Why real estate investors prefer hard money lenders
Research has shown that traditional lenders are risk-averse, and will never lend money to borrowers with poor credit scores. Even with good credit ratings, if you don’t have a substantial income history, getting approved for a loan by a conventional lending institution can be a daunting task no matter how high your income is.
Hard money lenders, therefore, come in handy for real estate investors looking for quick cash to finance their real estate investments. They’ll approve your loan application based on the value of the property you offer as collateral, and will not care much about your credit reports or income.
Below is a review of everything you need to know about these loans:
What are hard money loans?
If you can’t get conventional financing due to a poor credit score or foreclosure, you could still get funding from hard money lenders. Unlike traditional lenders who will approve your loan application based on your credit history, hard money lenders are more concerned with the value of the property you use for securing the loan.
Hard money loans, therefore, are short-term loans that are secured using real assets. Hard money lenders are private investors or business owners in the lending industry with the necessary capital to offer the borrower.
The lending process
The first step in acquiring a hard money loan is to identify what your goals are. Your lender will need to know every detail before approving your loan request. What do you intend to use the loan for? Are you planning on flipping the property? Do you have a contractor in mind? What is your estimated budget, and how long do you think the renovations are going to take? These are some of the factors you need to consider before applying for the loan.
It is also important that you disclose the property details like address, purchase price, renovation cost if you are planning to renovate it, and the loan amount you need.
Once you have identified your goals, you now need to find a reputable lender. It’s necessary that your hard money lender be your partner, that way, you will be able to achieve your goals. The best way to identify good lenders is to join real estate investment clubs in your area and attend the organized events. Speak to other investors and find out about their past experiences with lenders. That way, you will know which lender is the most popular and help you determine who to work with.
After identifying a compatible lender, and are ready to start the process, the lender will do some background check on you and the property. The soft check usually is not to lock you out because unlike traditional lenders, hard money lenders do not offer a loan based on your credit scores or creditworthiness. Their main concern is the value of the property offered as collateral.
Once you are done with the prequalification process, you’ll have to fill out the lender’s loan application form. By filling out the forms, you authorize the lender to check out your employment and income history, and credit. As mentioned earlier, these details don’t determine your eligibility for a loan, but lenders take them into consideration.
The loan application form then goes through processing. The processor checks for proper documentation and accurate paperwork. He then passes it to the underwriter who will identify the risk involved in the loan and determine if you are worth funding based on the value of the property offered as collateral, capacity to pay, and your credit scores. Your credit, however, is the least of their concerns.
The last step if your loan request is approved involves the lender sending you a letter with all the terms, payments and closing costs of the loan. To make sure there is a recorded trust deed that the borrower follows all the loan requirements, an escrow agent must be present for this final step. And once all the necessary requirements are followed, the loan is closed.
Interest rates charged on hard money loans
Due to the risk involved in this form of financing, hard money lenders usually charge a high interest rate than conventional lenders. The amount charged as interest range between 10-15% and points are between 2-4% of the loan amount.
The rates charged, however, vary from lender to lender, and the state you come from. If you come from a state where there are several hard money lending firms, then the interest rates are likely to be lower because of the stiff competition. The interest and points vary depending on the loan to value ratio.
How much can an investor borrow?
The amounts hard money lenders can lend greatly depends on the ratio of the loan amount divided by the value of the property also known as loan to value ratio.
Many lenders will lend up to 65 – 75% of the current book value of the property. Others will use the after repair value (ARV) when determining the loan amount.
The only downside of using the estimated value of the property after improvement to base how much a borrower is eligible for is that it makes the loan riskier. The value of the lender’s capital increases while the borrower’s capital decreases. This then makes the lender charge a higher interest rate.
Another scenario is when the lender finances the rehab costs and a higher percentage of the AVR. It may look like a lucrative deal for the borrower but the interest rates are much higher at 15-18% with points in the range of 5-6. As a borrower, you should check the expected profit margins after the loan deductions, and if they are still higher, then this may be a good deal for you.
So why use hard money loans in spite them being expensive?
Many real estate investors still prefer hard money loans for the following reasons:
If you are in a hot market with multiple offers, you know how important it is to close a deal quickly. Banks can take forever to approve a loan request because of the numerous credit checks, income verification, and proof of creditworthiness. Hard money lenders will approve your loan application based on the value of the asset you offer as collateral. They may check your credit and income, but not with the kind of stringent procedures that banks use.
Lending restrictions vary from lender to lender. Unlike traditional lending institutions where rules must be followed to the latter, hard money lenders are more flexible and can tailor your loan to suit your needs. They treat each deal differently. So, depending on what deal you intend to use the loan for, let your lender into your plans. That way, they’ll help you achieve your goals.
If you need a hard money loan, all you need is an investment property, residential property or rental properties that you own or wish to purchase and offer them as collateral to your lender.
The lender’s main concern is the value of the collateral assets. You don’t need to worry if you had a recent foreclosure or short sale in your reports. The lender may not even check them.
Most lenders always keep a low loan to value ratio to ensure that even if the borrower defaults on payment, they can still recover their money by selling off the property quickly.
You can use hard money loans as a last resort or a bridge loan to finance the purchase of an investment property you intend to purchase or renovate, and resell quickly to pay off the loan within one year or so.
To get profits out of the deal, plans have to be followed to the latter. It’s also important to note that lenders value property differently, and your assets may not fetch much as you expected.
Hard money loans are expensive and if you decide to use this method of financing, be ready to part with double digits interest rates and origination fees on several points. You could use FHA loans as an alternative to hard money loans because they also allow you to borrow with a not so perfect credit.
Quick tip to borrowers
- Before applying for hard money loans, ensure that you have plans in place on how to repay your loan. Defaulting on payments could lead to loss of your property through foreclosure.
- A shorter loan term is better than a long term loan because of the high interest rates charged on these loans.