Hard money lenders, or private lenders, offer you the chance to secure funding for a home that a standard lender would not provide. The most common group of people that use this type of lending is those that rehab or flip homes. Many lenders will not provide funding for this type of transaction, which leaves investors in the lurches for financing. Luckily, there are investors out there that want an alternative to standard investment options, such as stocks and bonds. These investors provide funds on the private market and supply their own terms for the funds.
Definition of a Hard Money Loan
Understanding the definition of a hard money loan can help you decide if it is right for you. Basically, it is a loan with a short loan term and that uses real estate as collateral. The money does not come from a bank; instead, it comes from a private investor. Every investor creates their own terms regarding the loans, but the typical term is around 5 years or less. As you can probably guess, the loans are balloon loans, which means at the end of the term, the entire amount of the outstanding balance is due. Some investors do require monthly payments along the way, though.
Who Benefits from Hard Money Loans?
As a general borrower and homeowner, a hard money loan would typically not be the right choice for you. Generally, the people that benefit the most are real estate investors. These are the people that purchase houses, fix them up and sell them in a short amount of time. There are varieties of different ways investors can use these loans including:
- To take cash out of the equity of a home they own
- To pay off a bridge loan
- To pay off a construction loan
The most common use, however, is for investors that literally flip homes and need money for the short term.
In very rare instances, however, regular borrowers can secure a hard money loan. If a borrower does not qualify for standard conventional or government-backed financing, a private investor is often the way to go since it allows more flexibility in the lending terms.
Hard Money Loans are Fast Loans
Another great benefit of hard money loans is the ease in which you can obtain the funds. If you were to go to a bank or credit union, you would have to go through the entire qualification process. This means going through the prequalification, underwriting and final approval states. This can take up to 45 days in some cases, depending on what type of loan it is and the workload of the lender. On the other hand, private investors can fund hard money loans in as little as 10 days. This can work to the real estate investor’s advantage since he can have the upper hand when he wants to bid on a home. Real estate transactions often come and go very quickly. If an investor has the ability to have the funds he needs within a week or so, it becomes easier to win the bids on the homes he wants to purchase, fix up and flip for a profit.
Owner Occupied Properties and Hard Money Loans
In some circumstances, traditional banks cannot provide funding for owner-occupied properties. This occurs when something does not fit the standard mold for the loan process. Because of the Qualified Mortgage Guidelines, many lenders are unable to provide funds to the people they use to provide them to because they will put their own financial well-being at risk. The people that fall into this category include:
- People that changed jobs often in the last 2 years
- Borrowers that experienced a short sale or foreclosure recently
- Borrowers that experienced a bankruptcy recently
- People with poor credit in general
These borrowers are prime candidates for subprime lending, but even that can be difficult to find with standard lenders. Sometimes these borrowers benefit more from hard money lenders because of the ease of approval and the ability to obtain the funds quickly.
Different Types of LTV Requirements
Every hard money lender has their own requirements regarding the amount they are willing to lend. For example, some private lenders strictly offer funding based on the appraised value. The standard maximum is 75%, but that is not always the case. Some lenders will lend more or less depending on their financial position.
Another unique aspect some private lenders offer is to base the loan amount on the ARV, after repair value. This is reserved for borrowers that purchase homes, fix them up and flip them. This gives the borrower money to not only purchase the home, but fix it up too. As you can probably guess, this type of loan comes with much higher costs as it is a larger risk for the investor.
There are some private investors out there that base your loan amount on the purchase price as well. If you are a real estate investor, this could hurt you in the long run. If you purchase homes for a lower price and turn around and sell them for a profit, your loan will not be as high as you wished for if the lender bases it on the purchase price. Shopping for a hard money lender that offers loans based on the appraised value is usually a better idea.
Qualifying for a Hard Money Loan
Qualifying for a hard money loan is much different than qualifying for a standard loan with a bank. The investor will need to know a little bit about you, but what they really want to know is:
- How much of your own money you will invest
- The value of the property, either as-is or after repairs
This does not mean that some investors will not inquire about your credit. They want to see that you have some semblance of financial responsibility. They also need to see that you can afford the monthly payments, however, they decide to figure them. If you purchase a home that requires repairs in order to flip it and you do not take a loan based on the after repairs value, you also have to provide proof that you can afford the repairs/changes in order to flip the home for a profit.
Last, but not least, you must be able to show the lender how you will pay the balloon payment. For example, if you take out a $100,000 loan and the lender only requires interest payments for 5 years, you will still owe $100,000 at the end of the 5-year term. The investor needs to see how you plan to pay that $100,000. He needs proof that you will not just walk away from the home and the loan. If you are an investor, you could show your history of selling homes for a profit or if you have the assets to pay the loan if you cannot sell the home, you can prove your worth to the investor to ensure that you are a good risk.
Lien Position for Hard Money Loans
Most investors will only provide hard money loans as a first lien position loan. They are not willing to take that 2nd lien position since the chances of them getting paid are slim to none should you default. If you need money to purchase and/or rehab a home, it must be one loan and there must not be any other loans on the property.
The Cost of Hard Money Loans
Unlike standard loans with a bank, there are no guidelines or restrictions facing hard money lenders. This means that all lenders could come up with their own terms and costs. The typical costs you should inquire about include:
- Loan points
- Actual fees to close the loan
- Amount and type of interest
If you live in an area where there are numerous hard money lenders, for example, you will likely not pay as many points as someone that lives in an area where there are very few private investors lending money.
The fees to close the loan typically include document, processing, appraisal and notary fees, but they can differ from lender to lender. The type of interest can also vary. Some lenders charge everything at the back end of the loan when you pay it off while others require monthly payments of interest only in order to keep you making good on your promise to pay back the loan.
The Hard Money Lender Loan Process
Because hard money loans are different than bank loans, it is important to understand the loan process:
- Shop around and talk with different hard money lenders to see what they have to offer
- Sign a sales contract
- Choose a private investor to lend you the money
- Inquire about the appraisal process with the lender
- Pay the hard money lender any upfront money they require to start the loan paperwork
- Receive the terms of the loan the hard money lender is willing to provide
- Close on the loan either at a title company or lawyer’s office
Whether or not you should take a hard money loan depends on your situation. If you cannot secure financing from a traditional lender just yet, it could be a good alternative. Just make sure you know the terms and understand all of the costs involved with the loan.
If you are a real estate investor, this can be the quickest and easiest way to secure the funds you need to quickly purchase and flip homes for a profit. If you are in the business, chances are you know lenders that provide the most affordable terms and are the most honest to its borrowers. If not, there are many resources available to help you find the hard money lender that is right for you.