How Does Hard Money Lending Work?
You need some quick cash for your next investment property. The bank isn’t likely to offer you a more traditional loan, so what other options do you have? Many real estate investors and house flippers turn to hard money lending for their financial needs. How does hard money lending work? These loans are a little more complicated than traditional financing options, but they do have unique advantages.
Before you settle on the financing for your next property, make sure to do your homework. Here are all of the facts you need about hard money lending and how it will impact your property.
What is Hard Money Lending?
Hard money loans, sometimes called bridge loans, are designed to offer short-term financing for someone who needs to invest in a project right now. They allow you to purchase a property faster than conventional financing will allow for.
While some people do use hard money loans to finance their personal properties, they are more often used by professionals. These loans are particularly appealing for house flippers who invest in a property for a short period of time and then sell it at a higher rate. Real estate developers also use hard money loans to renovate and develop properties prior to reselling them.
The primary difference between hard money lending and traditional financing is the source of the money. Instead of working alongside banks and mortgage companies, private lenders are mostly responsible for these types of loans.
Hard Money Lending vs. Traditional Financing
Because the funding source is different, so are the qualifying criteria. Before a bank is willing to issue you a loan for a real estate investment, they examine how likely you are to repay the loan. In other words, they are looking at your creditworthiness, income, and debt-to-income ration among other things.
Private lenders who issue hard money loans are going to look at the collateral. In other words, they are concerned with the value of the property you plan to purchase.
They will compare the initial investment with the after-repair value (ARV), the amount that you plan to sell the property for after your renovation is finished. The difference between these two amounts may make the difference in whether they choose to invest in your project or not.
As you can see, there is quite a difference between receiving traditional financing and hard money lending. This means that there are likely to be different terms to your financing that should be taken into consideration before you choose hard money lending for your real estate investment.
Traditional financing typically spreads out your payments over many years. You’re probably already familiar with the concept of both fifteen-year and thirty-year mortgages. Hard money lending isn’t designed to last for the long haul. Most private lenders will push for faster turnaround times on their investment, only issuing loans for twelve months or less.
Making payments on a hard money loan is also different than typical financing. Instead of paying toward the balance and interest, most hard money lenders require interest-only payments. The final balance is paid in one lump sum after the project is completed.
Benefits of Hard Money Lending
If you’re serious about flipping houses and developing real estate, you’re bound to consider hard money lending at some point in your career. Understanding when and how to use it effectively can make all the difference. Take a look at some of the benefits of hard money loans to see if they’re right for your next project.
Obtaining financing through your local bank can be a slow and painstaking process. Closing on a new property could mean weeks of paperwork and bureaucratic red tape. Hard money loans cut through much of the mundane tasks associated with banks and mortgage companies. In other words, you get the money you need faster. Most people can see their funds within the first week of applying for a hard money loan.
These loans are relatively easy to obtain. You can apply and receive a response in no time at all. Knowing what funds you have available can speed up the process of purchasing a property that may not be on the market for long.
The bank is looking at how likely you are to repay the loan. Private lenders are looking at the same thing, but they do take other things into account. Because they are more interested in the value of the property and its ARV, they may offer more leniency on your own creditworthiness and income. Previous foreclosures and other personal financial discrepancies might not mean an automatic disapproval for financing with hard money loans.
Investors who have unique circumstances may desire the flexibility offered by hard money loans. Private lenders can often offer unique terms and repayment plans because they do not have to be held to the same standard as traditional loans.
Disadvantages of Hard Money Loans
Unfortunately, not everything about hard money loans is ideal. You should really consider the big picture before deciding to take the leap on your next investment property. Take a look at these disadvantages and see if this type of financing still makes sense for you.
It’s undeniable that there is a definite expense associated with hard money loans. In order to make up for the risk they take, most investors will charge higher interest rates than those offered with traditional financing. You can expect to see interest rates soar into the double digits with your next financing offer. Factor this significant cost into the equation when calculating your profits from a project.
Short Repayment Period
You may have no problem with a short turnaround time on a project, but what happens if you hit unexpected bumps in the road? A shorter repayment period could prove problematic. If you have any concerns about flipping your property within the typical twelve-month repayment period, a hard money loan may not be the right fit for you.
You could also face a problem with repayment periods if you attempt to sell a flipped home in a buyer’s market. Longer selling times may push you over the edge and cause you to default on a hard money loan.
Make sure to have a refinancing plan in place, just in case you can’t repay the loan in the given time period. Finding alternative financing sources might be more challenging than you anticipate. Mortgage lenders typically require you to own the property for a set period of time before they will take on your refinance. You may not meet the minimum requirements within the short time period found with hard money loans.
Don’t be caught unprepared. As you near the close of your hard money loan, set plans in place to make sure that your loan will be okay.
Much like traditional financing, you will still find that private lenders require you to come up with some cash on your own. The specific loan-to-value (LTV) ratio will vary based on the lender. Some lenders will base the required LTV on your after-repair value of the property.
No matter what the specifics are, be prepared to put down a substantial amount of your own cash. It’s possible that a private lender will require twenty percent of the cost of the property, just like your traditional lender.
Lack of Oversight
Getting a loan through your bank gives you peace of mind that you are being treated fairly. There is a lot of oversight from the government for federally-insured financial institutions. However, the same can’t be said for private lenders. Be aware of the fine print when you sign on the dotted line for your next hard money loan.
You’ll likely encounter at least a few unscrupulous lenders if you spend much time searching for a good hard money loan. Ask questions if you need clarification on certain parts of the terms and conditions of your loan. Never assume that the loan is written to be fair to your or your business. Make sure to vet each lender thoroughly and choose with care.
Choosing the Hard Money Loan
Hard money lending certainly has its benefits for house flippers and real estate professionals who can confidently flip their properties. It comes at a significant cost, but the convenience and flexibility might make it worthwhile. You’ll need to sit down and see what makes the most sense for your next project before you make any major decisions.
Feeling confused about what your options are for financing your real estate investment? You aren’t alone. Many people find the world of real estate investment to be a little confusing at first, particularly as it relates to the different types of financing available. The right investor may find that hard money lending has more potential benefits over other traditional financing offers.
Financing your real estate investment projects is an inevitable part of the business. Understanding how does hard money lending work, offers your business the key to helping you turn a profit on your next project!