Hard Money Loans: A Complete Guide
Most people assume the only way to finance properties is via main street lenders, and mortgages.
We all know the approval process is slow, painful and many times; unsuccessful.
Hard money loans offer an alternative to these main street lenders.
Instead of assessing your ability to pay back a loan, hard money loan lenders will look at what you have as collateral. This is their security against you not paying.
What Is A Hard Money Loan?
Hard Money loans are non institutional loans funded by private real estate investors, companies and funds – using their own money – most often secured by a first Trust Deed against the subject property.
These types of loans are referred to by many different names, such as, private money, equity-
based, asset based or hard money.
Such equity-driven mortgage loans typically require 40% equity in the property and or collateral in another piece of real estate. These types of loans also carry a heavier burden and interest rate for the borrower for the simple reason that they also pose higher risk for the lender. They are most often a temporary solution that opens doors for a more permanent financial solution or exit strategy.
Why Use Hard Money?
Above all, speed is the reason hard money is a great option.
From filling out that first document, through to seeing money in your bank, a mortgage can take 2-6 months to go through; not good enough.
This timeline is cut to weeks or even days when using hard money loans.
So, how is that possible?
Mortgage lenders will analyze every aspect of your finances before accepting your application.
They’ll check out:
- credit scores
- the stability of this income
- any missed payments
- outstanding credit
- Basically – everything.
Lenders are interested in one thing; short term loans. And, assets to secure them.
If the loan is not repaid, they have the right to seize these assets to pay off the loan. So, it is important you have a means to pay these loans off.
At first glance, this might all seem a little bit risky.
But here’s the thing; hard money loans give people the chance to pounce on profit making opportunities.
If this finance option wasn’t available (meaning the borrower has to revert to main street lenders), there’s a good chance the opportunity would be missed.
How Much Hard Money Costs
Hard money loans will typically start at 7.7%, although the actual rate will depend on the loan to value required, and the liquidity of an asset.
For example, using real estate as collateral that’s in an unpopular neighbourhood (illiquid) is going to be subject to a higher rate than real estate in an extremely popular neighbourhood (liquid).
One cost that a lot of borrowers forget to account for is the loan arrangement fee.
For brokers, this is their profit from the deal. You should expect to pay a fee of around 2% for a 6 month finance deal and, around 3% for a 12 month deal.
Types of Hard Money Loans
As a borrower, you will not be able to get hard money finance without security. There is one type of security that is going to be accepted more readily than any other; real estate.
Put simply, lenders are looking for liquid assets. Most real estate is going to fall into this category.
If you have real estate as security against the loan, you’ll then be given the option to structure a deal in one of four formats.
Commercial Hard Money Loans
Commercial hard money loans are labelled as any loan that is not given directly to a private borrower. Instead, these borrowers are business entities.
Many lenders will consider a commercial borrower to be riskier than lending to an individual. For this reason, the loan period tends to be extremely short (1-12 months).
Most businesses that are using hard money loans are looking to upgrade equipment, purchase more inventory or make property improvements.
With the use of the loan, they are able to hit a new (and, higher) capacity. The profit from the higher capacity allows them to easily pay off the loan.
Wholesale Hard Money Loans
If you’ve ever had a loan or mortgage where you deal with a broker, not directly with a lender, then you’ve had a wholesale loan.
Fix and Flip Hard Money Loans
If you are looking to make repairs or any type of renovation to a building, you’ll be looking at a fix and flip hard money loan. They can be used for apartments, houses or commercial buildings.
Usually, fix and flip hard money loans are used to improve a property ready for resale.
Due to the short-term nature of the loan (and the additional equity the improvements to the property provide), the interest paid is almost unnoticeable.
Cash-Out Refinance Hard Money Loans
Borrowers looking for a “top-up” on their mortgage will need what’s called a cash-out refinance loan.
Benefits of Using Hard Money Loans
When most people think about hard money loans, they think about high interest rates.
Agreed, 7.7% is slightly higher than a typical mortgage, but the benefits far outweigh the costs.
