This is how hard money loans work
Let’s start with the basics of hard money lending. Hard money loans are loans offered by private financial institutions or private individuals to investors interested in acquiring investment properties. The private lender will provide a mortgage that traditional financial institutions are not willing to fund. The borrower is using the property as collateral to secure the loan. The lender will count on the borrower to repay the loan offered, in the event of a default the lender will take possession of the asset. This article will explain to you how hard money loans work and how easy it is to qualify to get one.
How hard money loans work
- These loans are offered for a short period of time typically the loans are for 12 months but they can also be for 2 or even 5 years. Some lenders will allow for 6 – 12 months extensions by paying an additional fee. These loans typically only have interest-only payments, which makes your monthly payment lower.
- This is how the interest rates for hard money loans are determined. The lender will measure the risk factor by reviewing the property and your documentation in a process called underwriting. Things like property location, down payment, condition, investor experience are some of the factors. Common interest ranges are 6% up to 14%, the longer the term will also increase the rate.
- The credit score is important but when it comes to hard money in real estate the asset is the most important factor. Do not let a low credit score stop you from applying, lenders may ask you for a higher deposit but it is very unlikely that a low credit score will deny an applicant.
Advantages of Using Hard Money Loans for Investment
Timing is key when making an offer on a real estate property, buyers want fast closings. The last thing a motivated seller wants to hear is that closing will take place in 4 to 6 weeks. Imagine if you present an offer to the seller with an estimated closing in 2 weeks. That is one of the main benefits of hard money lending, closings can be done as fast as 2 weeks as long you have submitted all the required documentation to your lender. On the other hand, traditional banks will take longer, and yes you may get a lower rate but you may end up losing the deal.
You can structure the loan under your Corp or LLC not only protecting your assets but also starts building business credit. Unlike a traditional loan, this type of loan will not reflect on your credit score giving you more freedom to invest in multiple properties within a short period of time. Also, hard money lending is available to refinance properties. If you own the property free and clear and need to borrow against your property quickly, this is the way to go. If your hard money loan term is due you may opt to refinance it using the same method.
Credit score requirements
Some lenders will not even check your credit score. The emphasis will be on the property, as long as there is good equity. When sellers have an overpriced property under contract and with not enough down payment is when excellent credit will help. Keep in mind that private lenders will always offer you a better deal when less risk is involved meaning a higher down payment. And this goes without saying, but if have a low credit score a traditional bank will not even consider you.
The investment property will be used as collateral and you should expect a loan amount that is 65% to 75% of the collateral assets value. In the real world when it comes to real estate investments there is no such thing as 100% financing.
Hard money loan agreements tend to be more flexible when compared to traditional loan contracts. Lenders want repeat clients so they will help you structure a loan that you can afford to pay and will advise you on how to make a wiser decision. With a simple goal in mind, if you achieve your goal on the transaction whether to buy and hold or fix and flip the property, they know investors can make multiple transactions per year.
Being that you will be dealing with private investors you have room to negotiate as long as your request is within reason.
As previously mentioned time can make or break a deal when you are buying a property you will always have the advantage versus buyers using traditional methods.
Another advantage is that hard money can be used as bridge financing as well, if you think you can qualify with a traditional lender but the seller does not have the time to wait then this will be the smartest route.
Some of the Disadvantages
Depending on your qualifications and underwriting guidelines your loan may have a fee if you pay earlier than anticipated this is known as a prepayment penalty.
Prepayment penalties are calculated based on the loan balance and the terms.
For example, your loan could be for 3 years and have a prepayment penalty of 2% the first year and 1% in the second year, and none in the third year. Be sure to ask your lender this is normal on this type of loan and they could be negotiated.
This is not always a disadvantage depending on how you see it. New investors are accustomed to seeing traditional rates but they have to understand the value of less documentation and speed. The opportunities with a hard money lender are endless this is literally using other people’s money to grow your business. Do not be discouraged by the rates.
Some people look at the short term as a disadvantage but in reality, is the complete opposite. These loans are intended for investors that typically will hold the property for a few years and the main goal is to profit from market conditions or by renting the property. A Short term real estate loan should always be looked at as an advantage. When in doubt call a private lender and get a straight answer from the source never rely on your acquaintances that are inexperienced for investment decisions.
The high cost of capital
Ask yourself what is more expensive, not having an income-producing property or having an income-producing property with possibly a 9% interest rate.
You will always have closing costs no matter what type of loan you will get, familiarize yourself with these terms origination fees, broker/lender fees, appraisals, and points.
Situations Where Hard Money Loans are the best option
If you are planning on holding the property for a short period of time and don’t want to go through the hassle of applying for a traditional loan will be one of the main reasons. Also, many investors grow their portfolio by doing a cash-out refinance and yes hard money can also be used as a refinancing tool as previously mentioned.
These are some of the properties that can be financed using hard money:
- Houses / Town Homes
- Apartments / Condos
- Vacant Land
- Office Buildings
Situations Where Hard Money Loans are not the best alternative
If you have a credit score well above 700, have all your financials up to date, and time is on your side a traditional lending institution could be an option. You should expect 4 to 8 weeks for closing, and the seller should also be willing to wait that long. Having a good relationship a great contact with your local bank will also improve your chances.
How to qualify for a hard money loan
Qualifying is a very simple and straightforward process. Most lenders will require a loan application, a copy of the purchase contract, proof of funds, and a copy of your credit report, that is all. Keep in mind that the first round of documents is just to get you qualified, expect an answer in 1-2 days. A traditional lender will require twice the amount of documentation and could take them one week if not more to give you an answer.
Are you a new or seasoned investor looking for a new hard money lender?
You can count on our team for your real estate and business financing needs. GoKapital is a top-rated nationwide private lender. Get started today by calling our office at 1-866-257-2973 and a loan consultant will guide you through the process.