Hard Money Lender
What is a Hard Money Lender?
Hard money is a way to borrow without using traditional mortgage lenders. Loans come from individuals or investors who lend money based (for the most part) on the property you’re using as collateral. When loans need to happen quickly, or when traditional lenders will not approve a loan, hard money may be the only option. Let's review how these loans work.
Usually, lenders are interested in your credit scores and your income available to repay a loan. If you have a solid history of borrowing responsibly and the ability to repay loans (as measured by your debt to income ratio), you'll get approved for a loan.
Getting approved with a traditional lender is a painfully slow process – even with great credit scores and plenty of income. If you have negative items in your credit reports (or an income that is difficult to verify to your lender’s satisfaction), the process takes even longer and you might not ever get approved.
Hard money lenders take a different approach: they lend based on collateral securing the loan, and they are less concerned about your ability to repay. If anything goes wrong and you can’t repay, hard money lenders plan to get their money back by taking the collateral and selling it. The value of the collateral is more important than your financial position.
Hard money loans are generally short-term loans, lasting from one to five years. You wouldn't want to keep them much longer than that anyway, because interest rates for hard money are generally higher than they are for traditional loans.
Why Hard Money Loans?
Speed: because the lender is mostly focused on collateral (and less concerned with your financial position), hard money loans can be closed more quickly than traditional loans. Lenders would rather not take possession of your property, but they don't need to spend as much time going through a loan application with a fine toothed comb – verifying your income, reviewing bank statements, and so on. Once you have a relationship with a lender, the process can move quickly, giving you the ability to close deals that others can’t close (that’s especially important in hot markets with multiple offers).
Flexibility: hard money agreements can also be more flexible than traditional loan agreements. Lenders don't use a standardized underwriting process. Instead, they evaluate each deal individually. Depending on your situation, you may be able to tweak things like the repayment schedules. You might be borrowing from an individual who’s willing to talk – not a large corporation with strict policies.
Approval: the most important factor for hard money lenders is collateral. If you’re buying an investment property, the lender will lend as much as the property is worth. If you need to borrow against a different property you own, that property’s value is what the lender cares about. If you’ve got a foreclosure or other negative items in your credit report, it’s much less important – some lenders might not even look at your credit (although many lenders will ask about your personal finances).
Most hard money lenders keep loan-to-value ratios (LTV ratios) relatively low. Their maximum LTV ratio might be 50% to 70%, so you'll need assets to qualify for hard money. With ratios this low, lenders know they can sell your property quickly and have a reasonable shot at getting their money back.
Hard Money Lender Example
Let’s talk about how a typical hard money loan works in a house flipping deal. The first thing to understand is that there really is no typical hard money loan and every hard money lender looks at things a little different. They each have their own underwriting criteria, borrower requirements, and loan structures. However, most hard money lenders size their loans based on a percentage of the borrower’s After Repair Value (ARV), an independent appraiser’s ARV, in-house ARV, percentage of the purchase price, percentage of As-Is Value, percentage of total costs, and/or any combination thereof.
This being said, we can make some generalizations. For residential flip loans, most hard money lenders will provide roughly 80%+ of the purchase price or 60-65%+ of the ARV of the house. So by way of example, if you are buying a home for $250k, spending $50k on rehab, and expect to sell it for $375k, you will probably see loan quotes anywhere from $200k-$250k. Again, this is a generalization, and some lenders will do a loan outside of this range. However, note that this example assumes your lender agrees with your $250k purchase price and/or your $375k ARV.
In addition to the amount a hard money lender funds at the initial purchase, some may reserve a portion of the loan funds for future advances. This is what is commonly referred to as a “holdback”. The holdback may be funded at certain milestones during the rehab, or in a single amount at the end, just before the house is put on the market. The holdback can provide a flipper with cash flow sooner by allowing them to pull some of their equity out of the house, prior to the eventual sale, which can take 60 days or more complete. It’s important to know that most hard money lenders charge interest on the entire loan amount, including the holdback, starting from the initial funding.
For loan pricing, most lenders charge between 10%-13% interest per year, plus a loan fee of 2%-4%, for a 6-12 month loan term. However, beware that in addition to quoted loan origination fees, some hard money lenders also charge fees for credit checks, appraisals, loan documentation, inspections, recordings, reconveyances, etc. (in industry jargon, these are typically called “junk” fees).
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