IC E-Lesson: Understanding Transactional Funding
In the past few weeks, I’ve gotten several questions from students about transactional funding that show that this relatively new kind of loan is still widely misunderstood.
The transactional funding business, at least as we understand it in the residential real estate business, had its origins in the short sale boom in the middle of the last decade. It sprang up to solve a problem: banks, when accepting short sales, began to forbid assignments of contract, requiring instead that the buyer (meaning, in this case, wholesaler) actually close on the property.
This was a problem that wholesalers were willing to pay to solve. But the traditionally-available investor loans didn’t fit the bill: both traditional and hard money lenders had qualification processes that were too long and too expensive to make sense when what the wholesaler needed was money for, say, an hour just to close and then resell a deal.
In fact, the more traditional loan products actually slowed down the process of re-selling the property, since getting a mortgage means getting a mortgage release, payoff, and so on.
So, with typical American ingenuity, someone looked at the situation and said, “What if I could provide financing that didn’t last more than a few hours, and somehow didn’t require a bunch of recorded paperwork to secure my investment?” and transactional funding was born.
The purpose of transactional funding is to give wholesalers no-qualifying financing for just long enough to buy a property and then immediately resell it. There’s no reason to appraise the property or check out the “borrower” if the property will literally be sold in a matter of hours after the loan is made, right?
In fact, transactional funders will typically not even wire the money to the attorney or title company until the end buyer’s money is already in the escrow account.
In other words, transactional funding is not a loan that allows you to close a deal and then look for a buyer—it’s a loan that allows you to close a deal when you’ve already found a buyer, and that buyer has already funded his purchase of the property with the title company.
That’s the only “protection” transactional lenders have—the fact that the title company/attorney has strict instructions (from the lender himself) that the lender’s money is not to be released for you to buy the property until your buyer has already put his money in the closing company’s escrow account and a closing has been set up, generally the same day as your purchase closing.
Transactional funding isn’t cheap. Companies charge between 3.25% and 5% of what you borrow for the funds, and most have an application fee for $500 to $1,000 dollars (if you’re wondering why, it’s because they get about 3x as many “applications” as they get actual closings—the company does all the work, prepares the paperwork, sets aside money to close…and then the deal falls through. The application fee covers their expenses for this administrative work. At the same time, you should be suspicious of lenders with extremely high fees; there are some who have to reputation of making all their money on fees rather than on actually making loans.)
But it’s REALLY cheap compared to losing a deal, assuming your deal is profitable enough to handle the additional expense of borrowing the money.
So to review:
- Transactional funding is only for wholesalers, and it’s only for the purpose of closing a deal so that you can immediately resell it.
- It is NOT a loan in the traditional sense. The buyer must already be in place before your title company can get the money from the transactional lender
- It’s not cheap, but it’s probably better than losing a deal and all the profit from it
One other service that a lot of transactional funders offer is a “pre-approval” letter. This is a letter, on their stationary, that states that you have been pre-approved for $xx,xxx in funding by them; in theory, it’s a way of getting past the bank requirement that offers on short sales and bank-owned properties be accompanied by a pre-approval or proof of funds letter.
Beware, though; many transactional funders have not taken any steps to appear that they’re real lenders online. When an agent Googles the company, they find that 1) the funding is only for 24 hours and 2) these letters are for sale by the company. Agents are on to this game, as are asset managers and lenders, so if you try to use one of these letters, your offer may never even get considered.
Also be aware that while most funders will charge a small one-time fee of around $300-$400 for these letters, others make most or all of their money JUST SELLING LETTERS. They do not, in fact, fund deals, though they claim to; they simply collect fees for fake pre-approval letters.
Need a transactional funder? Nationwide, try BestTransactionFunding.com. In the Cincinnati Tri-State area ONLY, one of my companies offers both transactional funding and extended transactional funding (up to 3 months, with different terms than a typical transactional loan); you can contact me about that at InnerCircle@theRealEstateGoddess.com
Transactional funding is another resource you should have in your tool box as a wholesaler; there are times when the seller or the situation requires that you close the deal, and transactional funding is an effective way of doing that.