What Is A Hard Money Loan And How Does It Work?
The carpenter is almost done framing a house when he runs out of nails and pulls out a box of screws to finish the last couple of 2x4s. He does not, however, change the tool and continues to hammer away trying to get the screws into the wood. Of course, no more framing was accomplished and the house was not completed. The carpenter needed a different tool. If he would have switched out the hammer for a screwdriver, the house would be complete.
Hard money is simply a tool for real estate investors. It is not meant to be used all the time and only works in certain situations. Understanding how and when to use hard money will help you complete your project!
What Is Hard Money?
Hard money loans can have different meanings to different investors but for the most part, hard money lenders have private capital that they use to make loans secured by real estate. The point about private capital is important because knowing that banks are not involved helps us understand how hard money lenders work. They do not have all the red tape with their lending decisions.
Many investors use hard money loans to fix and flip houses, but some investors use hard money loans to bridge a gap or a short term financing need or if they simply need to close on a deal fast. Typically, hard money loans are high-interest loans with a lot of underwriting flexibility used to satisfy a short-term need.
How Does A Hard Money Loan Work?
To some extent, hard money loans work like other types of financing. You will need to get pre-approved with the lender and have them review you and your deal before they will commit to funding your project. The primary difference is in the underwriting.
With conventional lenders you will need to fit into a specific box to be approved. Specific credit scores, debt to income ratios, and stability requirements. Conventional lenders also loan based on appraised value or purchase price, whichever is less. That is a huge difference with hard money lenders. They are more concerned with a quality project and will base loan decisions on what a property will be worth after it is repaired. Each hard money lender will be a little different with this but Pine Financial Group will loan 100% of the costs to do the project as long as the loan does not exceed 70% of the completed value.
There are tremendous advantages with hard money. Hard money lenders make their own lending decisions so there is both flexibility and speed. They will loan a lot more of a deal than conventional lenders, can close in days or weeks instead of months, and don’t care if the house needs work. In fact they probably prefer that the house needs work. It is possible that they can possibly work around any issue that would stop a conventional lender.
Learn The Risks
There is no additional risk to using a hard money lender compared to other types of lenders as long as you understand the terms of the loan. Both will ask for a personal guarantee and both will want a piece of real estate as collateral.
Interest Rates & Points
The downside to hard money of course is the price. Hard money lenders charge more. You will see higher fees and higher interest rates. This is the one downside and the primary reason this is not the right tool for every investor in every situation.
Property Types Suitable With A Hard Money Loan
All property types are suitable for hard money lenders depending on each hard money lender’s appetite for the loan. Hard money is more about the situation than the type of property. Here are some reasons to consider hard money with your real estate investing.
1. Fix & Flip
This is probably the most common loan hard money lenders originate. It is the perfect fit because fix and flip houses are typically beat up which make them hard to finance. The need for the money is short term and hard money lenders will look at the after repaired value to determine the loan amount, limiting the investor’s down payment requirement. Pine Financial Group will actually loan 100% of the purchase and repairs making it a true no money down fix and flip loan.
2. Rental Properties
Much like a fix and flip loan, the hard money lender will loan on properties in need of repairs. The only difference is after the repairs are made and the property has a tenant, the investor will refinance the loan instead of selling the house. This enables the investor to buy a beat-up house as a rental with little to no down payment.
3. Multi-Family Homes
It is common in the multifamily space to find projects that have some deferred maintenance and low vacancy numbers. These issues make it hard to get a traditional loan. Hard money lenders will finance the purchase of these distressed assets, giving you the opportunity to fix them up and lower the vacancy. Once you hit certain vacancy thresholds, the building is bankable so you can refinance out of the hard money loan.
4. Commercial Real Estate
The use of hard money in the commercial space is very common, especially for distressed assets as mentioned above. Investors will use hard money loans when buying commercial projects that need some love.
Requirements Before You Can Borrow Hard Money
Hard money requirements vary greatly across the industry, so it is always best to call your hard money lender and ask what they are looking for. Here are some of the items that are important to hard money lenders.
Outside of the project itself, this is likely the most important part of qualifying for a hard money loan. Hard money lenders want to know that you know what you are doing. Pine does not require experience but we do want to know that you have support around you that has experience. This is extremely helpful in case you hit any roadblocks as you progress with your project.
