Updated September 9, 2020
A hard money loan is when a borrower receives funds in return for offering up real property as security. Hard money loans are often provided by investors or companies at higher interest rates than conventional loans, both because of the shorter term and the higher risk.
How to Get a Hard Money Loan
- Save up for a down payment
- Find a reputable lender
- Show investment potential
- Apply for a loan
- Protect yourself
- Make a quick repayment plan
Noticeably missing from this list of steps are some of the concerns that a borrower would have to face when working with traditional mortgage lenders, such as working on their credit score, securing a well-paying salaried job with a long-term track record of success, and all the various other odds and ends that make up traditional consumer financing.
This is because hard loan lenders are engaged in asset-based financing. Their asset-based loan is a way for investors to obtain funding for an investment, regardless of their personal credit score or work history. Hard money lenders don’t care about the ability of the borrower to make monthly payments as much as they care about getting their money back, or having a nice piece of property as collateral. They know that the loans they issue are short-term loans with higher interest rates, which will provide them with financial benefits and minimized risk.
Traditional lenders invest lots of time and energy analyzing whether or not a borrower can repay the loan, and particularly if they can repay it with monthly payments—since it would be unlikely for a consumer purchasing a home to pay off a loan in one large lump sum. By contrast, hard money lenders know that they’ll either get their money back (with interest) or they’ll acquire some real estate. Their focus is not on the borrower, but more on the asset the borrower wants to purchase or improve.
What Is a Hard Money Loan?
Getting approved for a loan with a more traditional lender like a large bank is a painfully slow process—and investors in fast-moving industries cannot afford to be slow. While banks have made applying for a credit card a simple online process, applying for a mortgage is still a process that can take months.
Traditional lenders are interested in credit scores, borrowing history, and debt-to-income ratio—which they view as factors indicating your ability to repay your loan.
Hard money is a way around these potential issues.
Hard money lenders are actually less concerned about your ability to repay the loan. They are more interested in the collateral, which they can take and sell if you’re not able to repay the loan.
Hard money loans will have higher interest rates, and they are regarded as a short term solution between financing construction and a long-term mortgage; for that reason, hard money loans are also called swing loans or bridge loans.
How to Get a Hard Money Loan
Save up for a Down Payment
Most hard lenders will not loan you the entire amount needed to finance a project. Instead, they will use a calculation called the loan to value (LTV) to minimize their risk. The LVT is basically the ratio of the loan to the value of the property. For example, if you need to borrow $700,000 to finance a $1 million apartment building, the LTV is 70%.
As it turns out, most lenders don’t want to get in deeper than 70%, though most will cover at least 60%. If you need more than that, they’ll often want another piece of collateral as security, and only issue the loan if they can place a lien on another piece of property you own.
In the case of a hard money loan, you will want to have around 30% of the property covered with cash in hand. Though there are some different strategies for obtaining that cash, one of the easiest is just to actually have it in the bank, built up from savings. This will make your project more appealing to vendors, and eliminate their need to place liens on additional properties you own.
Find a Reputable Lender
If you’re actively involved in real estate—or hoping to be—you’ll want to make sure there are some reputable hard money lenders already in your network, so you don’t have to scramble to find a good one whenever you have a deal on the proverbial ice. Some hard money lenders are genuinely interested in helping you finance your project, while others are pure loan sharks.
There are a few barometers you can use to gauge how trustworthy a lender is. Do they have a professional-looking website, or is it simply a landing page for gathering your personal information to pass on to a third party? What do other investors say about this lender? Are there any outstanding lawsuits against them? Do they have a portfolio of past projects? Can you meet them or a designated agent in person? Many genuine hard money lenders will want to see (or send someone to see) the property you’re offering as collateral.
Some lenders might only focus on specific types of projects. For example, if they finance hospitality ventures like hotels, they may be reluctant to finance other types of commercial real estate or residential real estate. Knowing which lender is best suited to your particular project will help everything move faster and more easily.
One way to set yourself up for success in finding great lenders is to build up a network of reliable professionals through a real estate investors association. Such an organization is dedicated to connecting real estate professionals of all levels to one another, which can certainly set you up to find a reputable lender when in need of a hard money loan.
Show Investment Potential
Once you’ve done your homework, you’ve got to show this lender that the property in question has potential. After all, they are more interested in the value of the property than your own financial position.
Despite the fact that the loan is founded on the value of the collateral, it helps to show some experience in real estate and that you know what you’re doing. The lender will also want to see pertinent documents like architectural plans, construction budgets, and contractor bid sheets. You will need to prove the value of the property, the surrounding neighborhood, and its potential for growth—which you can do using publicly accessible information from a multiple listing service (MLS) like Trulia or Zillow.
Apply for a Loan
While traditional loans can take months to process, a hard money loan can be approved in a much shorter amount of time—say two weeks. You will want to make sure all your documents are lined up and taken care of, not just for the loan, but for the property in question as well. Contractors and designers should also be informed of the time frame so you can put them to work as soon as the loan is approved.
