After the housing crash, real estate investors were shut out of most sources of funding fix and flip properties and residential rental homes. But today, real estate investors looking for funding for real estate investments have more options than ever.
Lenders woke up to fact that there was pent-up demand for capital to fund the abundance of available properties. They stepped up to fill the void and it’s changed the way real estate investors fund properties.
It’s true that money follows opportunity. Capital poured into niche lenders who specialize in funding investment properties. This is the world of hard money lending.
Hard money lenders work primarily with real estate investors and provide capital for purchasing and renovating properties. They have a well-rounded understanding of the unique needs of the investor and because of this, they work much differently than the typical mortgage lender.
In this guide, you’ll discover:
What is Hard Money?
Why Use Hard Money?
How a Hard Money Loan Works
Hard Money Rates and Terms
An Example of a Hard Money Loan
What Hard Money Lenders Need from the Borrower
What a Hard Money Lender Looks for
How to Shop for the Best Hard Money Lender
What is a Hard Money Loan?
A hard money loan is asset-based financing typically used by real estate investors for shorter term projects such as fix and flips or income properties that will be renovated and refinanced. Hard money has been called “easy money with hard terms.”
Funding for distressed properties is a much riskier proposition for the lender so rates are higher and terms are shorter. But hard money lenders will readily consider properties and borrowers that traditional lenders won’t.
Even in the cases of severely run-down properties, a hard money lender considers the “after-repaired value” of the property as part of their lending criteria. We cover that in more detail ahead.
Why Use Hard Money for Real Estate Investing?
We already alluded to the lending criteria. Hard money lenders are in the business of funding real estate investment properties – not the typical homeowner’s dream house.
More often than not, investment properties need work to bring them up to their full potential. Usually that means it’s either for resale (the fix and flip model) or for buying and renovating a rental property.
Hard money loans provide a viable option for real estate investors who don’t have deep pockets to pay cash for every property they purchase.
Even with the higher rates and shorter terms, borrowing hard money is simply a numbers game. When the cost of the property, repairs and financing all come together for profit, then hard money can be a good choice.
For those who balk at the higher rates, think about this. If you don’t have another source of funding, part of something is better than all of nothing. If you have to walk from a deal because of a lack of funding, it may be that hard money is a good choice after all.
The Top Three Reasons to Borrow Hard Money for Investment Properties
Timing – Hard money lenders know investment real estate. They move quickly to approve applications and fund the property and renovation project.
Approval Criteria – Hard money lenders will finance properties and people that other lenders won’t.
Flexibility – Hard money lenders know that even the best laid plans can go awry. When it happens, hard money lenders are more nimble than a big institution.
How Does a Hard Money Financing Work?
Hard money loans are closed much more quickly than the typical 45-day home loan. In real estate investing, time is always of the essence and most investment property purchases need to happen in days, not weeks.
Hard money lenders specialize in underwriting and closing real estate investment loans quickly. It’s not uncommon for the application process to take only a day or two, and closings can happen in as little as a week.
So where do hard money lenders get money to loan? They get funds from private money lenders – individuals, not institutions. Private money lenders place their capital with hard money lenders to put their money to work earning returns.
Hard money lenders then deploy that capital to real estate investors to use for the purchase and renovation of investment properties. In most cases, the hard money lender is responsible for underwriting and servicing the loan, including screening borrowers, evaluating properties, dispersing funds, and collecting revenue. Most hard money loans are only for a few months or a few years at the most.
Is Hard Money the Same as No Money Down?
Even though hard money loans provide funds for both the purchase and renovations, they are NOT “no money down” loans. The borrower must have skin in the game in the form of a down payment at closing.
At closing, the real estate investor typically receives funds to purchase the property plus a “draw.” The draw gives the investor cash to begin the renovations. As the project proceeds, the investor requests additional draws. With each draw, the lender will assess the progress of the renovations.
Also during this time, it’s expected that the investor will make interest-only payments to the hard money lender. Once the property is renovated and re-sold (or refinanced), the investor pays the balance of the loan including principal and interest.
Hard Money Lender’s Loan to Value Considerations
Many homebuyers today are required to put at least 20% down on a home for purchase. For example, on a $100,000 home, the buyer would need to bring $20,000 as a down payment and would get an $80,000 loan.
