When loans need to happen fast, or when traditional loans will not get approved, hard money may be your only option. So let's crack this crab down!
What is a Hard Money Loan?
A hard money loan is a short-term loan secured by real estate. (the collateral, the physical asset). Unlike traditional loans who are based on your (the borrower) credit score. Hard money loans can be obtained from individual “private” investors, funds or an investor group as opposed to conventional lenders such as banks or credit unions.
The terms are usually around 12 months, but the loan term can be extended to longer terms anywhere from 2-5 years. The loan requires monthly payments of only interest or interest and some principal with a balloon payment (one big payment) at the end of the term.
The amount the hard money lenders are able or willing to lend is directly based on the value of the property. The property can either be a property you (the investor/borrower) already own (with available equity) and can use as a collateral or the property you are trying to acquiring. This is why when the banks say “No”, the hard money lenders can still say “Yes” even in cases of recent foreclosure or short sale.
Which Property Types can get Hard Money Loans?
You can get a hard money loan on almost any type of property: single-family residential, multi-family residential, commercial, land and industrial. Some lenders may specialize in specific markets/niches. It is a good thing to ask them upfront which type of loans they are willing and able to do. Many hard money lenders will not lend on owner-occupied residential properties due to the extra rules and regulations. Almost All hard money lenders will do loans in 1st lien position (rarely 2nd) because of the increased risks for the lender.
Why Use Expensive Hard Money Lenders (HML)?
Hard money has its place in your portfolio strategy, mainly when you cannot get traditional funding when you need it.
Speed: because of the property collateral focus (instead of your finances), hard money loans can be closed faster than traditional loans. Lenders are not looking to acquire your property, and so they spend less time going through a loan application (verifying incomes, bank statements etc.). Invest time to build relationships with lenders, once you can move faster, you can close more deals. Speed is a great advantage in hot markets!
Flexibility: hard money agreements can also be more flexible than traditional loan agreements (no standard underwriting process here). Depending on your situation and built relationship, you might negotiate better repayment schedules, interest rates and more. You can also borrow more than with traditional loans require 5 - 20% down payment. The lower the down payment the higher the interest. A HML might lend up to 100% of the purchase price and even 80% ARV (after repair value) for only interest payments and of course the balloon payment at the end.
Approval: Most hard money lenders keep loan-to-value ratios (LTV) relatively low between 50% to 70%, so you'll need assets to qualify for hard money. With ratios this low, lenders know they can sell your property quickly, make profit and get their money back. So this might give you leverage when starting out and having no history to fall back on for the traditional loans. Once you build report and portfolio you can expand to a Line of Credit with traditional loans with lower interests.
When Does It Make Sense?
Short term loans, like for a quick Fix-and-flip you just want to own a property just long enough to increase the value. Buy Fast, Fix, Flip, Repay and Cash Out. If you plan to hold you might need to refinance fast once there is a value add with a traditional loan.
Hard money loans are ideal for situations such as:
Fix and Flips (speed and difficult with traditional loans)
Land Loans (traditional loans avoid risk)
Construction Loans (traditional loans avoid risk)
When the Buyer has credit issues.(No personal credit check but NOI)
When a real estate investor needs to act quickly.
Considerations With Hard Money Lenders
Hard Money Lending has it’s time and place in your real estate investment strategy. As a new investor you really need to dive deep into your numbers to see if and when it makes sense to partner with a HML. Always calculate for:
Higher “double digit” interest rates (12 - 20%) that might considerably lower your profits.
High initiation fees also known as Points. These are additional fees a lender charges for giving the loan. A point refers to a percentage point of the total loan amount these may go up to 10% in some cases depending on the risk even higher.
Closing costs: 2% – 5%
Independent appraisals: $300 – $400. Usually the HML will appraise very conservative on your investment to make a safety cushion in case of a forced foreclosure, so your loan value/amount can be lower than expected.
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How To Get Approved For A HML?
It makes sense to think of the Hard Money Lender as a colleague investor. The Money-Lender is not trying to get ownership over your investment, but rather trying to find out if it’s a great investment providing you with enough cash flow to pay back your loan and profit. So make it as easy as possible to qualify/evaluate your investment.
The approval and funding process:
Prequalification: As little as 3 minutes in most cases almost instantly online
Funding: As quick as 3 – 5 days (longer for higher amounts)
This allows investors to compete with all-cash borrowers and close on a house quickly.
Loan Qualification Checklist
Hard Money Lenders have standardized loan qualifications for their private money loans and will expect to see the following during prequalification:
Credit Score of 550+
2 – 3 Months of Bank Statements
Property Location & Expected Purchase Price
If you need a rehab loan you will need to get the renovation budget approved and funded:
Curriculum Detailing Experience and Prior Projects
Renovation Scope of Work
After the closure, the lender will also want to have the following documents:
Purchase Contract stipulating the agreed purchase price and terms of sale
Title of the Property or 1st Lien Position on the Property
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