If you are looking for a rehab investor loan on residential property, there are a number of rehab loan terms you will want to be familiar with. For most residential rehab investor loans, you will be making interest only payments for anywhere from three to twelve months. Many of these residential rehab loans will have an interest reserve built into them. This is not the same as a prepayment penalty, and we will take a look at the difference in this post.
One of the most important aspects for a rehab investor should be knowledge of the prepayment penalty involved with the rehab financing. Most rehab loans have an interest reserve of some type built in, but you need to differentiate between that interest reserve and your prepayment penalty. Let’s take a look at the various options typical of these types of loans.
Prepayment penalty – There are two basic types of prepayment penalty, a straight prepayment penalty and a guarantee of interest. A 6 month guarantee of interest is not the same as a 6 month prepayment penalty.
Typicaly prepayment penalties equal out to 80% of 6 months worth of interest. With a 6 month prepayment penalty, if you pay the loan off in month 5, you still owe the same penalty as if you paid if off month one.
Guaranteed interest, however, is different. It guarantees the investor that you will pay interest for a given period of time. Using the above mentioned example, a 6 month guarantee of interest paid off month five would cost you only one month worth of interest.
Finally, we get to the interest reserve. An interest reserve is not guaranteed interest nor is it a prepayment penalty. It is a reserve account set up to make your payments for a set amount of time. Interest reserves are great, as you can typically get them financed into the rehab loan, and if you pay the loan off before the interest reserve runs out, you get that money back (unless you have a prepayment penalty of one type or another). When combined with a builders control account, you can rest easy (and so can your investor), knowing that you should incur no out of pocket expenses for a period of time while the rehab is being done.
Most rehab investor loans for residential fix and flip transactions should have no prepayment penalty. Be sure to ask your investor how yours is structured, and remember to make sure you differentiate between a prepayment penalty and an interest reserve.