A subject not often discussed is some of the downsides to hard money borrowing. I talk to lots of folks on both forums and experienced investors are very aware of some of the pitfalls associated with this practice.
Anyone who knows me knows I am not shy about talking about sensitive issues and this isn’t a white paper on the hard money dynamic but I can share some personal info I have personally accrued over the last 4 years.
Hard money can open doors never available before. The flip side is it is a seductive partner that can leave you hurting without the discipline or means to repay in a timely manner.
My HM lender is Bruce, and a typical loan is structured with 5 points and 12
% interest(now 15%). Collateral is two lakefront free and clear properties appraised at 1.4M (600K+and 750K) this gives us a credit line of approx 700K (50% max LTV). We’ve never pulled this kind of cash, but we borrow 100- 160 several times per year. We can repay as we please with a point of balance minimum payment due each month…P&I due in full in one year.
In good times, this works well.Borrow 160K put up4 L/H packs sell two, put two in rental portfolio,rinse,repeat.foolproof, nobrainer, right? In a declining market it can get messy. The interst keeps ticking each month and what has happened in my business, the availability of this cash has made us lazy. Instead of working tirelessly to finish them up and get 'em sold (the way it is with personal money) there is procrastination…160K costs only 1600 per month, right? After 10 months we just paid 16K in interest.
Fortunes are made by the disciplined usage of HM. No one I know would have the assets they have without leverage. The problem we have is we haven’t been real smart the last few deals. To work well with hard money in my market these things must hsppen:
A clear, concise plan on what the funds will be used on.
A clear time line.
Delegation of responsibilities. (who does what when)
No funds comingled.
6, Clearly defined exit stratagy.
We owe 23K on the remainder of our last HM loan of 160K and we will have that paid 6/1/08. We probably won’t borrow more without tightening up our business plan.
Some of the mistakes we made with this last batch of homes.
Funds were co mingled. LH money got mixed with retail purchase homes and month to month bill paying. Bad idea…Job costing was miserable, we lost receipts for two septics (3400) and over 4K in lumber, carpet,pergo. This skewed our profit number onall four homes. Took 5 months to get the first 2 sale ready (should take 5-6 weeks). Didn’t buy land at rock bottom prices…we had 160K inthe bank, why negotiate it to death? Stroke a check and move on (laziness). We will still make good money on these homes, but not the money we should have…and we both know it.
On a personal note, I’m not up at 7AM readt to hit it hard, get up at 8 or 9 go barefoot ski for an hour, be in the office by 10 or 11. Not good. That is the seductive part of this for me…have $in the bank, and if we run short, borrow some more. I reread DOW and this is EXACTLY what Lonnie warns about…it carried into my personal life…last month I had 16K in CC debt. Put 5400 on it and all gas, meals, etc. are cash this month.
I’m writing this to put this up for discussion, if it shows a weakness on my part I am OK with that. This is important stuff and I believe that a problem shared is halved.
What brought this up for me was Bruce commenting, " Greg,this is the longest you have ever kept a file open…I like it!" I don’t like making him rich(ER). He has over 7M out today.
Any comments? happened to you? Is this common? Thanks all!