Hard Money Loans - The Ultimate Guide
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What Are Hard Money Loans?
Hard money loans are short term, real estate loans that are primarily used by real estate investors and developers as a source of financing. Hard money loans have origins dating back to the 1950’s, when access to capital from banks and conventional mortgage lenders was much more prevalent, and ‘hard money loans’ were seen as a last resort because they bore higher interest rates.
However, today the opposite is now true. Banks have become especially stringent on not only owner-occupied real estate loans and mortgages, but even more so on commercial real estate loans and construction financing. Now, hard money loans are increasingly the first place real estate professionals, investors, and developers go, new and seasoned, in order to secure the financing that they need to build or develop their projects.
Jumping into the world of hard money can be confusing, so in this detailed guide, we highlight the structure, process and little-known-facts about hard money lending.
Why do they call it "Hard Money'’?
Hard money loans are considered ‘hard’ because they are typically secured by real property. Also, because these loans extend over shorter periods of times, hard money loan interest rates tend to range from 7% to as a high as 20%. Since hard money financing does not have the same underwriting requirements that you would find elsewhere, lenders charge higher than average interest rates as a way to compensate for the risk.
How Long are Hard Money Loans?
Hard money loans on average range from 3 months to 36 months but some lenders may have different rules. Some loans may have pre-payment penalties and some may not. There are, however, legal ways, in which a borrower with a current hard money loan at the end of the loan period can ‘extend it’ by re-apply for the loan under the same terms. However, this is never guaranteed.
How Large are Hard Money Loans?
The size of hard money loans can vary widely. Most hard money lenders start around $50k to $75K and the top end is usually $1M to $5M. The amount approved for is mostly dependent on the loan-to-value percentages that each individual lender sets but can reach in the millions of dollars. A loan-to-value, or LTV, is essentially the maximum loan amount a lender is willing to finance on a property calculated as a percentage of its purchase price. For example, hard money loans at 80% LTV, will offer up to $160,000 to a borrower, on a home that they want to buy for $200,000. If the property has a lot of potential and the borrower needs financing to cover the construction expenses, some lenders may even offer 110% LTV loans, or, using the same example, a loan for $220,000.
How Do Hard Money Loans Work?
Unlike what the name implies, the actual process of applying for, securing and paying off a hard money loan is actually straightforward and simple.
- A potential borrower finds a residential or commercial real estate property that they want to purchase.
They call around different hard money lenders, shopping and comparing rates and fees.
- When the borrower has settled on a lender that they would particularly like to use, they fill out a business loan application , providing all the information about the property and the borrowers information.
- The lender and the borrower will setup a meeting (either over the phone or in person) to discuss what the potential borrower plans to do with the property, how marketable the property will be after the borrower’s planned work is complete, and otherwise iron out any holes in the application.
- The lender will then evaluate the borrower and the property to determine what it is worth in its current state and what it could potentially be worth.
- If the lender agrees to loan the money, they move on to underwriting the property and borrower.
- Once fully approved and at closing, the borrower will sign not only the documents to assume ownership over the property, but will also execute the loan documents and the loan and the transaction is closed.
- If rehab is financed in to the deal, there will be a series of inspections and draws on the rehab funds throughout the loan term.
- When the property is completely rehabbed, the property will either be sold or turned in to a rental. At that point the hard money loan will be paid off.
What Are Hard Money Loans Used For?
Hard money loans can used for the purchase of a variety of different property, and for a variety of different buyers. Specifically, hard money loans are commonly used for both residential and commercial property, such as single-family homes, rental properties, vacation rentals, short term rentals, hotels, industrial property, warehouses, commercial retail storefronts, office buildings, and in some cases even raw land. They only major universal requirement is that the property can not be owner occupied, again to avoid triggering additional legal scrutiny.
Why Do Hard Money Loans Take Less Time?
Getting approved for a hard money loan takes much less time than other forms of financing because there is less back and forth between the borrower and the lender. This is largely because hard money loans are a form of asset-based meaning, meaning lenders will largely base their decision on whether to extend the loan or not, based on the value of the property, not how well the business or individual meets the underwriting requirements.
Traditional bank and business loans require the borrower to present proof that they have the ability to make the mortgage payments throughout the entire life of the loan. Bankers and mortgage brokers will consider an individual borrower’s credit score, borrowing history, debt to income ratio, income over the last two years, and tax filings to assess their ability to pay. Some lenders may even request the borrower put up collateral, or promise to relinquish ownership in other assets that they own, as a type of security for the loan.
