Hard money loans might be easy to get but they are not always easy to understand. I have been getting several questions recently on why or when a real estate investor should consider hard money. Some of the most successful investors that I know utilize hard money to some extent, and I thought it would be a good idea to write a brief article as to why it is such an important tool.
First it is important to understand that hard money is a tool. It is only a tool. You would use a hammer for a nail and a screwdriver for a screw. The tool you pull out of your belt is very dependent on what you are trying to accomplish. I start with that because hard money is not a good idea in every situation but is a great idea in some situations.
What Is Hard Money?
Hard money is non-bank money for real estate deals. Most hard money lenders finance their loans through private money they have raised, some debt, or a combination of both. Hard money lenders typically keep the loans they originate, so they have full control on what loans they approve and what loans they deny, and they have what I like to call a commonsense approach to underwriting. What I mean by that is, if the lender can see a clear path to get paid back, they will probably do the deal. This means things like lack of income, low or no down payment, or damaged credit can be overlooked with a good deal and a plan. Hard money is more expensive than other types of financing, which is why we say it is just a tool and should only be used when needed.
When Do Investors Use Hard Money?
There are a handful of reasons real estate investors utilize hard money:
- A property needs work: Most banks and all mortgage brokers or conventional lenders need the property to be in a livable condition or they cannot finance it. The word used in the industry is habitability, and if a property is deemed to be not habitable, the lender will deny the loan. Because many investors look for value add opportunities, meaning property they can add value to, they are constantly coming across properties that need work. If the bank or conventional lender says no, your options are limited, but this is the exact loan hard money lenders want, so there is money out there for your deal.
- Speed: Hard money lenders can close in days rather than a month or more. For that reason, real estate investors can rely on money being there if they negotiate with sellers for a quick closing.
- Ease of Draws: Hard money lenders will typically loan money to purchase the property and make repairs. In these cases, the lender will want to inspect the property before issuing draws. Banks are slow and can often take weeks to get a draw complete. Hard money lenders are typically much faster, which keeps the cash coming in so you can pay the team and keep the project moving.
- Bridge A Gap: If you have a short-term need, hard money is a great resource. Some examples of gaps could include a deed restriction that prevents you from selling a house for a certain amount of time, or if you are waiting for a deal to close to come up with the bank required down payment. There are many, many examples of when you need to bridge a gap in your financing. Any time you need short term money, hard money loans come into play.
- Qualifying: Although many borrowers are extremely bankable, meaning they have great income, assets, and credit, sometimes a borrower is lacking in one or more of these areas. Hard money lenders can get creative and can have flexibility in loan structure to get deals closed. This does not mean the hard money lender will make risky loans, it just means they can help you get creative to overcome obstacles.
- Low Down Payment: This is the most common reason we see investors use hard money. There are often limited to no down payment requirements. This means your liquidity stays in your pocket. The benefits of this include higher return on investment, it is safer and smart business to keep reserves in the bank for a rainy day, and the opportunity to do more deals and make more money. Check out this video about other ways to limit your down payment and be sure to subscribe to the channel while you are there. https://www.youtube.com/watch?v=n9W1YKg54B0
Remember, Hard Money Is A Tool
Many seasoned real estate investors use hard money loans. With that said, it is important to understand that hard money is one tool among many. Take your time and do your research before making any decisions regarding loans and investments.