Considering a Private Money or Hard Money Loan? For the right real estate investment, a hard money loan can be the difference in getting the deal or not. But they are not for everyone and should only be used for real estate investing and for short periods of time. Here are a few of the pros and cons of Hard Money.
There are just times when a transaction has to close quickly, or you need to make a cash offer in order to get a property. Hard money loans are made by Private Lenders. A Private lender is just a person like you who has money to lend. Because they are individuals, they can make their own decision on whether they want to make a loan or not. They make their own underwriting guidelines and can make quick decisions…usually same day. This allows for loans to be introduced and closed in the same week…sometimes in just a few days. If you want to offer cash on a foreclosure, or bank-owned property and don’t have all the cash a Hard money loan is a great alternative to institutional financing.
Institutional Financing comes from Banks and credit unions. These institutions are regulated by the government and have set underwriting guidelines that include credit checks, bank statements, completion of taxes, credit limits and others. A Private Lender can look past many of these issues and can give you financing based solely on the equity in the property for which you are getting a loan.
Private Lenders can set their own payment schedule and can work with clients by lending them the money to make the payments upfront from the money lent on the property.
Points or loan fees are the cost that a private lender charges to make the loan. Private lenders are in the business of making loans and there is a cost for them to do so. Most private lenders have staff, building, and business costs that they recoup by charging upfront points or loan fees.
Hard money interest rates are probably the least appealing part of a hard money loan. They can range but are typically 2 to 3 times the rate a person could get if they can qualify for a conventional loan. One of the reasons for this is that Hard Money loans are typically short in duration and have very low underwriting requirements…so it makes sense that you would expect to pay more for a 1-year loan with little upfront requirements than you would for a 30-year loan in which you have been thoroughly vetted by an underwriting team. The interest rates are typically interest only which means that you are not paying down the loan. The expectation is that you will refinance the loan or sell the property to repay the loan vs an amortized loan which you make small principal payments over a long period of time.
The reason a Hard Money lender is forgoing the underwriting process is because you have a significant equity stake in the property or are bringing more cash to the transaction than might be required for a conventional loan. In a Hard Money loan the equity in the property is what is allowing for the ease and speed of the loan. For this reason, Hard Money lenders will typically only do loans with lower loan to values (LTV). Since a Hard Money Loan is given by a Private Lender their LTV requirements will vary. Typical LTVs for a Hard Money loan will range from around 50% LTV and sometimes up to 80%LTV. If higher LTVs are required, then a borrower is going to need to go through more formal underwriting to qualify you as a borrower.
Institutional lenders want to make longer-term loans with 5-years being the general minimum duration. Banks usually loos money for the first 2-3 years of any loan and need to make up that money over time. Hard Money Lenders specialize in short-term loans lasting from 1-month to a few years. You will want to make sure you have an exit strategy or way to repay the loan either through refinancing, the sale of another asset, or the sale of the property for which you have received the loan.
At the end of the day, a loan makes sense when the value to having borrowed the money exceeds the cost for which you had to pay to get the loan. Hard money loans make the most sense when you need quick money and only need the money for a small period of time.
Real estate investors who are looking to pay cash for a property in order to get a reduced purchase price is a good reason.
If you are buying a property for which you plan to fix it up and sell it (Fix-and-Flip) is another instance when a short-term loan can make sense. The idea is that you are going to buy a distressed property at a low price, increase the value by fixing it up and then selling the property for a profit. It is also common for real estate investors to fix up a property and then refinance it after the renovations have been completed and the value of the property allows them to get an institutional loan.
Hard money Lenders are typically private investors or Private Lenders who are lending you their own money. They typically only lend in the areas that they are familiar with in in locations close to them. While there are Private Lenders who lend nationwide, locations that they know and are familiar with is ideal. Look for a local lender who you can meet and who understands what you are trying to accomplish and can be a resource to you. It is also a good idea to talk with local real estate agents or real estate investors who have had positive experiences with a Hard Money Lender. Read reviews of other people who have worked with that lender. If you can’t find reviews, that is not a great sign. People who do good work and treat people fairly never mind getting reviews.