On the contrary, most hard money loans require no personal income verification requirements and allow lower credit scores. The security, or the lender’s assurance that they will get their money back, is not based on the individual borrower’s ability to pay, but the property’s ability to pay for itself. In other words, when hard money lenders do their due diligence, they want to ensure that in the worst-case scenario, they can foreclose and liquidate the property, recovering at least the full loan amount. This is what they look for when investigating the current and proposed future value of a property that is being secured by the loan. Because property’s and property values are a lot more objective than a person’s entire financial and credit history, this cuts down on the processing time.
What Happens If You Default on a Hard Money Loan?
In the off event that you do default on a hard money loan, the lender will foreclose or assume possession and ownership of the property. They then have the option to liquidate the property, or sell it quickly and at a discounted price to another investor or developer, who can complete the work. Additionally, hard money lenders who were once developers, may decide to finish the project themselves and sell it in order to recover the defaulted loan amount.
Keep in mind though, some states do not treat the foreclosure process on a hard money loan like that of a personal property or an owner-occupied home. Hard money loans in California, for example, are secured by trust deeds, which will allow a hard money lender to keep any profits they make on the home, over the defaulted loan amount. While that may seem unfair, remember hard money loans are made for business and commercial purposes, and therefore do not provide the same rights of an individual homeowner. The advantage to this, however, is because lenders retain this option, a default will not necessarily hurt your personal or business credit, and may not even show up in your financial history at all.
Do Hard Money Loans Require Down Payment?
Unfortunately, we can only be so flexible – hard money loans do require some form of a down payment. Down payments can range in size from as high as 30% to as low as 10%. While that may seem like a very scary range, the good news is that the actual amount will truly vary depending on your relationship with the lender and your track record. This is where it helps to make form a long-lasting relationship with one lender, like Neal Business Funding, to prove that you pay off your hard money loans consistently and earn lower down payments as time passes.
How Much Do Hard Money Loans Cost?
The cost of hard money loans also ranges depending on the lender’s individual preferences and business model. However, in addition to the interest rate a hard money lender charges, across the board there are five additional fees a borrower can expect to pay:
Points, not to be confused with mortgage points, are percentages of the loan amount that a lender collects for its service. They are also known as loan origination fees, and are a form of compensation for the lender. These can range anywhere from 1 point to 5 points. That means if you are approved for a $100,000 hard money loan and the lender charges 3 points, you will have to pay $3,000 in fees.
Loan Document Fees are the fees a loan processor charges the lender to prepare the actual loan documents that you will sign to officialize the loan. Lenders will pass this on dollar for dollar to the borrower, which must be paid by the time the loan funds. These range in size, but are consistently between $500 and $2,500 dollars, all depending on the specific loan’s structure.
Prepaid Interest is essentially the interest, or fee,a lender charges the borrower when they receive the money in the middle of the month. For example, the way loans work, interest accrues from the beginning of one whole month, and is paid off on the first of the following month. However, what happens when your loan closes on the 15th. Prepaid interest is the cost to ‘rent’ the loan proceeds for those 15 days before the 30th, and before the real interest fees kick in. These are calculated by the escrow officer, confirmed by the lender, and paid at the close of escrow.
Prepayment Penalties are a type of early termination fee, imposed only on borrowers who pay off their loan before it’s due. There are two main events that will trigger a prepayment penalty, either 1) repayment of the loan in full or 2) large partial repayments of the loan within a certain time period. The former is much more commonly and takes places when a property is sold or the borrower refinances of the loan. In the case of joint venture agreements, partnerships, and syndications, though, bringing in additional capital or a new investor may also trigger these. Prepayment penalties can take the form of several months interest, due and payable if the loan is paid off within a certain time period, or as a percentage of the remaining loan balance. Not all lenders require prepayment penalties.
Miscellaneous Fees, such as appraisal fees or inspection fees, may also be charged by hard money lenders. Appraisals can be anywhere from $400 and up. Inspection fees can be from $200-$300 per inspection.
Interest Rates can range from as low as 7% to as high as 20% depending on many factors such as your experience and the LTV (loan to value).
Are Hard Money Loans Interest Only?
Most hard money loans are interest only, meaning the monthly payments pay only the interest, and do not pay down the balance of the loan. Many real estate investors and developers are comfortable and prefer this type of loan structure because it lowers the monthly payments they will have to make while carrying, or owning, the property, and allows that money to be used in other places, such as renovations or marketing the property for a faster sale. Interest only hard money loans also involve a balloon payment, or payment of the full loan amount at the end of the loan period. Again, considering how hard money loans are used, most investors fully expect to sell the property or refinance the loan long before the full loan balance is due.
