Hard Money Loan: The Best Starter’s Guide in 2020!
Real estate investing is lucrative. Plus, making cash is straightforward. “Purchase a distressed property in need of repairs. Rehab it. Sell it off at current market rates.”
Sounds simple? Well, it is easier said than done. See, most investors struggle with raising capital. Very few people have moneybags lying around.
Taking out mortgage loans always seems sound. But there are three big problems with this credit option: Bank loans are slow, strict, and conservative. If you want to close a risky but good deal quickly, just forget any conventional mortgage loans. And let’s start with the hard money loan definition.
What Is a Hard Money Loan?
It’s a private loan used in place of traditional mortgage loans. The main merits of a hard loan include the less stringent qualification criteria and fast loan process. Private lenders – companies or individuals – give out these loans to real estate investors.
The hard money loan is asset-backed. Therefore, the lender can sell off the property if you default. Hard money loans are versatile in their use. They are suited for bridge financing, rehab financing, or purchases. It’s essential to have an investment strategy before approaching a lender. For instance, most investors aim to borrow to renovate and flip multifamily homes.
How Do Hard Money Loans Work?
Think of hard money business loans as having three pillars:
1) The Deal
The deal is usually a distressed property that you can fix and resell at a higher price. Therefore, its purchase price must be lower than the after repair value (ARV). The general guideline often called the 70% of the ARV rule, is that the purchase price and rehab costs must be 70% of the ARV.
For instance, if the purchase price is $100,000 and the rehab costs are $40,000, then the ARV should be $200,000.
There are no hard & fast rules when it comes to the soundness of a deal. Some investors consider good deals to be those with an ROI of more than 10% or $30,000.
Each property and market is different. You must ensure that every minor detail has been considered, and even have a second set of eyes go through the deal.
Remember that the hard cash loan is asset-based. In case you default or the project runs into problems, the lender might foreclose on the property to recoup their investment. Very few lenders ever want to undergo the foreclosure process. It’s often expensive and may drag on for many months. That’s why they carry out their evaluation of the property and deal carefully.
2) The Borrower
You’ll need to form an LLC to obtain a hard loan. Therefore, you may need another business partner. The borrower’s aim is mostly to purchase the property, fix it up and resell it as fast as possible. However, some find tenants to occupy the units & collect rent.
Projects are often delayed by bad contractors. Any delays or work that needs to be redone will eat into your profits and delay the loan repayment. It might be also worthwhile to take out cheaper traditional loans in the future to pay off hard loans.
3) The Lender
You can also call them hard money lenders. They are more interested in the asset and place less focus on your credit scores, debt level, etc. Therefore, you may qualify for hard loans with low credit scores.
Most private lenders have experience in real estate investing. They can spot the best deals and cater for any contingencies. Provided the deal is good, they may overlook the risk level.
Why can’t private lenders take their money to banks? Private lenders know that banks can’t offer them good interest rates on savings accounts. Therefore, they choose to lend their money privately. Some lenders aggregate their funds into a fund managed by a fund manager.
To learn more on “how do hard money loans work”, here is a table summarizing their features:
|Interest rates||9 to 15%|
|*Loan to value ratio||60 to 75%|
|Loan amounts||100K+ (Depends on the ARV)|
|Loan term||Typically short-term around 12 months, but maybe up to 7 years|
|Downpayment||Required 15 to 35%.|
*Loan To Value Ratio
One key aspect to grasp in order to understand what is a hard money loan for real estate is the Loan to Value Ratio.
Private lenders don’t finance the purchase and rehab of the property 100%. They offer loans that are up to 65% to 75% of the property’s market value. For instance, if the ARV of a property is $100,000, an LTV of 65% will get you a loan of $65,000. You’ll have to pay the leftover amount as downpayment before the deal closes.
What Is a Hard Money Loan for Real Estate?
It’s a private loan offered to borrowers for the purchase of distressed properties. It comes with higher interest rates, but it’s much faster to obtain than mortgage bank loans.
What Other Fees Are Associated with Hard Loan Money?
Borrowers have to pay “points.” These are fees paid to the lender to cater for expenses incurred when originating the loan. For instance, the private lender might have hired additional support staff to go over the documents. Points are paid upfront and are usually 1 to 5% of the loan’s value.
Hard Money Loan Requirements
Hard loans real estate are not as difficult and tiring to qualify for as mortgage loans. Private lenders require far less documentation and proof of creditworthiness. Still, there are some basic requirements you must fulfill and understand what is a hard money loan:
Most private loan lenders want to work with proven investors. They look for investors with established records of getting projects done and on time.
If you have no experience, you can form an LLC with someone more experienced than you. Now, it doesn’t mean that newbies can’t qualify for private loans. Generally, more experience leads to favorable loan conditions. For instance, the lender might expect a lower downpayment.
2) Ability to Repay the Loan
Real estate projects might not always go as planned. Therefore, the lender will be looking to see if you have enough income to support the loan repayments.
3) “Skin In the Game”
If you don’t have “skin in the game,” it’s very easy to bail out when things get tough leaving the lender to deal with all the mess.
Private lenders mitigate this risk by requiring borrowers to have skin in the game. You must use your cash to pay a sizable downpayment. For instance, if the property is worth $100,000 and you pay a downpayment of 30% ($30,000), it’s quite difficult for you to walk away from the project.
Private lenders will provide the funds for the rehab. It ensures that you simply don’t run out of cash leaving the project uncompleted.
Table of Hard Money Lenders vs. Traditional Lenders
|Hard money lenders||Traditional lenders|
|They are fast and provide funding within 3 to 7 business days.||Slow to fund loans. Might take up to 90 days.|
|Flexible because they are often private individuals||More rigid in their underwriting process|
|Sought after by investors who don’t have time to wait||Sought after for normal, low-risk purchases|
|Require fewer docs with decisions handled by one party||Demand more documentation & committee decision making|
|They are more focused on the borrower’s ability to repay the loan||Banks look at the borrower’s credit history, financial position, employment, etc.|
|Willing to lend cash on properties that need improvements or partially completed||Might only lend on properties with verifiable income streams|
Reasons to Borrow Hard Money Loans Real Estate
1) Quick Funding
If you’re working on a time-sensitive deal, these loans are better than conventional loans. You can expect to get funded in less than a week.
2) They Are Available
Across the country, thousands of private lenders are offering loans for deals banks would never touch.
3) Less Strict Underwriting Criteria
Private lenders don’t have to adhere to strict lending laws or government guidelines. They can choose to fund deals with the best returns.
4) Reduced Bottlenecks
Most private lenders understand that some deals must close quickly. You don’t need to have your loan subjected to rigorous processes, only to get rejected.
5) Benefit From the Lender’s Experience
Some private lenders are willing to take newbies under their wing. Since the outcome of the project matters to them, you might pick their brain on issues to do with finding good contractors, keeping rehab costs down, getting necessary approvals, etc.
Where to Find Hard Money Loan Lenders
Don’t know where to find private money lenders? Nowadays, most businesses have websites. Just try this search phrase and see instant results, “hard money lenders in [state].” The sites might be direct lender websites or loan matching services.
Your next best bet to find lenders is through the American Association of Private Lenders (AAPL). Head over to their website, and start finding connections in the industry.
The last option is speaking to friends, real estate agents & attorneys, etc.
The Final Word On the Hard Money Mortgage Loan
Summarizing everything we have said: Hard money loans are lent out by individuals, not banks. They are great for closing on distressed properties with high ROIs. Interest rates are higher but not too steep as to impair your ability to make profits.