The average consumer may not have ever really thought about transactional lending or even what it is. When it comes to financing real estate, most activity and interest is focused on regular mortgages and their interest rates. However, investors have very different requirements, especially when they’re engaged in fix and flip or wholesaling.
So, what is transactional funding?
Transactional funding is very short term lending to facilitate a real estate deal. Fix and flip investors and real estate wholesalers both need this type of funding unless they happen to be cash rich. Let’s talk about wholesalers first. They normally locate deep discount properties that they can flip to another investor without any rehab work on the property. They are profitable only if they are very good at locating distressed owners or foreclosure/pre-foreclosure properties before the competition gets wind of them.
If they want to totally control the property and increase their profit, they enter into a purchase contract and actually commit to buy the property. They have their buyer lined up, usually another investor, perhaps a rental property buyer. Their goal is to commit only the earnest money required by the seller to lock up the purchase, and then they want some transactional funding to close the purchase. They schedule their buyer’s closing later the same day or maybe the next day, and the transactional funds are required to actually buy the home so that they can sell it at the second closing.
The transactional lender provides the funds to buy the home at the first closing, and they collect their fees and get their loaned money back at the second closing. Fees are substantial, and many deals require somewhere between $2,000 and $5,000 in interest and fees for the use of the money for the short period between closings. However, the wholesale investor can normally get more for the home in this type of transaction, and they factor those fees into the deal when they offer it to their investor buyer.
The fix and flip investor has a very different time span for their loan, as they are going to take ownership of the home and then complete rehab and repairs on the home before it is sold, again, normally to another investor. Fee structures change a bit, and the short term lender may charge lower fees, but their profit is increased by the interest on the loan until the home is sold. This can be for weeks or months while the work is completed. Even if the cost of this type of loan is high, fix & flip investors, at least the good ones, enjoy higher profit margins. They make money on the home, as well as on the rehab work they do to bring it up to marketable condition.
Where do you find these lenders and what do they require for a loan?
Investors can locate transactional lenders through local real estate investment clubs, or a quick search on Google yields a great many companies in this business. One lender’s website makes the process sound simple:
This is simple. A one to three day, back-to-back real estate transaction funding involves three parties and two stand-alone closings.
“A” – Seller
“B” – Investor
“C” – End Buyer
“A” sells to “B” (AB Closing) and “B” sells to “C” (BC Closing)
This is pretty much how it works. The lender’s risk isn’t really tied to anything like the investor’s credit history or their personal debt load, unlike the normal mortgage lender’s concerns.
For wholesalers, transactional lenders are concerned with the value of the home as it exists when purchased. They will limit the funds loaned to an amount below value that will cover them should the final buyer (C in our example) disappear and the lender must take the property and sell it. For fix & flip investors, the lender will also consider the ARV, After Repair Value, of the home, as well as the experience level of the fix & flip investor and their previous successful deals. They will issue “proof of funds” letters for investors to use in putting deals together.
For people looking to enter real estate investing using short term strategies, transactional funding will be of interest, and there is plenty of availability for those who do their research. Carefully consider all of the terms and conditions, as well as the total of fees and interest.
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