What is Transactional Funding?
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A Short History of Transactional Funding
Transactional funding (also known as same-day funds or “flash cash“) has been used by businesses and investors for many years.
For a real estate investor who needs to take title to a property as a formality, for the purpose of getting it re-sold the same day to another buyer at a higher price, this creative financing strategy provides the short-term funds needed to make this in-between transaction happen.
In the United States, it has become an increasingly common way for real estate investors to fund double closings that occur back-to-back, on the same day.
Prior to the financial crisis of 2008, it was fairly common for real estate wholesalers to use the end-buyers purchase proceeds to fund both transactions in a double closing. This is often referred to as single-source funding.
With this closing maneuver, the end-buyer can sign their closing documents and submit their full payment for the property in the B-to-C transaction. The closing agent will hold these funds until the wholesaler has completed the closing with the original seller in the A-to-B transaction. When all closing documents are signed for both transactions, the closing agent would issue the sale proceeds to the wholesaler for the B-to-C transaction, and these funds could then be used to issue the sale proceeds to the original seller for the A-to-B transaction.
With the significant increase in lending regulations and oversight after the financial crisis of 2008, the seemingly “tricky” nature of single-source funding is less common today.
Double closings are still common, but instead of using single-source funding, it’s much cleaner for the wholesaler to come up with their own cash to close the A-to-B transaction, rather than using the end-buyer’s funds.
Not every wholesaler has a large cash reserve available to buy properties outright, and that’s where transactional funding becomes very useful.
How Does Transactional Funding Work?
Transactional funding is typically provided by a hard money lender or private money lender and is only used when there is an established and well-documented end buyer in place. This end buyer should be ready to buy the subject property from the wholesaler immediately after the wholesaler purchases the property from the original seller, and the sale proceeds from the end buyer are used to pay back the transactional funding loan.
Transactional funding can be used with any type of real estate, provided the closing agent is willing to facilitate both transactions and the lender can verify all the important details before dispersing the funds.
Here’s how transactional funding works:
- The wholesaler/investor finds a motivated seller and both parties agree to a below-market purchase price (the A-to-B transaction).
- When the wholesaler/investor finds an end-buyer, they will sign a new purchase agreement (the B-to-C transaction) to purchase the property at a higher price and close on the same day as the A-to-B transaction.
- The wholesaler/investor secures transactional funding to buy the property from the seller.
- When both transactions are complete, the wholesaler/investor repays the transactional funding loan from the proceeds of the B-to-C transaction and keeps the difference as their profit.
How to Qualify for Transactional Funding
Most lenders who participate in transactional funding will require the investor/borrower to have an end-buyer under contract with proof of the end-buyer’s funds to complete the B-to-C transaction (proof of the end-buyers earnest deposit may also be needed).
The lender may also pull a credit report and background checks on the borrower to verify there are no background issues, collections or judgments against the borrower. They may also do some basic due diligence on the property itself, including a desktop valuation and taking pictures of the interior and exterior.
A transactional funding lender is entitled to evaluate a borrower in accordance with the standard 5 C’s of Credit (which includes pulling a credit report and verifying the value of the collateral), but since there is such a heavy reliance on the borrower’s take-out financing (i.e. – the end buyer’s purchase proceeds and ability to follow through), there is a big emphasis on verifying the borrower’s ability to use the end-buyer’s proceeds to pay back to loan quickly.
In the event that the investor/borrower closes on the A-to-B transaction, but the end-buyer fails to close on the B-to-C transaction (thereby killing the borrower’s exit plan), the lender could take corrective action such as:
- Option 1: Requiring the borrower to refinance their short-term loan with a traditional lender.
- Option 2: If the condition of the property or the credit of the borrower does not allow for conventional refinancing, the lender could take possession of the property and rehab and resell it.
- Option 3: The lender could also wholesale the property to another borrower and charge an origination fee and interest for their time.
Of the three options above, Option 1 is the preferred remedy, and this is why some transactional funding lenders will take extra steps to verify the borrower’s creditworthiness and/or the value and condition of the property.
Advantages of Using Transactional Funding
Transactional funding provides several advantages to an investor who is working as a wholesaler or “middle man” in a double closing.
- With a double closing, the investor can keep a clear separation between the seller and the end-buyer, which reduces the opportunity for both parties to cut the investor out of the deal.
- Transactional funding is typically for 100% of the purchase price. The investor doesn’t have to put down any of their own money to complete the deal.
- It puts the investor on equal footing with cash buyers, providing a competitive edge to close the sale.
- Transactional funding can be used for any type of property—vacant land, single or multi-family homes, condos, REOs, and all types of commercial property.
- Transactional lenders usually don’t require title insurance or appraisals, which means fewer administrative costs to cut into profits.
- Funding a transactional loan takes place in a matter of days which makes it ideal for a quick closing.
- Transactional funding is typically less expensive than hard money loans and fees are paid at closing.
Disadvantages of Transactional Funding
Although the advantages tend to outweigh the disadvantages, it pays to know the potential pitfalls of using transactional funding, such as:
- Transactional funding is very short-term; with most lenders requiring full repayment within 1 – 3 days (some transactional lenders will offer extended terms at a higher rate).
- Some title companies and end-buyer lenders may not be willing to work with this type of funding.
- If the deal doesn’t close in the agreed-upon timeframe, additional fees and interest can get expensive.
How Much Does Transactional Funding Cost?
The fees associated with a transactional funding loan can vary based on the loan amount, the length of the term, and how risky the lender perceives the deal to be.
A common fee structure for transactional funding is anywhere from 1% – 2.5% of the loan amount, but it can cost more if the term extends longer or other risks come into the picture. It ultimately depends on what the lender and borrower negotiate.
A transactional lender typically expects to be repaid within 1 to 3 days (sometimes up to a full week), although there are some lenders who offer extended transactional loans for as long as 360 days.
For example, a lender might charge 2% plus 12% annualized interest. If an investor borrows $150,000, the cost of the loan would be $3,000 plus $49.50 per day in interest.
Some lenders skip the interest and charge a flat “transaction fee,” which is paid at closing.
Can investors use transactional funding for more than a few days?
Theoretically, a transactional lender can extend the term of the loan as long as they’d like. However, the nature of transactional funding is extremely short-term; most loans are repaid within 48 hours, if not on the same day.
If a lender does make extended transactional loans, the borrower should expect to pay a lot more for the money. Some lenders charge as much as 8 to 10 points for longer-term funding; if interest is added on, the costs can be prohibitive.
The longer you need transactional funding, the more the loan will cost in terms of points, fees, and interest. If you need the money for more than 30 to 60 days, alternate forms of financing may be more suitable.
What Are Some Alternatives to Transactional Funding?
If investors can’t close quickly or are unable to work with a closing agent who deals with transactional funding, other funding sources may be required such as:
- Asset-Based Hard Money Loans
- Private Money Lenders
- Joint-Venture Capital
- Bank Loans
- Home Equity Lines of Credit
- Business Lines of Credit