Hard money loans may fill some with confusion and others with fear. There’s great uncertainty when it comes to these types of loans loans, but when used properly, they can be a truly effective tool that can help you finance real estate investments or take on new property opportunities, on top of other potential assets, without needing to deal with traditional lenders. Read on to learn more about hard money loans and how you can find a hard money lender to work with.
With traditional loans, the lender requires proof of your ability to repay them on time and in full. They will ask you for your income history, employment, and credit scores, all to determine if you have a good history of borrowing and repaying – thereby predicting if you would be a candidate for a loan. The process is intensive and slow, even when you have good credit and income history. Negative items on your credit can lead to an even longer process that may not even end in an approval.
Hard money loans are short-term bridge loans that are based entirely on the value of the property instead of the borrower’s credit worthiness. With a hard money loan, the property or asset that you want to buy becomes collateral for the loan. Therefore, if you fail to repay your loan, the lenders can get their money back by seizing the property and selling it. This naturally makes the value of the collateral more important than your past credit history.
Due to the inherent risk involved, most traditional lenders, including banks, will not offer hard money loans. Most hard loan lenders are private investors or small groups who may see value in the risk.
Hard money loans are designed to be short term, usually lasting just one to five years, which should be enough time to finish most projects. Most people would not recommend going longer because of the high interest rates.
Property Types for Hard Money Loans
Although you can potentially use hard money loans for different types of assets, they are most often reserved for real estate. Hard money can be used to purchase just about any type of property, including:
- Single-family homes
- Multi-family residences
- Commercial buildings
- Land development
- Industrial properties
Some hard money lenders have one specific niche or specialize in one type of property. For example, one group may offer hard money loans for commercial buildings but won’t do loans for large, multi-family condo units due to a lack of experience.
Furthermore, new rules and regulations have scared most hard money lenders from providing loans for residential properties that the borrower intends to actually live in. There are, however, some lenders that may be willing to wade through the paperwork to help the borrower.
Interest Rates for Hard Money Loans
Interest rates for hard money loans vary greatly based on a wide range of factors, including region. Hard money lenders in California, for instance, tend to offer lower interest rates because of the sheer amount of competition throughout the state.
Overall, you can expect hard money loans to have much higher interest rates than traditional loans, mainly because of the inherent risks involved. Interest rates are usually around 10 to 15 percent depending on the lender and the property, and you can expect to pay up to 4 points. Points are a fee that you pay to the lender as a means of lowering the interest. One point equates to one percent of the total loan.
Hard Money and Loan-to-Value Ratios
The loan-to-value ratio is measured by the total loan amount divided by the value of the property. Lenders use this ratio to determine how much money they can actually lend you. Hard money loans generally have low loan-to-value ratios. Most hard money lenders will loan about 65 to 75 percent of the current property value.
Some lenders will take into consideration the after-repair value, or ARV, and base the loan amount on that. The ARV is the estimated value of the property after you have completed repairs and renovations and should ideally be higher than the property’s current value.
However, the ARV presents higher risks for the hard money lender as there are no assurances for the final value after the home’s renovation. Furthermore, with after-repair value, the lender puts in more capital while the borrower’s invested capital decreases.
In order to offset those high risks, hard money lenders may charge higher interest rates and may even offer to pay for parts of the rehab costs, but you can expect even higher interest rates up to 18 percent and 5 to 6 mortgage points with little to no down payment. Still, if you think that you can generate a profit from the project, it may be worth it to take on the extra risk.
Why Should You Use a Hard Money Loan?
Hard money comes with a ton of benefits for those who can’t get traditional funding when they need it. The biggest benefit is convenience and speed. With other conventional loan types, the lender has to take time going through your application, verifying income and employment, reviewing credit scores and bank statements, and covering all their bases to make sure you can repay them. That can take up to 45 days, even more if you have any negative items in your credit history or run into any discrepancies in your application.
With hard money loans, the lender still needs that information, but they are mostly concerned with your property and its collateral value. That means they don’t need to spend as much time analyzing your application, which inevitably means faster approval. Once you have found a lender and built a relationship with them, the rest of the process should move quickly and smoothly. In most cases, you can close a deal on a hard money loan within one week.
Hard money lenders are also much more flexible. Remember that most hard money loans come from private investors, not large corporations. These private investors don’t often have a standard underwriting process or set terms, and they usually look at each deal individually. That also means you can actually talk to the investor like a person, which often means negotiating your loan terms. You may be able to change repayment schedules or even reduce or eliminate certain fees.
Approval is also much more simplified with a hard money loan. Your collateral is the most important factor for a hard money lender. They will disregard any foreclosures or other negative marks on your credit history. Some lenders will even allow further flexibility here. For example, some lenders may allow you to secure a loan using a retirement account, a residential property that you own, or other assets.
Some Drawbacks to Hard Money Loans
Really the biggest drawback to a hard money loan is the cost. You can expect to automatically get charged 10 percent higher than conventional loans, on top of costs for origination, loan servicing, and closing.
Hard money loans are short-term and designed specifically to help investors get a property on the market as quickly as possible, but that also means that they have shorter repayment plans. If you do choose a hard money loan, it’s important to understand just how soon your property will be profitable and how much of a profit it may generate so that you can repay your loan in full.
When to Use a Hard Money Loan
Hard money loans are best for short-term investments. Fix-and-flip investors most commonly use hard money loans. They purchase a property long enough to perform any repairs, increase its market value, and sell it, all usually within one year.
The quick funding from hard money loans is also a big benefit to real estate investors who are often competing for a single property against several other bidders.
Hard money loans are ideal for:
- Fixing and flipping homes
- Land loans
- Construction loans
- Those who may have credit issues
- Real estate investors who need to act quickly on a potential property investment
You can potentially use a hard money loan to purchase a property that you plan to occupy, but you would want to refinance as soon as possible to avoid the high interest rates.
The Loan Process: How Do Hard Money Loans Work?
To get a hard money loan, you have to connect with the right investors, which means finding those in your community that lend based on collateral. A good place to start is local real estate agents and real estate investor groups. Once you find someone who can cater to your needs, you can begin to develop a relationship and fund your projects.
As with any loan, hard money loans start with an application, which should be less intensive than traditional loan applications. Some lenders may not need as much of your financial information. Most will mainly need information about the property, including its purchase price, repair costs, and after-repair value.
Hard money lenders will usually also require a draw schedule, which shows your plans for renovation, when you plan to make each of those changes, and the cost of each change. The lender can use this to schedule its own periodic payments. Most lenders will require that you pay the first draw before they proceed with the next payment as a means of protecting themselves.
You will also need your property appraised before you can get your funds from the lender. An appraisal is an estimate of the property’s real worth as determined by a licensed appraiser. This gives a lender a good idea of how much to actually give you.
If you are looking for a hard money loan, Del Toro Loan Servicing can provide you with the personalized help that you need through in-depth services, experienced personnel, and connections through our expansive network of brokers and lenders. Contact us today if you have any questions about getting a hard money loan for your next real estate investment.