How To Calculate Hard Money Loan Payments?
Hard money loan payments are calculated by multiplying the interest rate by the loan balance. Let’s assume, for example, that you are able to secure a $100,000 hard money loan from us here at Neal Business Funding, and you want to know how much the monthly payments will be so you can account for it in your budget. If you’re interest rate is 8.5% you would simply multiply 0.085 by $100,000, to get $8,500. This is your annual interest. You would divide that by 12, and get $708.33, which will be your interest only monthly hard money loan payment.
Do Hard Money Loans Require An Appraisal?
Yes. Most hard money lenders understand, especially when working with flippers, that the property will appreciate in value significantly than what is on paper today. Therefore, they will commonly look at comparable properties to assess what the present and future value may be, which provides much more information than can be obtained from a full appraisal report.
Are Hard Money Loans Regulated?
While Hard Money Lenders are not regulated like typical residential owner occupied mortgage companies, many states do regulate them through their bureau of real estate or departments of financial services. That said, you do want to do some due diligence to make sure your lender is reputable.
Who does Hard Money Loans?
Hard money loans are usually done by private individuals or investors. They may be people who were once real estate developers and investors themselves, but were able to save up enough capital to lend it out to others and some are backed by large hedge funds. Many lenders specialize not only in hard money loans, but also a full array of financial products for restaurants, businesses, hotels, and more. Lastly, hard money loans are done by high net worth individuals, on their own or with a group of friends, to generate additional passive income.
How do Hard Money Loans Compare to Other Options?
The best way to know if hard money loans are worth charting new territory can be answered by comparing them to the alternate forms of financing business owners and real estate developers and investors have available to them.
Hard Money Loans VS Bank Loans
Less transparency and slower processing times are not the only reasons to be cautious when apply for a real estate loan with a traditional bank. Unlike hard money lenders, all banks, like Chase, Bank of America, Citibank, use their customer deposits in mass to make loans. Because these deposits are guaranteed by the federal government, banks are thus required to make sure that all their investments are guaranteed. That essentially means, nothing can go wrong.
For you as a loan applicant, this typically translates into more stringent loan terms, such as calling the loan, or requiring the entire loan balance to be paid in full within thirty days, in the event that the property’s values drop, you lose your full time job, you take on more personal debt, your construction is behind schedule, or any other reason, established by them, that they think has the slightest chance of threatening their ability to get the money back.
For a hard money lender having a bank representative who has little knowledge nor care about the fluctuation of real estate and construction can cause a lot of unnecessary anxiety. For this reason, hard money loans offer an excellent alternative to traditional commercial bank real estate loans.
Hard Money Loans VS Lines of Credit
There are two main types of business lines of credit: secured lines of credit and unsecured credit lines. Secured business lines of credit use the borrower’s personal or business assets as collateral, and are typically for larger loan amounts. Unsecured business lines of credit are not tied to any assets, meaning should the borrower default, lenders may not be able to fully recoup their funds. For unsecured credit lines, lenders solely rely on the owner’s personal credit history, and therefore these tend to be much smaller and have higher interest rates.
The main drawback of lines of credit, however, are the rates charged tend to be even higher than what is typically charged by hard money lenders. This is because these loans are not always tied to a specific property, and can still rely heavily on the borrower’s proof of credit, income, and collateral.
In this respect, for real estate investors and property flippers, who already have a specific property in mind or only plan to use one loan for one project, hard money loans offer a far superior option. However, once your business grows, establishes a solid, standalone credit history, and expresses an interest in buying multiple properties or larger projects ($1 million and above) lines of credit can offer a highly flexible source of financing. As the burden of collateral shifts from one specific property to you, it provides you the freedom to make offers on more properties at one time at a much faster pace (since the lender in that case would not need to appraise or evaluate every single property you come across).
What Are No Doc Hard Money Loans?
No doc hard money loans are a subsector of the loans available that do not require certain documentation. It does not mean however, that absolutely no documents are required in ordered to secure a hard money loan. Usually, ‘no doc’ implies that the lender will not require tax returns.
Usually, Banks will at the minimum request to see you past tax returns, typically two years. The main difference, is unlike other traditional lenders and banks, no doc hard money lenders will not ask for your tax returns but only bank statements and somewhat decent credit. Some Hard Money Lenders will go down to around a 600 credit score.