Your Credit Standing
Credit is typically not a stumbling block. Most hard money lenders are much less concerned with credit than the project itself. They will still likely pull credit just to get a sense of your payment history. If you have a lot of current delinquencies it could cause an issue so be sure to bring up any credit concerns early so you can find a way to work through it.
Your Payment Plan
How do you plan to pay the loan back? Are you going to fix and flip or use the money until you can get a refinance? The lender will require a plan, so have one before you call. If your plan is to refinance, the hard money lender might want to be sure you qualify for the refinance to be sure to protect you and their money.
The Property’s Value
Hands down, this is the most important criteria for hard money lenders. Although there is a personal guarantee on the loan, it is unlikely a hard money lender would pursue a borrower directly. It is far more common for the lender to just foreclose on the home and take the property. For this reason, they want to be sure they are at a low enough loan to value that they can recoup their loan amount if they have to foreclose. Most hard money lenders will limit their loan to 65% to 70% of the property value.
The Area Of The Property
This is less important than the value but is extremely important to determine the value. Items like busy roads, a commercial property influence, or other location challenges could severely hurt the property value and hurt your chances of getting a loan. Lean on your Realtor to pull comps with similar location influences or be sure to adjust the value of your project to account for this. My advice to newer investors is to always stay away from poor locations because the only way to find out how bad the influence impacts value is when you try to sell. And then it is probably too late!
Is A Hard Money Loan The Right Option For You?
If you are using a screw you will need a screwdriver. When you have some nails, a hammer will do the trick. The tool you use depends on what the situation is. Although expensive, hard money loans can be the perfect tool for your real estate investing deals. They are short term loans meant to satisfy short term needs.
Why You Should Go For Hard Money Loans
Fix and flips – If you plan to buy rehab and resell a house, hard money could be the perfect fit. The interest rate does not matter as much with these projects because you are in and out as quickly as you can be. Hard money works well with fix and flips because you can borrow more money, can close fast, and can finance ugly houses.
Fix and hold – If you are in the market for rental properties, you might consider a short term hard money loan to buy and rehab the house. This is a bit more expensive but allows you to close fast and get in with little to no money down.
Bridge needs – If you are buying a commercial building or an apartment building and just need some time to get the building performing, hard money is the perfect fit. Many hard money lenders can finance all of the purchase and a portion of your construction on a short term basis, giving you the time you need to be successful.
The Most Suitable Time For A Hard Money Loan
Any time can be a great time to borrow hard money, but it is especially useful when you need to close fast, have a hard to finance project, or are a less than qualified borrower. It is also really helpful to be successful when you can borrow money to buy and rehab your property.
Who Will Benefit From Hard Money
Hard money loans are best used for real estate investing. In fact most hard money lenders won’t even look at a deal if it is not an investment. For this reason, hard money lenders are experts in the real estate investing business. Any investor, no matter the experience, can benefit from hard money in the right situations.
What To Look For In A Good Hard Money Lender
Because hard money lenders vary so much and in many states they are not regulated, it is important to do your due diligence. Some of the issues we have seen with less than stellar hard money lenders are making promises to close when they can’t, lack of funding, slow draw process, and lack of responsiveness. Here are some of the items to look for when choosing a hard money lender.
Are they members of the BBB or have online reviews? If you were not recommended to them, you might want to check their website for testimonials and check online for reviews or complaints. If you are funding a larger project, it might even make sense to ask for references. Any good hard money lender would not have a problem sharing some client names and contact information to help get a new client comfortable.
Speed & Simplicity
Lets face it, real estate investors have deadlines to meet. Missing a closing could have catastrophic consequences. You need to know that your lender will be there for you when you need them. Be sure you understand their timeline and structure your deals accordingly.
Rates are less important than understanding the overall costs as well as what you get for that price. Some hard money lenders are cheaper than others but require more money down or more experience. Putting money down could change the deal for you by reducing your return on investment, increasing your risk, and limiting your reserves. It might make sense to spend a little more for the money so there is more of it to work with. Be sure to look at origination fees, interest rates, draw fees, and other administration fees when shopping for the right hard money lender.
Finding A Hard Money Lender
The best way to find a hard money lender is from another real estate investor. I would attend networking meetings and get to know other investors and ask them who they use. You can always do some online searching and there are online hard money lending directories like the one you will find on BiggerPockets.com: https://www.biggerpockets.com/real-estate-companies/hard-money-lenders I would recommend that you try to stay local if you can. Many of the major markets have local lenders who understand the area well and tend to have more flexibility and better pricing than their national competitors.