Hard money loans are often used to fund transactions when a quick turnaround is needed such as a fix-and-flip purchase. Conventional bank loans are generally used in situations where the property will be held for a long-time. Quicker turnaround is possible with hard money loans because there is less bureaucracy involved. These loans can be approved and closed in a few days, sometimes as little as 72 hours.
Property purchases made with hard money loans include single-family residential houses, multi-unit dwellings and some commercial properties. Most hard money lenders are willing to finance the purchase of both commercial and residential properties, but avoid loans involving owner-occupied residences due to more regulation on these transactions.
Interest rates on a hard money loan vary by lender and by the borrower’s specific circumstances. At present, rates generally begin at approximately 10% and rise to the mid-teens. Some lenders allow interest payments to be deferred until payoff. This can benefit rehabbers by eliminating monthly payments during the period when capital is needed to renovate the property.
The duration of a hard money loan can range from a few months to two to three years, depending on the type of property and the borrower’s specific needs. Loans for renovating single-family homes generally range from six months to one year while loans for commercial properties such as a shopping center can have a two-to-three-year duration. Interest rates are typically higher on longer-term loans. To close a hard money loan, the lender may require the borrower to obtain a title policy, insurance, and an appraisal of the property. Most hard money loans have origination points, which can range from two to 10 points, and require a personal guarantee from the borrower and a first lien positioning.
While hard money loans for single-family homes are usually fixed rate, a floating rate is more common for commercial properties due to the longer maturity. Loans are often structured with balloon payments although flexible payment terms such as an interest-only option are sometimes available.
Compared to traditional bank financing, the main advantages of a hard money loan are the simpler application process, faster turnaround, and less scrutiny of the borrower’s personal financial situation. The principal disadvantages of these loans are higher interest rates and origination fees. Because of the higher costs involved, hard money loans make the most sense for borrowers when a quick closing is mandatory, or when there is an exceptional investment opportunity, but limited access to traditional financing.
There are hundreds of companies that make hard money loans. Here are six tips for choosing the right lender:
- Look for a firm that specializes in hard money lending. The origination, servicing and compliance requirements for hard money loans are complex and need the expertise of a dedicated hard money specialist. In addition, an experienced hard money lender knows how to structure loans to facilitate a good outcome for all of the involved parties.
- Focus your search locally. Many hard money lenders want to inspect the property that will secure the loan in-person so your best option for finding a lender may involve searching locally. There are some hard money lenders that operate nationwide, but these firms tend to offer less flexibility than a local lender.
- Insist on a high degree of transparency. All of the involved parties should have access to the loan data during the origination process and the hard money lender should adhere to published loan program guidelines. Be wary of lenders who advertise teaser rates that are never available in real lending situations.
- Check for licensing. The best hard money lenders are licensed by their state Department of Real Estate and registered with organizations such as the Nationwide Mortgage Licensing System and Registry. You should also confirm that the lender has a valid Real Estate Broker License and check whether any complaints have been filed against that license. Also visit the lender’s website and profile on Linked In. The image conveyed by the lender’s on-line presence should be consistent and professional.
- Determine your hard money needs. Many loan types are available for hard money financing. There are hard money lenders who specialize in foreclosure rescues, investor financing and commercial properties. When presenting a project to a lender, be prepared to provide the address of the property, deadlines critical to the transaction such as the closing date, the purchase price of the property, the renovation budget and the projected post-renovation asking price.
- Understand the significance of the loan-to-value ratio. Unlike conventional lenders, hard money lenders use the value of the property “if sold today” as collateral for the loan, Hard money lenders usually take a more conservative approach to valuation than the standard appraisal method used by large banks. The focus for hard money lenders is on asset value and the loan-to-value ratio. Most hard money lenders won’t lend more than 70% of the home’s value, whereas banks may lend as much as 80% and some government-backed loans may exceed 90%.
Hard money lenders differ from one another in their loan-to-value guidelines, the type of real estate they finance, minimum and maximum loan size, the geographic region they serve, and in the level of service provided. A good starting point for finding a hard money lender is to seek referrals from local title companies, mortgage providers and realtors, since these businesses are involved in home sales and purchase transactions on a daily basis. Another strategy is to ask for input from local real estate investor groups. Investors should plan on reaching out in advance to a few lenders in order to begin building relationships that will facilitate quick funding of projects as opportunities arise.