Gorman sets up a simple LLC (limited liability company) to hold a second mortgage on the house at a higher rate than the first. “You can do this a couple of times a year. As time goes on, you will create a substantial side income.” He says that he did this three or four times per year over 15 or 20 years and never lost a dime.
Refinancing with a new mortgage is not as easy today as when property values were skyrocketing and interest rates were low, but it’s still appropriate in some cases. “Even today, you see some people with higher-than-market interest rates and a lot of equity, which makes this a viable strategy,” Gorman says. That makes it a good idea to ask prospects about their current interest rates when talking about financing options. Some people will include extra cash for investments if they can get a higher rate for that money than they are paying for the mortgage.
Financing on the improved home value is where the lender lets the borrower refinance for the projected value of the home after the improvements have been completed. It’s only appropriate for large projects, and it requires that the contractor have some market knowledge and financial sophistication.
Some lenders are more aggressive about chasing these loans than others. For instance, Countrywide Financial has a formal One-Time-Close program for large remodeling projects where the cost of the renovation is 50% to 60% of the existing value of the home. It’s a combination construction loan and mortgage, according to Al Dimoush, the company’s executive vice president of National Construction Lending.
Say that your customers have a home worth $500,000 and they want a $300,000 remodel, including some interior work and an addition. An appraiser determines that the completed house will appraise for $800,000, so they get approved for $720,000, which is 90% of the appraised value. At closing, $400,000 goes to pay off the underlying first mortgage. The remaining funds are drawn out as the project progresses. During construction, the customer makes interest-only payments. They start by paying interest on the $400,000, then on increments as the construction loan is drawn down. When construction is complete, the loan automatically converts to a permanent mortgage.
This doesn’t work for smaller renovations that will not sufficiently increase the home’s value. It’s also not the best proposition for borrowers with low first-mortgage rates. If someone has a 5% first mortgage, it makes little sense to pay that off with a 6% or 7% loan.
The contractor needs enough market knowledge to predict the value of the completed house, as well as a working relationship with a good appraiser. We see problems when the borrower or builder doesn’t clearly communicate the scope of work to the appraiser,” Dimoush says. “This includes big mistakes, like not accurately defining the square footage, or smaller ones, like [getting the wrong] specs for flooring. It’s important that the appraiser knows exactly what needs to be done.”
This type of financing is also used by buyers who are considering buying a home but will only do so if they can borrow enough to make the improvements they want.
Keith Steier, president of Knockout Renovation in Manhattan, finds that a lot of these people don’t actually end up buying, so he now charges a $300 fee for preparing the estimate for them to bring to the bank. “We started doing it about a year ago,” he says. “We get calls for estimates three or four times a week, but a lot of them don’t want to pay the fee. It weeds out those who are speculating or are not serious buyers.” If they end up hiring his company to do the work, he credits the fee toward the job.
There’s often more to credit products than what’s on the surface. With a little creativity, you can learn to use them in ways that bring you jobs you might otherwise have lost, as well as profits you’d never considered.