Like many things in business, the first place to start to ensure any process goes smoothly is proper planning and expert providers. In the case of hard money loans, this planning is relatively simple and painless compared to traditional loans. With this guide, you will learn everything you need to know about obtaining a hard money loan and working with hard money lending. The first step is determining what type of project you are funding and your exit strategy for that loan.
What is a Hard Money Loan?
A hard money loan is a type of short-term financing that most commonly used for real estate investment properties. Hard money loans are provided by private individuals or companies (often referred to as “hard money lenders”) rather than traditional banks or financial institutions.
Hard money loans are also different from standard loans because they are collateral-based, meaning that they can be secured with the equity from the real estate property. This makes these types of loans quicker to get approval for, more flexible, and not reliant on credit score, unlike standard loans.
How Do Hard Money Loans Work?
The time it takes to qualify and get a hard money loan is much faster than a bank loan.
The hard money loan process is relatively short since hard money lenders do not spend time with stringent conventional bank criteria for loan approvals. They focus on sound real estate investment and business models. Most first-time borrowers are surprised to learn their credit rating is not one of the main criteria to get a loan.
This is where Hard Money lenders differ from other conventional lenders. With a Hard Money Company loan, the borrower receives the money directly, as opposed to other companies that broker out a loan. Because the loans are collateral based, they are secured against investment properties that are submitted to purchase or already owned, and are handled quickly.
It is important for the client to remember that collateral, the amount the borrower contributes towards the purchase, location of the property, and—for cash out loans—the equity in the property are the determining factors for hard money loan approvals. Typically, clients provide 10–30% cash down. Primary residences can very rarely be used to get a loan, with the exception of a bridge loan or the money is being used strictly for business purposes. Once approved, points are generated for acquiring the loan but because a hard money loan is not conventional, these percentages can be discussed with the lender. Hard money loans have terms between 12–24 months and include additional fees such as legal, tax and appraisals. Once the terms and fees have been decided then the property will be given a valuation. This is generally determined through a Broker Price Option (BPO) or an independent appraisal.
What Are the Requirements for a Hard Money Loan?
Regardless of the type of loan you are pursuing, most hard money lenders will require the following information in order to finance your project:
- Cost of initial property acquisition and purchase contract.
- Estimated After Repair Value (ARV) of property.
- Proof of funds for down payment on the loan.
- Proof of income
The lender may utilize factors such as appraisal, purchase price, and nearby property values in order to determine the Loan to Value (LTV) of the borrower’s property. First loan terms and fees for things like appraisal, taxes, and legal fees will be determined. Then once terms are set, the broker will move forward with determining the LTV. With a high quality lender, nothing should seem hidden or unknown. Any reputable hard money lender will clearly communicate to potential borrowers what their process for application and lending looks like. Expect the process to move quickly and with clarity.
How Long Does It Take To Secure a Hard Money Loan?
Non-consumer hard money loans can close in a little as 2-3 days. This is because hard money loans specifically designed for businesses have the least amount of regulations. So, if escrow is already open and a preliminary report has been prepared for the loan, it can be funded quickly.
How Are Hard Money Loan Rates Set?
Setting up any type of traditional loan almost always starts with the lender reviewing the borrower’s financial information and credit worthiness to see if they think the borrower will be able to pay back the loan in a reasonable amount of time. The lender also considers whether the potential reward of making a profit through payback plus interest is worth the risk of being only partially paid back or not paid back at all. However, with a hard money loan, the lender often doesn’t look too closely through financial documents at all and there is a much quicker turnaround time. This is, in part, due to two reasons, the first being that they often come from private lenders which often have less red tape, and the second being the borrower puts up property as collateral.
Even with collateral, the lender is still giving out money with a possibility they won’t be paid back. Combine this with the lack of financial information the lender likely received from the borrower, and it becomes clear that hard money loans can carry a pretty high amount of risk for the lender. This is why, in order to help mitigate the risk, hard money loan rates are often high, anywhere from 2-10% higher than the interest rate of a traditional mortgage.
Pros and Cons of Hard Money Loans
The positive aspects of working with a hard money company are that you work with the private lender directly, there are less requirements to get a loan, speed, decisions based on profitability for the borrower and lender. Frequently the decision on the loan approval is based solely on the asset value and the contribution from the client.
A hard money loan is not for you if you are looking for a personal loan, a primary mortgage, or debt payoff. A Hard Money loan requires a property as an asset.
What Types of Projects Are Hard Money Loans Used For?
Hard money loans are generally seen as alternative options to traditional loans or short-term bridge loans for a lot of financial transactions. They are primarily used in real estate transactions and put down as collateral to secure the transaction.
Fix and Flip Loans
A fix and flip loan is one where the purchaser is investing in a property in order to renovate and resell the property at a profit. Hard money loans are very popular with fix and flip loans as they allow the borrower to secure funds quickly in order to purchase available properties in a competitive property market. The exit strategy for these loans is to repay the borrowed amount with the profit from selling the property.
Buy and Hold Rehab Loans
A buy and hold rehab loan is one where the purchaser is investing in a property in order to maintain ownership, often for the purpose of renovating the property and then listing it as a rental. The exit strategy for buy and hold loans is typically to refinance the loan into a traditional mortgage once renovations are complete. This is sometimes called the “buy, rehab, rent, refinance” approach. In the case of a hard money loan funding renovations to a property which you already own, this may be called a rehab loan.
Bridge Loans
A bridge loan offers quick access to capital in order to continue work while securing long-term funding. The exit strategy for a bridge loan is usually refinance.
Commercial Hard Money Loans
A commercial hard money loan is used for multi-family dwellings, industrial, retail, and other commercial settings. The exit strategy for these loans is more likely to utilize business capital or refinance.
The first step is determining what type of project you are funding and your exit strategy for that loan.
