A-to-Z Hard Money Loans Guide for Real Estate Investors in 2021
Even though the information on this web page is provided by a qualified industry expert, it should not be considered as legal, tax, financial or investment advice. Since every individual’s situation is unique, a qualified professional should be consulted before making financial decisions.
In this A-to-Z Hard Money Loans Guide for Real Estate Investors you will learn:
- what hard money is and how it works (with an example)
- many of the common myths that surround hard money lending
- why more and more investors are choosing this form of financing
- why borrowing hard money may be a good idea and in what situations a hard money loan is worth it
In fact, I often answer questions about these aspects of hard money loans when newbie real estate investors address them to me as a professional hard money lender.
Let’s start with the definition.
What Is a Hard Money Loan in Real Estate?
Hard money financing, also known as ‘private financing’, is a way to borrow funds without using a bank or other sources of conventional borrowing. It’s mostly used for short term real estate investing projects. The primary factor for approval is the borrower’s amount of equity in the collateral property and feasibility of the project rather than their credit history.
The hard money lender is usually a private group of individuals or investors who pool their money together, which they then lend out to borrowers. In order to secure the loan, the borrower must put up collateral. When it comes to real estate, the property is used as collateral for the loan.
These types of loans are almost exclusively used by investors, rather than homeowners. They’re also usually taken out for a short period of time, to cover a specific project, such as renovating a property before flipping it.
Seasoned investors choose hard money loans to leverage their money, reduce the amount of risk they take on by spreading it to the lender, or if they need to close quickly on a property.
Hard Money vs. Conventional Mortgages
Given the unique structure of hard money lending, there are a number of key differences between this and conventional forms of financing:
- Firstly, as the lender is a group of individuals rather than an institution, there is far less regulation and bureaucracy (more on this point below). This means that the time it takes from application to the funds becoming available to the borrower can be significantly shorter.
- The individuals that make up the lender are often experts in their field (i.e. in renovating and flipping distressed properties). Therefore, they’re able to assess loan applications on the potential return the project could provide (known as After Repair Value or ARV), rather than the approach of conventional lenders who focus largely on the borrower’s ability to repay based on their credit history. This means that borrowers who struggle to get financing through conventional forms of lending may have a better acceptance rate with hard money lenders if the project is assessed as being profitable.
- They are primarily used to finance projects with short time frames and a specific exit strategy. The classic example is a fix and flip project, which may have a 3 month renovation window and a 3 month sell-on window, therefore the borrower would look for a loan with a 6 month term.
- As the above example shows, hard money loans are often used as “bridging loans” where an investor is looking to profit from arbitrage, such as buying a distressed property, renovating it, then selling it on at a higher price. This enables the investor to cover the costs of the renovations, the interest payments during the term of the loan, and then repay the loan at the end of the project, while also making a profit.
- As with all forms of borrowing, the shorter the term, the higher the interest rates. This is generally the case with hard money loans, especially if you were to compare the rates against a conventional mortgage with a much longer term.
Are Hard Money Loans Interest Only Loans?
Generally speaking, the vast majority of hard money loans are interest only. A balloon payment of the principal (the total amount that was borrowed) is then due at the maturity of the loan.
The borrower usually repays the principal either by selling the property on (i.e. flipping) or by refinancing, such as taking out a rental loan, if they want to keep hold of the property and find a tenant.
As the loans are usually interest only, this can help the borrower with their cash flow during the project, as the monthly loan payments will be a lot less compared to repayment loans.
Is a Hard Money Loan Considered Cash?
There is some debate within the industry as to whether or not hard money loans are the same as cash. Legally speaking, they are not and these loans must be stated in the purchasing contract as financing.
However, some of the reasons why most sellers favor cash buyers also apply to hard money buyers. Primarily this is down to speed of purchase, as hard money borrowers can usually access funds a lot quicker than borrowers using conventional forms of funding.
