What is a rehab loan?

A rehab loan is a fast financing option developed specifically for investors that flip foreclosed properties. It is a short-term loan, ranging from six months to one year. The interest rate is higher than in a conventional mortgage.  The initial loan amount covers the purchase of the property, with the rest of the capital coming in draws during multiple stages of the renovation.

How does a rehab loan differ from a hard money loan?

One difference is that a lot of hard money lenders have minimum loan amounts of 500,000 - 1,000,000 USD, which is way more than what most investors need for a rehab loan.    

Hard money is a loose term that describes any loan given by an individual or an institution that does not fit under conventional mortgage guidelines. The main difference between the two is that a hard money loan is based on either the property’s current value or the purchase price (LTV) , while a rehab loan is based on the after repair value (ARV). This makes a rehab loan a much more suitable tool for fixing and flipping properties, as its gives the investor a lot more leverage on a property by allowing them to obtain more capital.

To illustrate the above example, let’s look at a typical rehab scenario and what the numbers of each financing option would look like.

Disclaimer: This spreadsheet contains an over-simplified breakdown of the costs and fees involved in these loans. The numbers in these scenarios are only meant to highlight the differences between the two financing options, and should not be viewed as a representation of specific terms on either type of loan or the expected return on capital.

hard money vs. rehab loan

For a hard money financed purchase, most private lenders would look at the purchase price as the value to base the loan on. Hard money loan-to-value ratios range from 50 to 75 percent, with most falling around 60%.

If the borrower decided to go with a rehab loan, they will get up to 70% ARV, with the initial down payment of 10-15% of the purchase price. In the case study, the ARV would cover both the purchase and the work needed, but the lender would still require an initial investment from the borrower to ensure they have skin in the game.

Finally, there is another major difference between the two financial products that is very beneficial to investors. A hard money loan is amortized with interest only payments, while the rehab loans we offer are paid off in whole at the end of the term. This gives the investor additional freedom in their liquidity so they can allocate the assets to other areas.

The above example illustrates how a rehab loan is far more beneficial financial product to a real estate investor because it is specialized to suit the typical rehab scenario. The major differences and advantages of a rehab loan over a hard money loan are:

1.       Less money down.
2.       Greater return on investment.
3.       No payments until note matures.
4.       Smaller loan amounts accepted.
5.       Residential purchases and cash out refinancing for free and clear properties only.