As you begin to learn more about Real Estate Investing, you may hear many terms thrown around that you may or may not understand. One in particular is Hard Money or Hard Money Loans.
What is a Hard Money Loan?
How does a Hard Money Loan work?
These are some of the questions that new investors might ask themselves while learning how to invest in Real Estate.
What is Hard Money?
A Hard Money Loan is a loan that is given to an individual or business by a private lender or a group of lenders that will aid in the purchase and repair of a parcel of real estate. These loans are “asset-based” loans in which the borrower will receive funds secured by the value of the real estate property in which they are investing. One of the main reasons why these loans differ from other loans is because the lender makes their decision on financing more-so off of the purchase and sale of a property rather than on an individual’s credit and financial history, but usually Hard Money Loans have much higher interest rates than other types of loans. (Usually in the range of 12-18% and 2-8 points paid at closing.)
Why Would You Want a Hard Money Loan?
When investing in Real Estate, a lot of times you have to close on a property very quickly. “Closing” in terms of real estate means the final transaction or the “settlement” of a real estate transaction between a seller and a buyer. As a real estate investor, you purchase a distressed property from a seller, then you repair the property, then you resell it or rent it out to make a profit. Closing is the last step after agreeing to purchase a property. This is where money is exchanged, taxes are paid, and all fees associated with the sale is paid. Usually, the seller of a property is selling their home for a discounted price not only because they need the money, but they need it FAST. Hard money lenders are able to give you the funds needed to purchase a property very quickly so that you can go to closing usually within 14 to 30 days after agreement to the seller of that property.
Another reason why investors use Hard Money Loans is because of the ease of obtaining the loan. All hard money lenders have their own terms and requirements on lending Hard Money. Some Hard Money lenders might check your credit score and may turn you down for a loan if your credit history and FICO score does not meet their standards. Then again, there are other Hard Money Lenders that might only pull your credit history just to check for repossessions, bankruptcies, or short sales. You could possibly have the worst credit history in the world, but if you have a “Great Deal” you will most likely get approved for the loan. Some lenders will not pull even your credit history, and only look at the numbers in the property and how much of a profit will be made in the end. If you usually get turned down for even the smallest loans at a bank or other financial institutions, you can very well obtain a $500,000 loan from a Hard Money lender if you are projected to make a big enough profit after repairs are made to the property. It really all depends on the particular lender and the specifics of the deal.
How Does Hard Money Work?
Unlike other loans, Hard Money loans come with High interest rates and points as well as other fees. Technically, a Hard Money loan is a mortgage. The definition of a mortgage is an agreement in which a person borrows money to buy property (such as a house) and pays back the money over a specified amount of time. Most mortgage loans that you would obtain from a bank or mortgage company typically have interest rates that average around 4% – 5%, and the loan terms are usually 15 years – 30 years.
In order to receive the loan from a bank, you will have to fill out a long application which will require information about your finances, credit history, employment history, debt ratio, income, personal assets, etc. Also, before giving you a loan, the bank has to make sure that the property that you want to purchase meets their standards. After the application is complete, it will take up to 30 days or more for the banks underwriting to check your information and decide if they will give you a loan. They will also need a down payment amount usually somewhere between 10% – 20% of the purchase price of the property.
However, with hard money loans, depending on the lender, you may or may not need to fill out long applications. Some hard money lenders will not need to have that much information. They will need to know about the property and the purchase price as well as the repair costs and the ARV. The ARV, also known as “After Repair Value” is the value of the property after it has been repaired. For example, if a property owner needs to sell their house because they need the money, they will sell it fast in its “as is condition”. The house may need a lot of work to make it livable again. The owner may have purchased the house for $200,000 years ago but now is selling it to you for $50,000 because that may be what the house is really worth in its “as is condition”. The $50,000 is the purchase price of the house. It may need about $50,000 in repairs. So after purchasing the property for $50,000 and repairing it which also costs $50,000, you have invested a total of $100,000 into the property. But after the repairs, the house may be valued back at $200,000. This is the After Repair Value (ARV).
The ARV of a property is primarily what Hard Money lenders tend to look at when deciding whether or not to give you a loan. Most Hard money lenders will typically lend up to 60% – 70% of the ARV and will not require a down payment. So if the ARV of a property is $100,000 dollars, then the hard money lender will lend between $60,000 – $70,000.