Therefore, a seller could favor a hard money buyer over a traditional mortgage buyer, as the sale could be completed a lot quicker, and is not contingent on the traditional mortgage approval process.
Are Hard Money Loans Safe?
Are Hard Money Loans 100% Legal?
There’s no denying that hard money lending has a bit of a bad reputation with the public. Uncertainty coupled with a lack of understanding of hard money lending practices have led some real estate investors to think twice about this form of borrowing.
However, an ever growing number of property investors and developers are using hard money loans to finance their projects. Between 2016 and 2019 hard money lending increased by an estimated 40%. And these numbers could grow exponentially higher in 2020, as the COVID crisis has caused a serious retraction in lending among conventional and non-QM lenders.
Unfortunately, there remains a lot of conjecture about the legality of hard money loans. To be absolutely clear, working with professional and reputable hard money lenders is 100% safe and legal, just like with traditional lending institutions. Not only that, but as the data in the previous paragraph makes clear, more and more investors are now turning to hard money lending to finance their projects.
Any form of lending that’s lightly regulated and managed by private individuals will always be viewed warily by some. But it’s important to state that hard money loans are asset backed lending, where the after repair value (ARV) is assessed by lenders who are truly experts in their field. What’s more, all seasoned investors approach hard money lending with a clear exit strategy in place.
To help you find a professional and reputable hard money lender, the HouseCashin team reached out to number of reputable hard money lenders and asked to provide our newbie investors with some actionable tips on the following topics:
- How to Find a Good Hard Money Lender for Real Estate Investing
- How to Get a Hard Money Loan to Flip a House
Are Hard Money Lenders Regulated?
Hard money lenders (HMLs) are all regulated to a certain degree, but this differs from state to state. However, generally speaking, it’s correct to say that hard money lending receives substantially less regulation than conventional forms of financing, as lenders are private individuals.
For example, here at We Lend LLC, we operate out of New York. The state’s regulation for hard money lenders requires anyone who lends over $50,000 to acquire a lenders license to do so. In addition, hard money lenders in New York aren’t allowed to charge interest rates higher than 16% and lenders are regulated by New York’s Department of Finance.
Do Hard Money Loans Show Up on Credit Reports?
Unlike conventional sources of finance, hard money loans don’t show up on credit reports. Furthermore, hard money lenders don’t report to credit bureaus. The main reason being is that hard money lenders lend to an entity backed by a personal guarantee from the individuals behind the entity.
How Does a Hard Money Loan Work in Real Estate?
Now that you know the ins and outs of hard money loans, I’m going to explain more specifically how these work with real estate. One of the more common questions I receive is, “how are hard money loans structured?”. What’s more, I often find that many first time investors are unsure about how to use hard money loans. I’ll answer all this and more in this section of the guide.
What Are the Typical Hard Money Loan Terms?
Here’s what to expect when it comes to hard money loan terms:
- Loan duration is usually between 6 and 18 months
- Interest only rather than repayment (as explained above)
- LTVs are usually lower than what you can get through conventional lenders, although experienced borrowers can expect to access higher LTVs. As a benchmark, 65% to 80% LTVs are around the industry average.
- While LTVs are usually lower than conventional loans, it’s important to note that LTVs are calculated against the ARV (as explained above), so this allows you to borrow higher values/use lower down payments than you might otherwise be able to via conventional lenders.
- Interest rates are typically offered in a range between 9% and 12%
- As with all types of property purchase loans, other fees apply, which can include underwriting fees, appraisal fees, and servicing fees.
- The lender will assess the ARV and will expect this to be at least a 30-40% return on investment to the borrower.
- Hard money loan contracts usually contain a default rate clause that sees interest rates rise significantly in case of default. For example, the rate may jump from 12% to 24%, depending on the state that you are in. If the loan remains in default, the lender will begin to file a foreclosure action. In the event of foreclosure, the borrower still has the ability to bring the loan current to avoid further penalties.