Keep in mind that the lender may still want to see some personal or business financial information, such as tax returns, bank statements, or earnings reports. You should have this documentation ready to go. It’s also important to stay in touch with the lender during the application process and beyond—return their calls and emails promptly. Hard money lenders are not banks, and keep much less capital on hand. If they feel you’re not interested in your own project, they may move on to working with a different borrower.
Real estate investing for beginners is fraught with challenges that fall along the learning curve, but one that’s very easy to overcome is eliminating your personal vulnerability. You should never conduct business under your own name, and always under a business name. Determining the exact structure of your business (for example, LLC or S-corp) will depend on your circumstances, but you definitely want to separate your personal assets from your real estate enterprise and eliminate the possibility of the lender coming after you, your home, or your personal tangible goods.
Keep in mind that hard money lenders are not regulated like banks, so you will have to exert an extra degree of due diligence. Review the paperwork with a lawyer. Make sure the lender has disclosed all the fees and provided a repayment schedule. Make sure it includes pertinent information like how much of the payment goes toward interest. If there are any red flags in the application process, these are signs that this lender may not be good.
You will also want to obtain insurance for your assets, and since lenders have a vested interest in your property, they will often require this. Many of the closing costs, fees, and underwriting expenses will be paid for by you, so make sure you’re able to cover these expenses so you can avoid placing yourself under undue financial stress on top of having to repay the loan.
Make a Quick Repayment Plan
Remember, hard money loans are meant to be temporary solutions. Many hard money loans are issued with a payment timeframe of twelve months, and if you don’t repay the loan by then, you risk losing the collateral. Some lenders will allow you to make a lump-sum repayment once you are done with your project.
If you don’t intend to improve and then sell the property, that means you’ll need to secure a long-term loan solution during this time. Fortunately, with an asset that now carries more value after completion, or generates cash flow, it should be easier to get an institutional lender interested in helping you with a long-term loan. If worse comes to worst, you may need to find another bridge loan to replace your original hard money loan, though this is obviously not an optimal solution—which highlights the importance of making sure your team is on board to get the project done on schedule.
Hard Money Loan Pros and Cons
Hard money loans are great for investors with short term goals, such as those who fix and flip or a real estate developer who will be selling off units. Hard money loans can also work for investors with a long-term project, such as some cash-flow-generating commercial real estate or residential real estate rentals. However, these investors will most likely need to be more experienced, have a decent portfolio and history of success, and be tapped into a good network of lenders, because they will need to get a long-term loan solution in place before the hard money loan needs to be repaid.
That said, hard money loans offer great speed. Though the lender would prefer to get their money back rather than the property, the collateral itself carries decent investment potential, so they won’t need to spend long amounts of time going over your loan application with a fine-tooth comb. This can help investors close deals quickly, especially when they’ve worked with a lender before. In some cases, a phone call to the lender can be followed minutes later by an all-cash offer and a handshake with the seller (although there will still need to be some paperwork).
Hard money loans also offer great flexibility. Banks and traditional lenders are often locked into strict rules about how they lend money, while hard money lenders can be more flexible about things like terms of repayment, interest rate, the property in question, and other factors. This is a great boon to investors who don’t want to be locked into paying a non-negotiable loan origination fee or suffering from a much-dreaded balloon payment.
On the other hand, there are some drawbacks.
Hard money loans have much higher interest rates, often in the double digits. Lenders needing to protect their own interests may also include a number of fees and penalties for deviating from the terms of the loan. For investors just starting out, it can be very difficult to lock down a relationship with a fair and reputable hard money lender—and there are plenty of loan sharks swimming in the water.
The future also is uncertain. If you can’t sell the property in time or you can’t lock down long-term financing, you might lose the property and the work you’ve invested in it, or you might have to search for another high-interest swing loan to get you through.
How to Get a Hard Money Loan
Despite their risks, hard money loans are incredible tools for investors, especially in today’s tight-fisted lending climate. There are, of course, other ways to get money than a conventional mortgage, such as a cash-out refinance on an existing property, real estate crowdfunding, and private investors who want a long-term stake in your investment property.
But all these options have drawbacks, such as taking up too much time or forfeiting some control over your investment. By contrast, hard money is a loan where either institutional or private money lenders engage in some asset-based lending. Since they care most about the value of your investment and minimize their risk with the loan-to-value ratio, they don’t care as much about less-than-perfect credit or even bad credit. The loan terms may favor the hard money lenders in terms of interest rate, but it certainly gives benefit of the doubt to the borrower in terms of credit history, flexibility, and speed.
Real estate can be a fast-moving business, and sometimes a great deal will disappear if you don’t get the financing together. Unfortunately, banks and traditional lenders are not as interested in the deal as you are, and will follow their due process before lending money, which can take months. A hard money loan is a fast and flexible option that can help investors move toward their goals—provided they play it right.
Hard money lending might seem like a mystery to anyone outside the most seasoned real estate investors. But there is nothing so mysterious about it. In fact, working with hard-money lenders is a lot easier than overcoming the underwriting process of conventional mortgage lenders, or even finding business loans from a bank.
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