Each individual hard money lender, however, will have their own definition of no doc, so it is important to clarify with them upfront what that means for them. As an example, for our hard money loans here at Neal Business Funding we do not require taxes, however we do like to see bank account balances and statements and we will do a personal credit check.
Hard money lenders are able to extend financing with little to no verified information is because they are asset-based loans. At the end of the day, being the most credit worthy and financially qualified applicant will not guarantee a successful loan. Ultimately, the primary security to a hard money loan will be the property that you are using the money for to purchase. Additionally, lenders understand that they must move nimbly and conduct their due diligence within a short period of time, as this is the nature of hard money loans. Some real estate deals may fall through, or you, the borrower, may find a different property that you like even more. It is much cost-efficient for a lender not to require a mountain of paperwork to review in such an environment.
Are Hard Money Loans Safe?
Hard money loans are generally considered safe so long as you use a reputable lender with experience.
Unfortunately, due to the flood of real estate investors, and fix and flippers after the Great Recession, there have been a plethora of hard money lenders that have opened up shop. The problem is, however, some of them are inexperienced, or implement overly burdensome clauses in their loan agreement, and have consequently given hard money lending a bad reputation.
Don’t however, let these few, what we’ll call, ‘bad apples’ in the business, discourage you from considering a hard money loan. Hard money loans are a viable business option for real estate investors and developers, especially those who are otherwise unable to qualify for the conventional real estate development or construction loans available. Arguably, hard money loans are considered ‘safer’ than these because they are not dependent on your personal financial history. In this respect, even in the most worst-case scenarios, such as inability to make payments or inability to pay for the balloon payment, largely your personal credit will not be affected. Hard money loans, after all, are considered loans for business purposes.
There are additionally steps that you can take to ensure that your hard money loan is safe. Thoroughly research each lender you are interviewing. Check their website and online reviews to get a sense for who they are, how past customers have perceived them and how they operate after a transaction has closed. Additionally, take ample time to review the documentation and make sure you understand all the different clauses. If you have any questions or don’t understand what is being outlined, request clarification from the lender themselves. Lastly, build a plan for how you are going to make the monthly payments and ultimately pay off the loan, and share it with the lender to ensure it makes sense.
While some hard money lenders will most likely check on a borrower’s credit report, there are very few instances where a hard money lender has reported delinquencies or defaults to the credit bureaus. Most hard money lenders are private lenders and don’t operate like a bank, so borrowing money from them Is not likely to show up on credit reports. For these reasons, a hard money loan is not likely to affect debt ratios and credit limits established as guidelines for creditors considering your application for credit.
Hard Money Loan Examples
Hard money loans are most commonly utilized by fix and flip real estate investors. As an example, let’s say an investor identifies a $300,000 single family home located in a neighborhood of homes valued around $500,000.The numbers on this house easily qualify for the 75% ARV required. The house needs work, so a bank and credit union most likely will not approve the loan without a substantial 25% down payment that he cannot personally afford. The investor does have $80,000 saved up, so he turns to a lender like Neal Business Funding, and applies for a hard money loan for 90% Financing, or for a loan amount equal to 90% of the sales price.
He’s able to secure a loan for $270,000, and put down only $30,000. The loan costs 2.5 points in origination fees, or $6,750, plus $1,500 for the attorney and processing fees, and the property closes at the end of the month, so there is no prepaid interest owed. Overall, the investor pays of $38,250 at closing, and now has $41,750 remaining in order to complete the repairs and make the monthly payments. If, in this example, the interest rate is 10.0% and the payments are interest only, meaning no payments are made to pay down the balance, the investor begin making monthly payments of $2,250 beginning 30 days after the loan has closed. Hard Money Lenders will require the borrower to show liquid funds available for 6 months interest payments.
This first 60 days gives the investor ample time to make the necessary repairs, and they decide to list the house on the open market, for $515,000. If the investor is able to close on the sale in 4 months, the full loan balance will be paid, and the investor can profit as much as $124,000 ($515,000 sales price – $270,000 loan balance – $38,250 estimated closing costs – $9,000= 4 -months of interest payments – $32,750 in repairs – $32,000 selling closing costs).
If for some reason, the house is unable to sell initially, the carrying costs, or the cost to continue making the monthly payments, will increases and the investors profits will decrease. However, overall, with as little as $80,000 a hard money loan enabled this investor purchase much higher priced properties than he otherwise would be able to and to create $133,000 in profit. If the investor chooses to finance the rehab costs too, this project could be completed with even less money out of pocket.