Hard Money Loan Example
Let’s take a look at the classic hard money loan example – a fix and flip project, and see how a hard money loan breaks down in terms of costs based on the following scenario:
- Current property value: $200,000
- Renovation costs: $15,000
- Down payment: $15,000
- After repair value (ARV): $300,000
Hard money loans for fix and flip projects can cover both the purchase price and the renovation cost, so the total loan amount would be:
- (Current property value: $200,000 + Renovation costs: $15,000) – Down payment: $15,000 = $200,000
As you can see, under a conventional loan this would produce a loan to value ratio (LTV) of 100% which is usually not possible for borrowers. However, HMLs can calculate the LTV against the ARV, which in this case would be 66.7%, which is well within the lending range of the average HML.
The loan then has the following terms attached to it:
- 3 points (origination fees) due to the lender: $6,000
- 10% interest for 6 months: $10,000
The investor would then also have other ancillary costs to cover such as appraisal fees, title fees and realtor fees when he or she flips the property:
- Ancillary costs: $5,000
So based on this example, the investor would make the following return:
ARV: $300,000 – down payment: $15,000 – Loan: $200,000 – 3 points: $6,000 – 10% interest: $10 000 – ancillary costs: $5,000 = Profit: $64,000
Do Hard Money Loans Require an Appraisal?
The majority of hard money lenders require an appraisal. Lenders have just as much skin in the game as the investor, as it’s their money that’s funding the project, so they need to be certain that the investor can make a good return.
As mentioned above, HMLs are interested in the ARV of the project and use this as one of their factors when making a decision on whether or not to lend to an investor. The ARV is the total value of the property once renovations are completed and it’s then ready to be sold-on or rented out. The ARV minus the investor’s total costs will determine the investor’s return.
All investors should prepare their own ARV calculations from the very outset, before they begin approaching lenders, to make sure the project is viable. This is the crucial calculation upon which profitability depends. Estimate the ARV too high or the repair costs too low and you could jeopardize the whole project. The sum is simple enough:
ARV = (Property Purchase Price) + (Value of Renovation)
However, calculating those two variables is what an appraisal does. Many investors pay for their own appraisal or Broker Price Opinion (BPO), as part of their due diligence, before engaging with a lender. However, you will normally not be able to use this appraisal with your hard money lender as they will require you to obtain a separate appraisal, by usually using their own approved appraiser.
As mentioned above, the LTV of hard money loans are calculated against the ARV, not the current value. Therefore, the lender’s appraisal of the ARV can determine how much you can borrow.
Can You Use a Hard Money Loan for Down Payment?
Hard money lenders do not finance the down payment. As mentioned above, all HMLs will want to see that the borrower/investor has skin in the game, therefore they will usually require the investor to place a down payment, based on the LTV of the loan.
Can You Refinance a Hard Money Loan?
Hard money loans can be refinanced and this is the usual exit strategy from the loan for investors who want to hold onto the property and rent it out, rather than flip it. This strategy is often referred to as BRRRR that stands for “buy, rehab, rent, refinance, repeat”. Read more in detail about it in this comprehensive article by We Lend LLC.
In a BRRRR investment project, the hard money loan is used to purchase the property and pay for the renovation. Once the project is completed and the property is ready to be tenanted, the investor refinances into a 30-year rental loan based on the ARV.
This borrowing against the increased property value enables the investors to pay off the hard money loan and possibly cash out some additional value as well.
Where to Find the Best Hard Money Lender in Your Area?
If by now you have decided that a hard money loan could be a powerful tool to boost your real estate investing business, your next step is finding a reputable hard money lender.
As a national rapidly growing platform for the real estate investors, HouseCashin has relationships with reputable hard money lenders throughout all the 50 U.S. states and Washington D.C. Get your deals funded on the best terms by a top-rated lender in your area by filling out our hard money loan application form.