Hard money loans are one of the most important financing options made available to real estate investors, but how can new entrepreneurs make sense of the maze?
Hard money is frequently heralded as one of the most important tools for new real estate investors. It has been said that hard money is the answer to getting started, buying, fixing, flipping, and it’s even a good option for those with bad credit. Of course, the path to hard money requires a bit of due diligence on your part. While it can certainly benefit those who know how to use it, it couldn’t hurt to familiarize yourself with the workings of hard money.
Hard Money 101
Hard money, and sometimes private money, refers to real estate loans that are traditionally approved based on the strength of the asset being offered as collateral. This is in contrast to conventional mortgage lending, which relies on complex data, income verification, asset verification, personal credit scores, and the ability to meet a barrage of other requirements. Common aspects of hard money loans include:
- Higher interest rates
- More points
- Faster closing times
- Less paperwork
- Lower LTVs
Hard money can often be used by anyone for purchasing and refinancing real estate. However, it is most commonly used for flipping houses. An increasing number of lenders are only loaning for business and investment purposes due to the restrictions of Dodd-Frank.
Understanding Hard Money Terms
Although many ‘hard money’ lenders became more like conventional lenders, they still generally operate a little differently than if you went to apply for a mortgage at a bank. This is due, in large part, to the financial crisis we are still recovering from.
They generally have a much shorter loan application, may choose to do their own unofficial valuations, often use attorneys instead of title companies, and they’ll want to know how you plan to exit the deal. Loan lengths are normally short as well. This may range from six months to two years, and rarely extend beyond that.
What’s most notably different, however, is the loan-to-value (LTV) ratio. Depending on the strength of the market, they may offer anywhere between 50 to 75 percent of the value of the property as a loan. When things are really good, they may go as high as 90 percent. They’ll also loan on after-repair-value (ARV), subject-to value, or total costs. This means a loan based on what the property may be worth once you have rehabbed it. Some will include funds for repairs. However, expect to come to the table with some skin in the game and a scope of work ready to go.
What to Watch Out For
- Remember the terms make these great short term loans, but expensive over time
- Ballooning maturity dates
- Upfront ‘application’ fees
- Low valuations based on foreclosure and short sale comps
- ‘Lenders’ looking for deals to scoop
- How repair funds are released
Lenders may not release all of your repair funds at closing. They can often be held in escrow, and released in parts. You’ve got to know this. You’ve got to know how many draws you can get, how much this may add to costs, and what you’ll have to provide to get the money. You may need receipts and proof of payment for repairs made to licensed, insured, and reputable firms.
Track Record Challenges
It used to be that if you could breathe and there was a square of ground involved you got a loan – no questions asked. Of course, time has changed the way things work in today’s market. You now need a proven track record, or something for lenders to go off of past history. This is frustrating for new real estate investors that were relying on hard money loans as their sole source of funding. The good news is that some will grow with you. They may give you a single, more conservative loan, and, if you succeed, will extend better terms across multiple deals. If they insist on a track record, consider bringing in a partner who has the experience.
Where to Find Hard Money Lenders
- Google searches
- Local real estate investor groups
- Referrals from other investors
- Via mortgage brokers
- In person networking
- Mortgage trade shows
Alternative Funding Sources
- True private money lenders
- Real estate crowdfunding platforms
- Mortgage brokers
- Friends and family
- Conventional financing
- Personal and business lines of credit
Hard money loans are an incredible tool for getting into real estate, and for funding great deals when your credit is less than perfect. Just recognize the right time to use them, and mind due diligence to find the best lenders.