My friend, Adam, came to me recently with questions about using hard money for buying his first investment property. He’d been wanting to start house flipping houses for some time but wasn’t sure he’d qualify for financing through a traditional lender like a bank or credit union. He had no idea how hard money worked, only that many real estate investors use it to fund their projects. So he wondered if it might be a viable option for someone like him just starting a career in real estate investing. I told him that I’d be happy to instruct him in hard money 101 so that so that he could make an informed decision about whether this funding strategy was right for him.
Hard Money 101: Funding Investment Property
For many new real estate investors who don’t yet have a line of credit with a bank or any connections to private lenders, a hard money loan can remove the barrier from buying and renovating a property by providing fast and relatively easy access to funds. The same is true if your credit is less than stellar or you’ve got a foreclosure on your record due to a long unemployment stretch or other past hardship. This is because hard money loans are awarded less on your credit-worthiness and more on the value of the property you’re purchasing.
More experienced real estate investors like using hard money as well because it’s easier to obtain and comes without all the red tape associated with conventional financing. It’s used for time-sensitive transactions that need to close quickly and for funding renovation projects that other lenders won’t touch. Hard money is also a favorite for many rehabs. The ideal turnaround time for buying, renovating, and selling houses is usually six to 12 months, necessitating a speed of execution that hard money lenders willingly accommodate.
What is Hard Money?
Hard money is asset-based financing that is secured by the value of the property being bought. The loans are short-term, normally around 12 months and sometimes for up to five years. Hard money loans are provided by private lenders or companies who are often investors themselves. Sometimes, they’re offered by a group of individuals who’ve pooled their money to lend on business-related transactions, such as real estate renovation and construction.
The qualifying criteria for a borrower can vary from lender to lender, but credit scores, payment history, tax returns, and employment status are rarely scrutinized. Instead, hard money lenders consider the real estate property being collateralized as the primary factor in determining loan approval, amount, and terms. As a result, authorizations can happen within a matter of days and, frequently, so can closings.
If you’re fairly new to real estate investing, however, it’s never a bad idea to have a real estate investor credibility kit on hand should you be asked for it. This package provides a nice overview of your real estate investing knowledge and successes. As such, it generally includes a list of properties from your portfolio and a business statement. It might even include before-and-after pictures and escrow closing statements. You may never need it, but it could improve your chances for approval if you have it.
Understanding Hard Money Terms
The goal of using hard money is to facilitate returns on investment quickly for both the borrower and the lender. Therefore, the short duration of the loans and the greater risk involved in granting them means that borrowers can expect to sign different terms than those from other types of lenders. Let’s take a look at some of the different words and their meanings that you may encounter when seeking a hard money loan.
Hard money loans are based on a percentage of the collateralized property’s current market value, which is defined as the purchase price at the time of the application. This is called the loan-to-value (LTV) ratio. The percentage loaned is determined by what the lender expects the property will sell for should the borrower default and the asset needs to be recovered. The LTV ratio is generally between 60 and 70% of a property’s price but can go as high 85%. In terms of actual dollars, loan amounts can usually range from $50,000 to five million dollars.
In an effort to streamline closing costs, hard money lenders charge a percentage of the loan amount as a one-time fee, rather than detailing the individual costs of processing the loan. This percentage—called points–—is assessed at between two and 10% of the loan amount and is based on the loan-to-value of the property, the complexity of the transaction, and the evaluated risk of the borrower and the asset. It’s normally paid up front.
Interest rates for hard money differ from those assigned to other real estate loans. Rates for traditional mortgages can be as low as three-and-a-half to four percent, depending on the borrower’s credit-worthiness and the amount of the property being mortgaged. Interest rates for hard money, however, range between 10 and 15% and can sometimes be as high as 20%. The difference is primarily due to the higher risk of lending hard money and shorter duration of the loan. It’s important to note that usury laws, which vary by state, limit the interest rates that can be charged by lenders and that these tend to max out between 10 and 20%—the typical rate charged for hard money.
Because hard money loans are only given at a percentage of the property’s purchase price, down payments are significantly higher than when buying with conventional loans or cash. Rather than a standard 10% deposit, or less than five percent as is the case with VA and FHA (203)k loans, down payments become the balance not covered by the loan. Therefore, if the loan-to-value of a property is calculated at 60%, the deposit becomes 40%. To close this percentage gap and reduce the added out-of-pocket cost of buying a property, some borrowers will take out a second hard money loan from a lender who’s willing to be in a secondary lien position.
A Few Benefits of Hard Money
For real estate investors, especially those just starting to flip houses, hard money loans hold significant benefits compared to typical real estate loans. In addition to the expeditious nature of hard money, interest-only payments are customarily made available by lenders. Of course, interest-only payments won’t pay off the loan during its term. But the low payments free up funds to go toward the renovation of the property and any related permitting or construction costs during the rehab. Provided the project is finished and sold at a profit before the loan comes due, borrowers don’t have to worry about using most of their money to pay off the mortgage. And, there’s usually no penalty for early repayment.
Another benefit of using hard money is that when you find fixer upper homes for sale, many lenders want to loan you what you need to help close the deal. Though their approval criteria may vary, they are in the business of funding riskier investments with riskier borrowers. And often all it takes is doing an Internet search for a lender, filling out an online application, and waiting a day or two to hear back. As long the lender thinks the property is worth investing in, and that they can make a few bucks off of you, your chances of approval aren’t bad.
Also, compared to other types of home rehab loans for investors, hard money remains a more convenient and accessible means for financing a renovation. Appraisals may be required as well as regular inspections to verify compliance with state and local codes—both of which a bank requires too But adherence to the Dodd-Frank Act, which can restrict lending, isn’t necessary with hard money. Additionally, mortgage insurance is not mandatory and deadlines for completing the rehab can usually be negotiated. These conditions make the use of hard money worth serious consideration for many investors.
The Benefit of a HomeVestors® Franchise
In my opinion, however, there’s only one best way to position yourself as a real estate investor for hard money lenders to consider working with. And it doesn’t matter if you’re a new real estate investor, like Adam, or a more seasoned one like me. Everyone can benefit, and it only takes one call—to the team at HomeVestors®.
Obviously, buying investment property always comes with some degree of risk—for both you and the hard money lender—whether you’re on your own or part of a franchise network. But as an independently owned and operated HomeVestors® franchisee, I have more confidence than the average investor that where and what I buy has the potential to produce returns. With HomeVestors®’ proprietary valuation tool, ValueCheck®, I’m able to calculate renovation costs to help me accurately estimate the property’s after-repair value so that I can buy at a price that makes lenders sit up, take notice, and give me good terms. So, the risk of owning a real estate investing franchise simply pales in light of the benefits.
If you would like to confidently buy investment property, give HomeVestors a call today.
Each franchise is independently owned and operated