You're about to experience an in-depth look at hard money loans; both from the perspective of the borrower and the lender. This training will unveil the most important aspects of hard money, including their role in the overall lending marketplace, how to obtain them, the obvious (and hidden) cost to borrowers as well as the risks from the eyes of hard money lenders. Plus, long time myths about hard money will be completely debunked. For anyone looking to obtain hard money at some point in the future, this training is mandatory. By the end, you will have gone further down the rabbit hole of hard money than you'll find anywhere else.
Real estate investors can often run into major issues when applying for a conventional loan. Even with great credit and a hefty down payment, it can still be a huge hassle to obtain a loan the conventional route. When I first got started with rehabs 15 years ago, I borrowed money from a hard money lender, and these days I am a hard money lender to the apprentices I mentor. I understand this business inside and out, and now I am going to share with you a very detailed look at Hard Money loans that you will find nowhere else.
What is Hard Money Lending?
Hard money is asset-based lending secured by real property, meaning in theory, a hard money lender should be most concerned about their loan to value(LTV) being much lower than the overall value of the property. If the value of the property is $100,000 loan to value would mean that the loan, as a function of value, is significantly less. Approximately 65% LTV, loan to value, sometimes a little more. That is the basis of hard money, the idea that the hard money lender is not lending 85, 90, or 95% of the overall value, but something significantly less.
In exchange the hard money lender usually charges 10 to 15% interest. They also typically charge an origination fee of 3 to 5% when you first receive the loan.
Why Choose Hard Money Loans?
Conventional loan interest rates are currently a fraction of this number so why would anyone consider paying such a high interest rate for the money? Great question. The hard money lender plays a specific role in this niche of creative real estate investing. First off, they're typically not concerned with how many other loans you have. When you apply for a conventional loan, the first thing the lender looks at is your credit. If they see a ton of other loans on your credit, they might become concerned. In fact, a lot of times conventional lenders won't grant you a loan if you currently have more than 8 or 10 loans. Fairly successful real estate investors with multiple loans, might only qualify for asset-based lending.
Another major factor is renovation costs. A lot of conventional lenders don't have loan programs for renovations. You can get a new construction loan through Fannie Mae or Freddie Mac, or maybe a local bank will have a quasi program they can customize for you. If you're currently looking to buy a home and can qualify for an FHA loan, you may want to consider a 203K loan because they allow for renovations to be paid for out of the loan itself. Conventional loans have stipulations and a lot of red tape involved. You can get a 65% LTV with a hard money loan, and they'll put out draws to pay for renovations. That can be extremely helpful.
Also, hard money lenders are not going to have the same stringent underwriting guidelines as conventional loans. This is an important detail because it’s a pain in the neck to get a conventional loan. It doesn’t matter how rich you are or how great your credit is, the process of getting a conventional loan is a giant hassle, whereas hard money loans can be a much easier process because they're primarily looking at the asset. They're looking at the house.
The Hard Money Myth
If the loan to value is 65%, people think hard money lenders shouldn't care about their experience level. They don't think their down payment or credit should be important because if they default on their hard money loan, the lender gets the property for 65 cents on the dollar.
This is incorrect. First of all, they would have to foreclose. The foreclosure process is expensive and time consuming. Most hard money lenders are not a private, wealthy individual. They tend to be a fund. A fund is a group of people that raise a large sum of money put together to invest for profit. It is the Fund Manager’s responsibility to turn that fund into profits and then turn that money over to create a return on investment.
If they were to return 4%, but promised to pay everybody else that contributed money to the fund, 6 to 8%, then they would lose a lot of money. The fund manager needs to make sure that they are consistently doing deals that are profitable. If a deal goes into foreclosure, the hard money lenders do not receive any interest, so they're unable to pay their investors. Foreclosures can take a year or more, so even though they typically get their interest back, it is a very timely process. That is why hard money lenders do not want to go into foreclosure.
If the property ends up in foreclosure but no one purchases the property at auction, the hard money lender become the owner. Then they would have to hire a company to renovate and take charge of putting the project into gear. What if the borrower did a bunch of un-permitted work, or the work they did do was terrible. They would have to go back and redo everything. They could potentially lose money, even if they thought they were at 65 cents loan to value because value can be a tricky measure. I have some great videos on this. The idea is that sometimes you can use comparable sales and still be off on what the house actually sells for.
Big myth debunked: Hard Money Lenders do not want it to go to foreclosure.
Hard money lenders are going to try to mitigate or reduce their risk. They require borrowers to get some “skin in the game.”
A larger deposit of 10 to 20% is required because when you put a good chunk of your own money into a deal, you're more likely to follow through.
In addition to the down payment, they want you to have some real estate experience. New real estate investors might have issues obtaining hard money loans because inexperienced investors can make huge mistakes, and lenders don't want to end up in foreclosure.
Ability to Repay
Another big concern of a hard money lender is your ability to repay. Most hard money lenders will run a credit check to make sure you do not have an extremely low score. They will also run a background check to see if you're a convicted felon who stole millions of dollars. Some will look into your income and financials to be sure you can afford the monthly interest payments.
Pitfalls of Hard Money Loans
Not only do you need the 10 to 20% down payment, you need to be able to afford monthly payments. Hard money lenders do not pay for closing costs, so you are responsible for those as well. Let's say you're getting a loan for $100,000. On top of the normal closing costs, there's a a $3,000 to $5,000 origination fee plus additional closing costs because there's a loan involved. When considering getting hard money, you've got to have some money available.
As is Value
One of the things that confuses people as well is the idea of value. Hard Money Loans are based on “As is Value”. They’re typically going to expect to not be in the deal more than 65%. It doesn’t matter if you plan on buying it at value, but then fixing it up to add value either. They want to be at 65 % AIV because after renovations raise the value of the house, their loan their loan remains at that 65% of value.
You also have to get great deals or, unfortunately, bigger down payments. If the as is value was $100,000 and that's what you're buying it for, and they agree to cover 70% AIV then you are responsible for the 30% downpayment.
Qualifying for Hard Money Loans
Ultimately, getting hard money can be difficult if you're not finding good deals and don't have skin in the game. I have a great video on “Money for Real Estate" that shares more about the other options besides hard money. A lot of investors believe finding a great deal qualifies them for hard money loans, but it's more complicated then that.
You'll need the down payment, money for closing costs, money for the origination fee, the ability to repay, and in most cases you'll need some sort of experience. They're going to be concerned about giving you renovation draws if you don’t know what you are doing. In fact, often times they will want you to pay for the renovations upfront. Then after you pay it, they pay you back in draws.
My Experience as a Hard Money Lender
If you build an amazing track record, you might be able to reduce some of these challenges. When I lend hard money lend to my apprentices, I don't charge all of the fees upfront. The interest is charged after the loan closes which makes life a lot easier for my apprentices. I am also not as interested in their "experience" because I am their mentor. A lot of times I don't even require the "skin in the game" if the deal is a home run. I only lend to my apprentices because I personally mentor them and know they know what they are doing. They're not going to make a bunch of stupid mistakes and my money is safe.
If you're looking for hard money you need to know all the options that are available. There are both commercial and residential hard money lenders. Some lenders will even offer hard money loans for rentals, not just for renovations. View the Hard Money Locator for a comprehensive guide of what the market is willing to offer. You'll be able to see what is truly out there and what you're capable of qualifying for.