Hard Money Loans [+7 Tips For Choosing A Hard Money Loan Lender]
As interest rates continue to rise, many individuals and businesses need help finding feasible financing options to fund their real estate investment dreams. When you think of hard money loans, you most likely think of easy business deals that make your real estate dreams come true! However, just because this type of loan provides fast financing does not mean it’s the best option for everyone. That’s why the professional real estate team at Westerfield Real Estate is here to talk you through what a hard money loan is, what you should be aware of, the pros and cons of a hard money loan, and several tips for choosing a hard money lender.
What Is A Hard Money Loan?
A hard money loan is a non-conforming, short-term loan for commercial or investment properties. It doesn’t come from a traditional lender. Instead, people or private companies finance this loan by accepting property or another asset as collateral. For example, a commercial borrower may turn to a hard money loan officer if a traditional lender denies their loan application. Another borrower might opt for a hard money loan to avoid the lengthy process of getting approved for a conventional loan.
A hard money loan is comparable to a traditional mortgage because it is a secured loan. However, a borrower will guarantee a hard money loan with the property it’s used to purchase. The “hard” part of the “hard money loan” refers to the tangible asset the borrower uses to back the loan’s value. So if a borrower defaults on a secured loan, the hard money lender can take ownership of the asset to help recoup their losses.
Unlike a traditional mortgage or more traditional secured loans, a hard money loan has a fast and typically less rigorous approval process. So if you need a purchase to happen quickly, a hard money loan may be right for you. For example, a mortgage approval typically takes a month from application to closure. However, you can close in just several days with a hard money loan!
Who is a Hard Money Lender?
A hard money lender is an individual, funding group, company, or private investor that will lend money to a borrower based on the overall merits of the deal. You will not find a hard money lender at your local bank. Unlike a traditional lender, a hard money lender doesn’t have a strict set of requirements they must follow or require multiple layers of proof that you will pay back the loan. In addition, they are not subject to the same regulations as a traditional loan lender, so they can make up their own rules regarding debt-to-income ratios and credit score requirements from their borrowers.
Instead, they evaluate a borrower’s situation, business plan, and exit strategy. It isn’t all about the numbers. It is more about the relationship and the potential the investment has. The most crucial factor isn’t the borrower’s creditworthiness but the value of the property the borrower wants to purchase. Often, you can determine your hard money loan approval with a quick phone call. Many hard money lenders seek to establish a transparent and mutually beneficial long-term relationship with the borrower.
How Do Hard Money Loans Work?
Typically, a borrower will find a property they wish to invest in. Then a potential lender evaluates the investment based on the value of the property the borrower wants to buy. Next, the lender will typically perform a quick background check of your finances and credit. However, this process is much less stringent than a traditional loan. This enables borrowers to get their money in a few days instead of several weeks.
Hard Money Loan Rates
Typically, a hard money loan is an expensive loan. According to Freddie Mac, in December 2022, the average interest rate on a conventional 30-year fixed-rate mortgage was 6.42%. While that is still relatively high, it is still considerably lower than a hard money loan which typically has an interest rate of 8-15%.
A hard money loan’s expense really depends on your preferred loan-to-value ratio. The loan-to-value ratio is a figure (expressed as a percentage) that determines the appraised value of a home you want to buy or refinance against the loan amount you’re seeking to borrow. Lenders commonly use it in real estate transactions to determine your eligibility for a loan.
If a lender only finances 70-80% of the value of your property, you’ll likely need to bring a large-sized down payment to the closing table. Unfortunately, if you don’t have the cash (or asset), you may have difficulty finding a hard money lender who wants to work with you.
5 Pros and Cons of a Hard Money Loan
There are several advantages and disadvantages to a hard money loan. Let’s briefly discuss a few here:
Hard Money Loan Pros
- Faster approval process
- Your approval comes from your property rather than your credit history.
- More flexible
- Not as strict underwriting
- The opportunity to fix and flip properties
Hard Money Loan Cons
- High-interest rates result in a more expensive loan option.
- Often require large down payments.
- Shorter terms mean less time to repay
- The lender takes on significantly more risk.
- It may require you to have a track record of successful house flips.
What Do You Use A Hard Money Loan For?
There are several instances where you may decide a hard money loan is a superior option to a traditional loan. A hard money loan is ideal for individuals with complicated situations or multiple properties that traditional lenders want to avoid financing. If you are a self-employed borrower or a business owner, a hard money loan may be the perfect way for you to fund your real estate investment.
1. Flipping A House
If you are a real estate investor hoping to make money flipping a home, a hard money loan may be just the thing you need. Typically, an investor will purchase a low-cost property needing a little tender loving care, make several value-boosting repairs and renovations, and flip the home for a profit. These types of projects usually happen quickly, so many professional flippers prefer faster forms of financing. In addition, if you want to flip the house, you typically will try to sell it within a year or less, so you don’t need a longer loan term as you’d get with a traditional mortgage.
2. Buying Commercial Property
A business owner may want to use a hard money loan to fund a commercial real estate property, especially if they can not secure traditional financing. In addition, hard money loans are helpful tools for entrepreneurs who want to purchase a unique property that may not qualify for conventional financing.
