Real estate investors often rely on hard money lenders to provide the funding necessary to acquire and rehab investment properties. A hard money loan is secured by real estate, has terms generally ranging from one to five years, and is made by private investors rather than banks. Repayment may consist of either monthly payments of interest and principal or interest only, with a balloon payment at the end of the term.
These loans are also referred to as bridge financing since they are often used to transition a property from one stage to the next. For example, hard money loans may fund a project through acquisition, renovation, refinancing, or the outright sale of the property.
Since the loan is collateralized by real estate, hard money lenders focus most of their attention on the value of the property rather than the borrower’s credit history. As a result, borrowers who may not qualify for conventional financing are sometimes able to obtain a hard money loan.
Hard money lenders tend to specialize in certain types of properties (residential real estate, for example) and aren’t as interested in lending outside their core areas. For that reason, when shopping for a hard money lender, ask upfront if the lender specializes in the type of property you plan to purchase.
Hard money lenders also sometimes specialize in certain types of loans. These may include: 1) purchase loans (used to fund real estate acquisitions), 2) refinance loans (used to pay off existing debt) and 3) cash-out loans (used to pay off existing debt or provide working capital for the existing property or another property).
When compared to banks, hard money lenders have the ability to fund loans much more quickly. A hard money lender can usually close a financing in a week whereas banks often require a month or more to process a mortgage loan. The faster turnaround of hard money lenders is valued by real estate investors, particularly in situations where a property has multiple bids. Being able to greet the seller with cash in hand, while others wait for financing, is often an effective strategy for closing the sale.
The interest rate charged by hard money lenders tends to be higher than bank rates due to greater risk, but rates vary across lenders and from region to region. For example, California rates are generally lower than rates in other parts of the country due to competition among California’s many hard money lenders. There are a few national firms and many regional lenders in the hard money segment. Many fix-and-flip investors prefer working with a local lender since lending is relationship-based and building strong relationships is difficult if contact is limited to phone calls or the internet.
When you are screening hard money lenders, your first priority should be verifying that the lender has a solid reputation and substantial real estate lending experience. This can be accomplished by making a quick visit to the Better Business Bureau site or posting a query with the local chapter of the Real Estate Investors Association. Hard money lenders come in two varieties – brokers and direct lenders. Direct lenders make loans using their own capital. Brokers serve as a middleman between investors and the borrower. Brokers provide a useful service for fix-and-flip investors, who are just starting to build their networks, but direct lenders are usually able to offer better rates and greater flexibility since there is no middleman involved.
Here are eight questions to ask prospective hard money lenders:
1) Points and interest. As mentioned above, points and interest rates vary across regions and by lender. The riskiness of the project also affects the interest rate. In general, borrowers should expect to pay interest rates ranging from 10% to 15% on hard money loans and points ranging from 2% to 4% of the loan amount.
2) Loan terms. Some hard money lenders focus exclusively on very short-term funding (12 to 24 month terms) while others may offer terms of five years or more.
3) ARV (After Repair Value). Inquire whether the loan will be based on ARV or the property’s current value. Also ask what LTV (loan-to-value) ratio is considered acceptable by the lender. Most hard money lenders accept loan-to-value ratios of up to 75 percent on income-producing properties and up to 50% on land. Find out whether points and interest are included in the LTV calculation and how ARV is determined. Does the lender seek an independent appraisal of the property or rely exclusively on comparable sales data?
4) Upfront fees. An important area to question is upfront fees. Appraisal and document fees are customary, but think twice before giving your business to a hard money lender who demands a loan application fee. Also ask if there are any hidden fees.
5) Down payment. Hard money lenders usually want the borrower to have at least some skin in the game. Inquire how much money you (the borrower) will need to put into the deal as a down payment.
6) Penalty fees. Ask about penalty fees that are due if the loan goes past term.
7) Disbursement of funds for renovation work. Find out if the lender will fund property renovation costs and, if so, how these funds are dispersed.
8) Time to closing. Ask the lender how much time is typically required for financing transactions to close.
You should also ask for references from prospective hard money lenders. Not every lender will accommodate this request due to confidentiality agreements with clients, but some will so it’s worthwhile to ask.