In some cases, hard money loans are the only option (especially on time critical deals).
Benefit 1: The Approval Process
The approval process for hard money loans is one of the main reasons people use them. Just because borrowers don’t have a solid income or credit score, doesn’t mean that they don’t plan on paying back loans.
A typical example of borrowers that don’t have a solid income to speak of are those that have recently retired.
Many retirees try to invest in real estate, but find the hurdles they must jump through to get a mortgage are just too complicated – even if they have collateral in their current property.
Bear in mind that many hard money lenders will look for collateral in the region of 60% loan to value (LTV). This ensures that if there is a default on the loan (or even, a decrease in real estate values), they can still get their money back via a sale.
Benefit 2: Speed To Acquire Funds
I know the question you want answered. How long does it take to get a hard money loan?
The answer varies depending on the underwriter and the underwriting process that they use. Typically, borrowers will be able to access funds within 7-14 days if they have sufficient collateral.
The lack of background checks needed (besides standard ID) means that lenders of harder money loans can shave off 2-3 months from the process, in comparison to a mortgage lender.
If you accept the first deal on the table, funds could be with you in as little as 7 days. However, having a broker compare and play-off lenders to get the best deal is going to mean you don’t get funds in this time frame.
If the reason you are getting a loan is time critical, take the first deal offered.
Benefit 3: Agreement and Timeframe Flexibility
Many people that apply for hard money loans are not typical borrowers.
They have a reason for getting these loans over traditional loans and mortgages such as:
- No proof of income
- Bad credit scores
- They need money fast
For this reason, flexibility is key.
Underwriting will be on a case-by-case basis, rather than an automated underwriting process that large and traditional lenders use.
Hard money loan lenders will ask the borrower:
- The amount they can afford to repay monthly.
- The repayment term they would prefer (between 3 months and 30 years).
- The value of the loan (between $50,000 and $20m).
Why People Avoid Hard Money Loans
The fact is, there are other options.
If borrowers do have a solid credit rating, proof of income and are looking for longer term loans, hard money is not the best option.
A standard mortgage is more suitable.
In comparison to traditional loans, hard money interest rates can be higher.
But, it’s an apples and oranges comparison.
Traditional loans are essentially, a different finance product, to be used in completely different circumstances to a hard money loan.
Should I Use a Hard Money Broker?
A lot of people associate the word broker with “adding a percentage on top of the original price”, and therefore, being more expensive.
In most areas of finance, the opposite is true.
Big firms want to get their hands dirty as little as possible. That means they don’t want phone calls, to have to sit there and fill out forms with borrowers, or offer advice.
What they want to do is process as many applications as possible, in the most automated way possible.
So, they pass the baton on to brokers.
Hard money brokers offer the personal service that a borrower needs, before passing on the completed application to the lender.
Brokers take away time input needed and stress, from lenders. And, because they do this day in, day out, they can access better rates than if the lender offered the hard money direct to the borrower.
What to Ask a Lender
The hard money finance industry is much smaller than the standard mortgage industry.
Many of the lenders that you are going to come across are not going to be names you’ve ever heard of. To ensure you pick the right lender, it’s worth preparing a set of questions.
These might include:
- Are you a broker, if so, what is your broker ID?
- For example, our broker ID is 01384244.
- How many years have you been trading?
Like other small pockets in the finance industry, there are a lot of rogue traders in this one.
You’ll want to pick a lender that has at least a few years’ experience. Not just to ensure they are a legit business, but also, they have the bargaining power to get you the best deal.
What projects will your firm fund?
You’ll need to outline your project and check that this broker will fund you.
Just a handful of questions can help borrowers distinguish the legit finance firms from the rogue traders.
How to Get Approved For a Hard Money Loan
Now you’ve determined that a hard money loan is the right type of finance under the circumstances, you need to get ready to apply.
The first thing a lender or broker will want to see, is the value of your collateral, and the equity you have in it.
If collateral comes in the form of real estate, check out the sold prices for similar real estate in your area.