Also, a hard money lender will lend 100% of the acquisition of the property and most (if not all) of the repair costs. “Acquisition cost” is the price and all fees required to purchase and repair a property. So if the purchase price of the property is $50,000 and the repairs are estimated at $50,000, then the acquisition is $100,000. Most Hard Money lenders will lend 100% of the acquisition if it does not exceed 60% – 70% of the ARV.
When obtaining a loan to rehab a home, you have to create a draw schedule. This schedule shows the lender what you plan to do to the home and when you plan to do it. This schedule will be used to give you some of the money at different scheduled periods of time when needed. With this being noted, most hard money lenders will require that you pay out the first draw before they will reimburse you. Of course it will be reimbursed, but in reality you will always be paying ahead a draw throughout the project until the last draw is issued by the lender when the house is complete. This is just how the lender protects himself, but you will need to be prepared with funds to front this expense.
Will I need an Appraisal?
Before a Hard Money lender lends you the funds for your project, most will need an appraisal. An appraisal is an accurate estimate of what a property is really worth. It takes a licensed appraiser to appraise a home and estimate the actual value of a home and what repairs are needed to the home. By having the property appraised, the lender will know exactly what the value of the property is and therefore will know what they are willing to lend to you. Hard money lenders need to know the specifics of the Property because they want to make a return on their money as well. That is why they are lending you the money quickly for a property flip because they know that you will make a profit and in return they will make a profit by giving you the money you need in the form of a loan faster than any other types of loan.
What are the costs associated with a Hard Money Loan?
Interest rates for hard money loans typically range from 12% – 18% and the points on the loan typically range from 3-8. But once again, all lenders are different. Some hard money lenders will add points after a certain amount of time, and some hard money lenders will add a point at the origination of the loan. Hard Money loans also typically have fees. Fees involved in underwriting, payoff fees, inspection fees, and other fees. Usually the term for a hard money loan is up to a year or 12 months. If you go beyond this term, there are usually renewal fees and points to pay. When rehabbing (fixing and repairing a property), you want to work fast and pay the loan off as quickly as possible. Most rehab projects usually take about 3 months to 6 months to complete. This is usually enough time to pay back a hard money loan before it begins to balloon. Hard money loans are not used for long term loans. The great thing about Hard Money loans is that you can get them very quickly but you must pay it back very quickly as well.
Will Hard Money Lenders lend to an LLC?
Yes. This is one of the best benefits of working with a hard money lender. They have no problem lending to Limited Liability Companies (LLCs). However, most of the time they will require you to sign a “Confessed Judgment” which enables them to impose a judgment on you if you default in payment without having to go to trial. They will also want to to personally guarantee the loan. This means that even though your company or LLC holds most of the liability, if something goes wrong, you personally still are responsible for paying back the loan and you will have a judgment on your credit report without being summoned to court. That responsibility falls directly on you as a person and not on your company.
Pros and Cons of Hard Money
Receive money quickly in a matter of days compared to typical mortgage loans
Credit is not an issue with most Hard Money Lenders
No down payment needed to obtain the loan in most cases
Will fund 100% of acquisition costs and most if not all of repair costs Will fund up to 60% – 70% of After Repair Value
High interest rates ranging from 12% – 18% compared to other types of loans
The whole project is not funded, only the purchase and repair of the property
Payment obligations fall on the person and not the company in most cases
Have to pay your first draw fee even though it will be reimbursed later
Must pay loan back quickly or points will be added and loan may balloon
Should You Use Hard Money?
Hard money loans are there to help you fund a deal. If you are not confident in the deal or project that you are seeking to invest in, then do not obtain a loan in any way shape or form. However, if you have done your due diligence and looked at the numbers (Purchase cost, repair costs, ARV, your profit) and you are confident that you will receive a nice profit after investing and you know that it will not take more than a year to complete and sell the rehab, then a Hard Money Loan may be an option for you. There are other options for obtaining the funding that you will need for a rehab project but hard money loans are one of the most popular ways to obtain financing for a Real Estate Investor.
For more information about Real Estate Investing, please check out some of our other posts by clicking here.
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