Here at Fund That Flip, we’re always looking for ways to manage risk for our investors. One tool we use quite frequently is the length (or “term”) of the loan. All rehab loans on our platform are written with six to twelve month terms.
This means that at the end of the term the borrower owes us all accrued interest and the principal. This is a powerful risk management tool because as the term comes due, if the borrower isn’t able to repay the principal, as a lender, we have legal rights to protect our investment.
This very simple mechanism does a few really important things from a risk management perspective:
It provides a really strong incentive for the borrower to complete the project on time. The faster work is completed on the project, the faster value is being added. This has an effect of lowering our Loan-to-Value ratios. The sooner equity value is added to the project, the better.
It provides a natural mechanism for us to be able to re-underwrite the loan at the end of the term. Often times we write six month loans with the expectation of extending for another three or six months. However, if at the end of the six month term, the project risk has increased, we retain the option to not extend and pursue a strategy sooner rather than later to recover our accrued interest and principal.
It allows us to have more control on the decisions being made by the borrower. The best example of this is when a borrower is holding out for a higher sales price than we believe the market can support. As the term approaches its end, a borrower will need to move quickly to sell the property at the risk of the loan entering default.
Setting appropriate loan maturity dates is a great way to ensure incentives are tightly aligned with our borrowers. As long as the borrower is working diligently and value is being added, we will always work with borrowers to offer appropriate extensions.
Pro Tip: Pay close attention to the term of each loan and understand if the loan includes an extension clause. If there is an extension clause, be prepared for the term of the loan to be extended. Include this in your timeline of when you can expect to get your principal returned.
While loan extensions can seem frustrating, keep in mind that as a lender, an extension means greater return in the future. Take a look at open investment opportunities and email us if you have any questions about our underwriting criteria. We’re happy to jump on a call any time to answer any questions you may have.