Why does the buyer need 20% down?
Because the lender’s loan to value (LTV) ratio is 80%. The lender will loan 80% of the value of the home. Lenders rarely, if ever, loan 100% for the purchase of the home. No money down, 100% loans are too risky. If the homebuyer defaults, the lender is on the hook for more than the property may be worth.
Now, let’s apply this to a hard money loan. A hard money lender is taking on even more risk and because of the risk, their loan to value ratios are much lower. On a property that’s worth $100,000, a hard money lender may only loan $65,000. That’s a 65% LTV.
Does this mean the buyer has to bring a $35,000 down payment? No, and here’s why. Most hard money lenders base the LTV on the value of the property AFTER it’s been repaired.
Borrowing Hard Money: Loan Rates and Terms
So you just learned how loan to value ratios are different for hard money loans. Now let’s explore even more aspects of borrowing hard money.
Length of the Loan: Hard money loans are meant to be short-term, temporary financing. The lender wants in and out quickly and the higher interest rates are an incentive to make that happen.
Interest Rate: It’s not unheard of to see rates in the double digits. It varies significantly – and could be based on location, risk or any number of other factors.
Origination Points: Points are a percentage paid up front for access to the funding. This too varies. Always inquire with your potential lender about points.
Fees: There are costs that go into closing a loan such as appraisals, wire fees and other administrative costs.
Make sure you know up front what rates, points and fees to expect. The cost of financing a property impacts bottom line profits, so knowing your cost of money is critical to projecting profits.
Hard Money Loan Example
Let’s put this into a real world example so you understand exactly how a hard money loan works.
Steve finds property that needs a lot of work but it’s got great potential. It’s in a solid location that attracts buyers quickly. This property has suffered from years of neglect, but with some quality TLC, it can be a great home again – and Steve can profit with the right renovations and the right funding.
He runs the numbers using commonly accepted real estate investor formulas and makes an offer.
Here’s the rundown of Steve’s deal:
The After Repaired Value of the Property (ARV) $100,000
65% LTV based on Value of Property 65,000
Expenses/Repairs needed to sell for $100,000 25,000
Purchase Price of Property 43,000
Steve approaches the lender with contract for the purchase at $43,000. The lender gets a “subject-to” appraisal that comes in at $100,000. Subject-to appraisals are based on the value of the property subject to renovations. This represents the after repaired value of the property.
The lender applies their loan to value ratio of 65% LTV to the ARV, so Steve has $65,000 in loan funding to work with. He offered $43,000 for the property, so this leaves him $22,000 for the expenses related to bringing the property up to its market potential.
With a budget of $25,000, Steve has two choices. He can adjust down his budget or he’ll need to pony up the $3,000 to complete the renovation. Steve doesn’t need to bring this to the closing table, but he will need to demonstrate to the lender that he has the funds to make the project happen. It can be his own cash or cash provided by a partner.
To get the deal closed, Steve also has to consider the costs of funding the deal and what he will need to bring to the closing table. Earlier when we looked at terms, we mentioned some of the costs of funding a hard money loan. Most of these costs are paid when Steve closes the loan and purchases the property. Here’s what he expects to bring to the closing table.
Costs Associated with a Hard Money Loan*
Loan Amount $65,000
Origination Points 3%: ($65,000 x .03) = $1950
Prorated Interest (1 month) 380
Subject-To Appraisal 500
Title Search/ Title Insurance 175
Prorated Property Insurance 100
Prorated Property Taxes 400
Settlement Fees to Closing Office 400
Government Recording Fees 100
Wholesale Assignment Fee 500
What it Costs to Close a Hard Money Loan
Since “no money down” loans are non-existent, Steve will need to pay these costs up front to access the $65,000 the lender has agreed to loan. Using this example, his total due at closing would be $4505.
At closing, Steve brings a certified check or wire transfers the funds to the closing office. The closing agent (usually a title office or real estate attorney) will execute loan docs. At closing, from Steve’s $65,000 loan, the agent will pay the seller the $43,000 for Steve’s purchase of the property. They will also disperse Steve a portion of the $22,000 in funds available for the costs of renovation.