You can do this quickly and easily on sites such as Zillow.
Once you’ve determined the value of your real estate, you will need to provide evidence of what you currently owe. This will give a net figure (equity) which will be used as collateral and will determine the maximum loan you can apply for.
Some lenders that have slightly stricter policies for lending, will want to see a project plan, and ask questions in relation to your plan.
- Are you planning to renovate and flip your current residence?
- Are you buying a warehouse with planning permission to convert into apartments?
- How long do you expect the process to take?
They will then determine if the plan is reasonable (given the timeframes that you have documented). This gives them a get-out clause.
If everything goes to plan, you’ll use profit to pay them back. And, if it doesn’t, they know they can recoup their investment via selling the asset and taking the remaining equity.
Once all the above is in place, the lender/broker will guide you through the application itself.
They want you to get accepted, just as much as you do.
How to Profit From Hard Money Loans
Just because hard money loan interest rates are higher than traditional loans, doesn’t mean there isn’t profit to be had.
The flexibility and speed of hard money deals means that borrowers can pounce on opportunities that they couldn’t have done with a traditional mortgage application.
Here are a couple of ideas to get you started.
Bidding for Multiple Deals
If you’ve managed to get accepted for a large sum via a hard money application, you could be looking at multiple pieces of real estate at one time.
Typically, a mortgage lender would not accept more than 1 mortgage application from a person at a time.
But as the method of security here is collateral, your free to bid and purchase as many properties as your loan allows.
So, if you already have a bid for a house and see a below market value property appear on the market, you have the flexibility to bid and purchase both.
Leveraging Without Selling
Circumstance plays a crucial role in profiting from real estate. If you need to sell quickly to fund the next deal, there’s a good chance you are going to need to drop the price (creating a below market value deal for other investors) and lose out on potential profit.
And, this isn’t a good business model at all. If you leverage hard money to work on multiple real estate deals at once, you are not relying on a sale to get the next deal going.
Just by using leverage and hard money, suddenly you can wait to get the real value for a property, creating more profit ready for the next deal.
Cash flow improves thanks to this leverage.
Not Missing Out On Opportunities
This is one of the biggest reasons people use hard money loans to fund real estate deals; opportunity.
Regardless of the extra interest rate in comparison to typical mortgages, hard money loans can still create profit.
A typical example might be real estate that goes to auction.
If you are using a traditional mortgage broker, it’s almost impossible to get a deal done at auction.
Why? Because most auctioneers want a 10% deposit upfront and all funds cleared within 30 days.
And, when they don’t get their funds within 30 days (as most mortgages take months), they take your 10% deposit.
The opportunities at auctions are endless. A lot of the people here are using 100% cash which means they have their heart set on 1 deal before they arrive.
So, on a day where a piece of real estate doesn’t get the attention it deserves, you have an opportunity to swoop in and get a below market value property.
- Use hard money to fund the real estate deal, ensuring you don’t lose your deposit.
- Once the real estate is secure, apply for a traditional mortgage at a much lower rate.
- You get the mortgage and put it the property up for sale.
- Now, any interested buyer can use a traditional mortgage to purchase your real estate. That means there’s increased supply of eligible buyers which leads to you being able to market the property at its true market value.
Renovating Your Home [Ready for Resale]
If you are thinking of upgrading to a new apartment or house, there’s an opportunity to make money.
Residential homeowners in this position go through a simple process to determine whether using hard money could produce a profit.
Get a valuation from a local real estate agent.
Alongside the valuation of the house in its current condition, ask for a valuation if obvious works were done.
This could include renovating the kitchen, bathroom, landscaping the garden or replacing single glazed windows.
Determine the cost to get these building works completed. Local tradesmen will be able to give estimates.
Determine if the cost of the works is less than the increase in equity that they provide.
If the cost is less, whatever the difference between the equity and cost is, is potential profit for you. Using hard money you can fund the cost of works (to be repaid when the house is eventually sold).
California Hard Money Direct are a licensed broker of Hard Money loans. Contact us today to discuss your requirements.