3. Purchasing Investment Property
If you hope to invest in real estate or rental property but do not qualify for a traditional financing option, you may want to use a hard money loan to pay for your investment. Maybe your credit history is not in the best place, or you need more money than a traditional lender will let you borrow. Then, a hard money loan may help you achieve your investment dreams!
7 Tips for Choosing a Hard Money Lender
If you are new to the land of hard money lending, it is confusing to know where to start. Not all hard money lenders are the same or operate the same way, so it is vital to understand how to choose a lender that prides itself on integrity, respect, experience, and efficiency. Here are seven tips for choosing the right hard money lender for you.
1. Educate Yourself On Hard Money Lending
You want to enter the hard money lending game with a basic understanding of the industry. While the underwriting criteria may vary from lender to lender, many hold the same core principles. While hard money lenders offer real estate investors several advantages, they work differently from conventional financing. So first, familiarize yourself with the differences, so you know what you are comfortable with when it comes to your hard money loan.
2. Choose A Local Lender
The real estate investing business is a local business, and so is hard money lending. Even if a reputable out-of-state lender closes your loan fast and on agreed terms, not being close to the property’s physical location makes servicing your loan challenging. Servicing is an integral part of any private lender’s responsibilities. A local private lender can help steer you away from poor and unprofitable investments in undesirable areas. A local company with boots on the ground can also reduce costs by efficiently managing your construction escrow. In addition, hard money lenders want to know how much equity is in the property. This is because equity is their protective measure against default. Therefore, most hard money lenders will want to inspect the property before issuing a loan. Choosing a local lender makes the inspection process more manageable.
3. Find A Firm that Specializes in Hard Money
Once you perform your initial research and know what hard money lending is, look for reputable lenders in your area. First, look through the lenders’ websites to ensure they specialize in hard money loans and that they service and originate the loans in-house. Next, reach out to a team member to ask questions and learn about the group’s specific experience and areas of expertise. For example, do they have the tools and knowledge to help you with your particular business ventures?
Pro Tip: Look for reviews and referrals
You can significantly narrow down your list of lenders by asking for referrals from people whose opinions you trust. Check out Google reviews and remember that a suitable lender will be more than willing to earn your trust, just as you need to earn theirs.
4. Focus On the Best Value, Not the Lowest Rate
It is tempting to grab the lowest interest rate with a hard money loan. We get it. As an investor, chances are you are working with slim margins, and every cost you can shave off adds another dollar to your pocket. However, if a low rate is your only focus, a low-rate promise can lead to a compromise on service and other terms. Instead, we recommend focusing on the best value, professionalism, honesty, reputation, and competitive pricing paired with expertise. A great hard money lender will provide a valuable relationship for years of future deals.
5. Have Some Kind Of Nest Egg
Few reputable lenders offer 100% financing with no contribution from you. They want to work with real estate investors and calling yourself an investor typically means you have money to invest. Hard money lenders admire big dreamers with little money. However, they are also running businesses. You should prepare to contribute something, as a reputable hard money lender wants to know how you can deliver on your promises so they, in turn, can deliver on theirs.
6. Know The Right Questions To Ask Your Hard Money Lender
You want to ask questions that help provide important insight into how a particular lender operates. Do not ask generic questions you found off of a template online. Instead, try to ask questions that help give you a better feel for who the lender is, their knowledge, how they operate, and how they treat their borrowers. Here are a few quick suggestions to help get you started:
- Can you tell me about your products?
- What are you looking for in an ideal borrower?
- What does it take to close a loan with you?
- What is the average timeline to close a loan?
- What is unique about your firm?
- What would past borrowers say about working with you?
7. Know The Red Flags
Unfortunately, every industry has seedy players, and private lending is no exception. There are several reputable articles out there on how to quickly and easily identify hard money scams, but here are a few quick red flags to be on the lookout for:
- Asking for money upfront
- Requesting you wire the funds directly to the lender
- Unusually low rates
- No borrower contribution requirements
- Opaque lender location
Pro Tip: We always recommend that while you do homework, you should always trust your instincts. Working with people when you like and trust them is a lot more enjoyable. Let your intuition help guide you in your journey to find a hard money lender with whom you can build a long-term relationship. While it is vital to have a lender who pays attention to detail, is punctual, and is trustworthy, it is also nice to add a bit of compassion, encouragement, and good humor to the process.
Alternatives To Hard Money Loans
If you decide that a hard money loan is not the best option for you but still want to avoid a traditional loan, there are several options.
Private money loan: Sometimes, you can find family or friends who believe in your business venture and would help you with a private money loan.
Homestyle® loan: If you need finances for a home improvement project, another option is a Homestyle® loan from Fannie Mae. This type of loan is government-backed and enables you to renovate your home.
We love helping people achieve their real estate investing dreams. If you hope to invest in the Southwest Florida real estate market and need a local expert guide with decades of experience, look no further than Jim Westerfield. We have a reputable team standing by, ready to help guide you in your real estate investment journey! Give us a call today!