As Steve completes milestones in the renovation, he applies for a “draw.” The lender looks at the work in progress and will disperse additional renovation funds throughout the course of the renovation.
During the course of the renovation and loan, Steve is responsible for paying monthly interest-only payments to the hard money lender. In this case, the monthly payment is $380 based on a 7% interest only loan of $65,000. When Steve sells the property, he will owe the hard money lender $65,000 since his payments were interest only.
*Costs will vary significantly. Location and lender will impact costs as well as additional fees such as surveys, flood insurance, HOAs and other property specific conditions.
What Hard Money Lenders Consider When Funding A Property
Lenders often use the “The Six C’s” decision matrix when considering funding a property. Their goal is to minimize risk while still making money.
Lenders are not just looking for higher yields, they’re looking for safe, secure investments that return capital and a solid ROI (return on investment). They want to know how and when they’ll be paid back and they like to build repeat business with investors – so relationship building is important.
The Six C’s of Hard Money Lending
Collateral – Lenders are in the money business, not the real estate business. They will carefully consider all aspects of the property – its physical condition, its marketability and its profit potential among others all to determine what kind of equity cushion the property offers in its loan-to-value (LTV). They consider the what if’s. What if we have to foreclose…what are we left with?
Conditions – In an effort to minimize risk and the what if’s, many lenders look carefully into the conditions surrounding the property – how is the market in the target investment area? What is the availability of resources, other property inventory and demand for the property at resale or rental?
Capacity – Lenders will look for assurance that the borrower has the capacity to carry out the terms of the loan and the proposed renovations. They will look at experience, outcomes, partnerships, resources and existing obligations of the borrower.
Capital – The whole notion of “No Money Down” in real estate investing is misleading. No money down transactions are rare – and nearly non-existent with most lenders. While it is possible to have none of your own money down, lenders still require that the borrower have skin in the game at the closing table.
Character – Many lenders also look into the character of the potential borrower. They may do background checks looking for liens and judgments, criminal background, and other derogatory public records.
Credit – With asset-based, hard money lending, credit isn’t the most important but it still plays a role. Good credit can make the difference between a yes and a no; it’s really a matter of how good (or bad) the borrower’s other 5 “C’s” look to the lender.
Be prepared to demonstrate and document any or all of the above to your broker or hard money lender.
The Hard Money Loan Application
When you’re ready to fund your next deal, here’s a summary of what you can expect the lender to ask for. They need information to assess the six C’s including you, the property and market conditions. Though hard money lenders are more focused on the property than the borrower, it’s important to be prepared with information that makes it easy to close the loan.
The Loan Application: Each lender’s application will be different
Personal Identification including legal ID and social security number
The Purchase Agreement: Provide the signed offer to purchase
Property Insurance Quote/Insurer’s Information
Renovation budget (including contractor quotes when applicable)
BPO (Broker’s Price Opinion) or CMA (Comparable Market Analysis) that demonstrates the potential value of the property after repair.
Every lender will have different requirements. Ask early on in the loan application for a list of the required documentation. Hard money lenders work quickly to close loans; be prepared.
How to Find Hard Money Loans for Investment Properties
Earlier we quoted the adage, “Money follows Opportunity.” It’s true but it’s also true that scams follow opportunity. When capital started pouring into the hard money market, scammers saw an opportunity to promise funding but had no real financial backing or sketchy business practices.
Private Money vs Hard Money
Though the capital for hard money loans is sourced from private money lenders, there is an important distinction. Private money lenders are individuals who work on their own behalf. Hard money lenders are entities that work on behalf of private money lenders to deploy their capital for a return.
Hard money loans are designed to provide short term funding for real estate investment properties. Often used by fix and flip investors, a hard money loan is quick to close and more flexible than traditional mortgage loans. Hard money loans are often called “easy money with hard terms” meaning they are easier to get but more costly. Real estate investors consider the cost of hard money as part of their profit projections on fix and flip properties.
Financing can make or break the deal.
Finding great financing is the Holy Grail of real estate. Whether it’s your first deal or 50th, it can be the most daunting–but most important–challenge you face.The good news is that today there are more ways to finance a property than ever before. If you know where to look, you can find nearly unlimited supplies of funding for your real estate deals.