Costs (15,000)
Interest Paid (12,000)
Reimbursed (29,500) (borrower’s skin-in-game)
Borrower’s Profit $43,500
Realizing that understanding the different loan structures can be confusing, we are always available to discuss your specific needs and questions. Don’t hesitate to reach out to us for any lending needs you may have! We are here for you and strive to make lending easy and the process simple!!