Most real estate investors eventually work with hard money or private lenders. These lenders outline loan terms with a letter of intent, and that letter concludes with a “this is the cash to close” line. When they see this final number, investors often ask: why is my cash to close a negative number?
With positive cash to close, you need to bring money to closing. When negative, you have extra money you can potentially spend. Your financing exceeds the deal budget, meaning you have a good deal. Most lenders won’t provide this negative sum as cash. Instead, they’ll adjust loan terms or amount.
In this article, I’ll explain some more considerations behind negative cash to close numbers. Specifically, I’ll cover the below topics:
- What is Cash to Close?
- Positive Cash to Close
- Negative Cash to Close
- Loan Options with a Negative Cash to Close Number
What is Cash to Close?
Before discussing positive or negative, I want to first explain cash to close. As real estate investors, we throw around the terms “closing costs” and “cash to close” frequently. While both of these terms relate to loans, they mean different things. Closing costs include all of your loan-related expenses besides the loan itself. While not a comprehensive list, common closing costs include: appraisal fees, loan origination fees, transfer taxes, attorney fees, title insurance, application fees, private mortgage insurance, and FHA or VA fees.
On the other hand, cash to close includes all money you need to bring to your loan closing. When working with hard money lenders or private lenders, this includes the above closing costs plus any required down payment minus any lender credits. For transparency’s sake, both hard money and private lenders will provide you a letter of intent that breaks down the general loan terms and all of these costs. The final line of a letter of intent will clearly state “This is the cash to close:” followed by a number.
This final cash to close number can be positive or negative, and I’ll explain both in the next few sections.
What is Positive Cash to Close
This represents the most common option for borrowers. In general, you’ll have a positive cash to close number at the bottom of your letter of intent. This means you need to bring money to the closing. In other words, if you want to close, you owe money. For example, if your cash to close line reads $20,000, you need to bring a check for $20,000 to the closing.
However, just because you owe money to close doesn’t mean that you need to use your money. A variety of creative financing techniques exist to cover cash you owe to close. While not a comprehensive list, here are some of the more common financing options:
- Business line of credit: This line of credit allows you to tap into revolving credit secured by your business operations. With a line of credit, you don’t need to draw money. But, you have the flexibility to draw up to the limit on your line of credit whenever. If you owe more money to close than you have on hand, you can borrow against this line of credit.
- Home equity line of credit (HELOC): A HELOC functions in the same way as a business line of credit. However, HELOCs are secured by, as the name suggests, the equity you have in your personal residence. You typically need to pay an application fee and annual administration fee, but you only pay interest on the money you draw against your HELOC. Once you pay off the outstanding balance, you no longer pay interest and have access to the full line of credit.
- Credit card loans: If you have solid credit, your credit card may offer you the opportunity to take a loan out against your limit. The interest rate will be higher than a mortgage—but far lower than interest on outstanding credit card payments. As a result, you can use these funds to finance your cash to close without accruing standard credit card debt.
What is Negative Cash to Close
What happens if I have a negative cash to close number? As stated, it’s more common to see a positive number, but, occasionally, your letter of intent will list a negative number for cash to close. Accordingly, I’d like to explain this situation—just in case you need to deal with it in the future.
Put simply, a negative cash to close number means you have extra money you can potentially spend. In other words, you’ve found a really good deal, because the lender has offered to finance more than you actually need to rehab the property. You’ve qualified for more financing than you need. Typically, lenders will adjust the loan amount down rather than list negative cash to close in a letter of intent. For this reason, you’ll rarely see a negative number with a hard money or private lender’s letter of intent.
However, if you do have a negative number, you likely won’t receive that in cash. For example, assume your cash to close states ($20,000). NOTE: accounting convention uses parentheses, not negative signs, to reflect negative numbers.
In this situation, the lender won’t give you $20,000 cash at closing. Instead, you’ll indirectly receive that money when you sell the property. Due to the fact that the loan balance is $20,000 less than it could be, when you sell the property and pay off the loan, you’ll effectively net that $20,000. Here’s how it would look:
Option 1: Larger loan balance
- After-rehab sales price: $250,000
- Loan balance: $200,000
- Profit: $50,000
Option 2: Smaller loan balance
- After-rehab sales price: $250,000
- Loan balance: $180,000
- Profit: $70,000
As these basic numbers show, assuming a smaller loan balance results in $20,000 increased profit when you exit the deal. In the end, this puts the extra money in your pocket without the lender assuming the increased risk of a larger loan.
Loan Options with a Negative Cash to Close Number
While lenders typically won’t give you money when you have a negative cash to close number, options do exist. You can request updated, more favorable loan terms to absorb that excess available financing. For instance, you can ask for:
- A larger rehab budget: The amount of money a hard money or private lender will lend you depends on the rehab budget you submit. If your lender will provide you more financing than you initially requested, you can ask for a larger rehab budget. This could let you do some optional work you’d initially planned on skipping, or you could build some contingency room into your budget. Things never go exactly as planned in a rehab, and a little buffer helps.
- Extended lender-paid days of interest: Most hard money and private lenders provide a number of months in lender-paid interest. This provides the investor a cash flow buffer. But, the longer the lender-paid period, the more you’ll need to pay. As a result, you could use that extra financing available in the negative cash to close to extend this interest period. For instance, say the original letter of intent calls for a five month period. You could apply some of this extra financing to request a seven month period, instead.
Bottom line, if you have a negative cash to close option, you likely won’t receive that in cash from the lender. But, options exist to take advantage of this extra financing.