Hard Money Loans for Rental Properties
Lastly, certain real estate investors will utilize hard money loans as a steppingstone to gaining long term ownership of rental properties. When it comes to rental properties there are more financing options available to investors. So long as the income generated pays for the estimated loan payments, banks and traditional lenders are more willing to extend loans to the owner. The only caveat is, most rental properties available to investors are either vacant, in need of serious repair, or otherwise would not meet the minimum property standards lenders would require, even if there are tenants.
As a response, real estate investors, have been known to purchase rental properties at foreclosure auctions or from motivated sellers, using a hard money loan. Within the time frame the loan allots, they make any necessary repairs, evict any non-paying tenants, and stabilize the property, or secure tenants willing and able to pay market rate rents. They will then refinance the property, lowering the monthly payment, paying off the hard money loan, and pocketing the difference each month.
Hard Money Loans for Distressed Sales
Hard money can also be ideal for real estate investors that specialize in closing distressed or short sales. In these types of sales, there is usually a long waiting period, followed by a quick closing period. Many banks and conventional lenders are not willing to sit around, will require the paperwork to be updated, and even if approved, would not be able to dispense capital to meet these requirements. Hard money lenders, however, understand their clients’ needs, and can provide the last-minute capital to make even the most distressed deals happen.
Hard Money Loans for Investors
Furthermore, hard money loans are a huge resource for real estate investors, developers, and professionals. As you will recall from our earlier articles, flipping a property involves buying a property at a bargain price, making any necessary renovations to it, and then selling it at a higher price in the expectation of a profit. Because investors look to do these types of deals in less than one year, so that they can move on to the next project, hard money loans provide a viable option.
Hard Money Loans for Flippers
For first time flippers with little capital and little documented experience, hard money loans offer a relatively safe capital option that can be accessed fairly quickly. Additionally, for real estate investors, both new and seasoned, like hard money loans for their ability to provide fast access to a large amount of capital with relatively little processing time. This allows them to focus on finding new properties and working more deals, and stay competitive in even the most saturated market, as opposed to babysitting paperwork.
How to Apply for a Hard Money Loan?
To apply for a hard money loan, most lenders will want to know the following information:
- What is the purpose of the loan? Lenders will want to know if you are trying to purchase, refinance, or newly construct a property.
- What is the property type? Is the property a single family, condo, a manufactured home, a duplex?
- Who will be buying the property? Will it be you as an individual or an entity that you have setup, such as an LLC or corporation? Most lenders will prefer to see an entity.
- What is the address? This is needed, so that the lender may begin their due diligence.
- What plans do you have for the property? Lenders will want to know what your renovation and construction plans, if any, are for the property. You will need a scope of work to submit, detailing all repairs and improvements planned. Will you be flipping this or turn it in to a rental?
- Liquid Assets? Lenders will like to see that you have sufficient funds available to pay the down payment, 6 months interest and a portion (usually 10%) of the rehab budget. Bank accounts, 401k’s and home equity lines can usually count towards the requirements as liquid funds.
- Do you have any experience? While experience is not required, lenders will want to know how many previous properties you have flipped / rehabbed. The more properties you have done, the lower your interest rate will be as you are rewarded for your experience.
- What is your Credit Score? Even though hard money loans primarily place most emphasis for the loan on the property, you still will most likely need a 600 credit score or better.
Hard money loans are so focused on the value of the property, that it is common to see stated income (meaning there is no income verification), poor credit, hard money loan programs. Lenders in the hard money lending sphere, like us here at Neal Business Funding, understand the need to maximize a borrower’s flexibility.
Are Hard Money Loans Worth It?
If you’re still not sold on whether hard money loans are for you, give us a call. Depending on your specific situation, hard money loans, can be an excellent bridge to other forms of capital, as well as a desired option for real estate investors and developers. As we’ve hope to outline in this article, the process for applying for a hard money loan is much more transparent and straightforward compared to applying for a loan from a bank, and funding can be provided in as little as 10 days.
Neal Business Funding Offers Hard Money Loans
If you are a real estate developer and investor or are just beginning your career as a property flipper, Neal Business Funding offers many different programs that may fit your needs, including hard money loans. In the past we have worked with and helped hundreds of real estate professionals grow into the robust investors that they are today. If you are potentially interested, give us a call 315-699-4703 and speak with a loan support expert, or send an email to email@example.com for additional information. We pride ourselves in making sure you have all the answers you need before making the next step.
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