When you need cash to purchase or improve an investment property, a loan from a traditional bank isn’t always an option. Whether you have irregular income, already own multiple properties, or just need to move quickly, seeking an alternative lending solution might be necessary. If you have a sound deal, a hard money lender can help you quickly get the cash you need for real estate investment.
What Is a Hard Money Loan?
Real estate investors often rely on hard money lenders to provide the funding necessary to acquire and rehab investment properties. A hard money loan is secured by real estate, has terms generally ranging from 1-5 years, and is made by private investors rather than banks. Repayment may consist of either monthly payments of interest and principal or interest only, with a balloon payment at the end of the term.
These loans are also referred to as bridge financing because they are often used as a bridge or temporary solution to get the property from point A to point B. For example, hard money loans may fund a project through acquisition, renovation, refinancing, or the outright sale of the property. Because the loan is collateralized by real estate, hard money lenders focus most of their attention on the value of the property rather than the borrower’s credit history. As a result, borrowers who may not qualify for conventional financing are sometimes able to obtain a hard money loan.
Important Information About Hard Money Lenders
Hard money lenders tend to specialize in certain types of properties (residential real estate, for example) and some work on all kinds of scenarios. For that reason, when shopping for a hard money lender, ask up front if the lender is interested in the type of property you plan to purchase.
Hard money lenders also sometimes specialize in certain types of loans. These may include:
- Purchase loans to fund real estate acquisitions
- Refinance loans to pay off existing debt
- Cash-out loans to pay off existing debt or provide working capital for the existing property or another property
When compared to banks, hard money lenders have the ability to fund loans much more quickly, often within a week, whereas banks often require a month or more to process a mortgage loan. The faster turnaround of hard money lenders is valued by real estate investors, particularly in situations in which a property has multiple bids. Being able to greet the seller with cash in hand while others are waiting for financing is often an effective strategy for closing the sale.
The interest rate charged by hard money lenders tends to be higher than bank rates due to greater risk, but rates vary across lenders and from region to region. For example, California rates are generally lower than rates in other parts of the country because of competition among California’s many hard money lenders.
There are a few national firms and many regional lenders in the hard money segment. Many fix-and-flip investors prefer working with a local lender because lending is relationship-based, and building strong relationships is difficult if contact is limited to phone calls or the internet.
How to Choose a Hard Money Lender
When you are screening hard money lenders, your first priority should be verifying that the lender has a solid reputation and substantial real estate lending experience. This can be accomplished by making a quick visit to the Better Business Bureau site or posting a query with the local chapter of the Real Estate Investors Association.
Hard money lenders come in two varieties: brokers and direct lenders. Direct lenders make loans using their own capital. A broker functions as a middleman between investors and the borrower. Brokers provide a useful service for fix-and-flip investors who are just starting to build their networks, but direct lenders are usually able to offer better rates and greater flexibility because there is no middleman involved.
Eight Questions to Ask Prospective Hard Money Lenders
If you’re evaluating your options for a hard money loan, ask about these eight important topics.
1. Points and Interest
As mentioned above, points and interest rates vary across regions and by lender. The riskiness of the project also affects the interest rate. In general, borrowers should expect to pay interest rates ranging from 7-12 percent on hard money loans and points ranging from 1-4 percent of the loan amount.
2. Loan Terms
Some hard money lenders focus exclusively on very short-term funding (6 to 24-month terms). Others may offer terms of five years or more.
3. After Repair Value (ARV)
Inquire whether the loan will be based on ARV or the property’s current value. Also, ask what loan-to-value (LTV) ratio is considered acceptable by the lender. Most hard money lenders accept LTV ratios of up to 75 percent on income-producing properties and up to 50 percent on land. Find out whether points and interest are included in the LTV calculation and how ARV is determined. Does the lender seek an independent appraisal of the property or rely exclusively on comparable sales data?
4. Up-Front Fees
An important area to question is up-front fees. Appraisal and document fees are customary but think twice before giving your business to a hard money lender who demands a loan application fee. Also, ask if there are any hidden fees.
5. Down Payment
Hard money lenders usually want the borrower to have at least some skin in the game. Inquire how much money you (the borrower) will need to put into the deal as a down payment.
6. Penalty Fees
Ask about penalty fees that are due if the loan goes past term.
7. Disbursement of Funds for Renovation Work
Find out if the lender will fund property renovation costs and, if so, how these funds are dispersed.
8. Time to Closing
Ask the lender how much time is typically required for financing transactions to close.
Ask Socotra Capital
We’re ready to answer all of these questions to help you decide if we’re the right fit for your hard money loan. We can also provide references so you can hear what it’s like to work with us directly from other borrowers. Not every lender will accommodate this request due to confidentiality agreements with clients, but we’re happy to share what we can.
No matter who you decide to work with, make sure you take the time to carefully evaluate all of your options. Read The Borrower’s Guide: Process, Preparedness, and Timeline for tips on choosing the best fit.