HARD MONEY 101
GETTING STARTED:
A hard money loan is a type of asset-based financing when a borrower is issued funds secured by real property. These loans are most often received from private investors or companies. While hard money loans typically have an interest rate higher than conventional residential property loans, they can finance deals that are of higher risk and shorter duration. Most hard money loans are best for short-term projects, such as a fix-and-flip.
A bridge loan is interim financing for an individual or business until permanent financing can be acquired. Like Hard Money loans, Bridge loans can come at a higher cost than conventional financing to compensate for the additional risk. Bridge loans are often used for commercial real estate purchases to close quickly on a transaction, salvage distressed property, or make purchases at foreclosure auction. Specifically, Rain City’s bridge loans are only for non-owner-occupied deals.
There are several, but one of the biggest differences is closing time. While a traditional loan might take 6-8 weeks to close, hard money loans typically take less than a week. In addition, traditional loans normally cover only single family homes and certain types of commercial properties – hard money loans can cover all types of properties, depending on their condition.
BEYOND BASICS:
Not every real estate transaction would benefit from using hard money. Primary residences, non-distressed properties, and transactions that can wait for an approval for a traditional loan wouldn’t be ideal for a hard money loan. Examples of good fits would be:
- Flips / Investments
- Land loans
- Construction loans
- Foreclosure auctions (or other similar “need cash fast” deals)
As an industry, hard money lenders tend to be more interested in the value of the deal than the specific credit history of the potential borrower. Different lenders have different levels of requirement, but they typically want to know that the property has good potential, that the borrower has a good exit strategy, and that the borrower can make the payments required for the loan.
THE NITTY GRITTY:
When a home goes into foreclosure and the owner is unable to stop it, the property goes to auction. A trustee company is responsible for arranging the date of auction, advertising the minimum opening bid, and verifying the identity of potential bidders. Because auctions are usually cash transactions, the trustee may also require a bidder to show ability to pay for the property before the auction begins. Proof of funds can be as simple as providing a copy of a cashier’s check to the trustee before it begins. Once the highest bidder wins the property, the trustee issues a receipt.
Some foreclosure auctions have a “right to redemption,” where the former owner of the home can pay to get the property back, even if it’s been sold at auction. The “redemption period” varies depending on what state it’s in; some states have a 90-day window, and some go out to a year. Tax foreclosure auctions work almost the same way, except the right to redemption is almost always between 2 to 3 years. Lenders are typically wary of a tax foreclosure sale, since its interest in the property isn’t fully secure until this redemption period is over.
Hard money has gotten some bad press. But there are a few easy ways to tell if a lender has your best interest in mind:
- Does the lender have suspicious upfront fees, like a $1,000 “Due Diligence Cost” or “Commitment Fee” ? This is a red flag. Some lenders will ask for a small (under $50) fee upfront to cover a background check or credit report, but be wary of larger fees you need to pay out of pocket before the deal is even in the works.
- Is the lender a member of reputable organizations? Many legitimate lenders are members of local real estate investment groups, are active on investment forums, and are sponsors of relevant events. If the lender has a presence online and at meetups, they are likely a solid lender.
- Can the lender provide references? Look for case studies, testimonials, or reviews on the lender’s website. Most lenders will have a blog or testimonials section to speak to their experience in helping real estate investors.
- Does the lender offer a 0% down payment option? While this may not be an indication of a scam, it certainly doesn’t look like the lender is in it for the long-term. Think of the risk involved in getting 100% financing – if, for some reason, the value of your property isn’t as much as you anticipated, you could quickly owe more to your lender than your property is worth. A lender that understands risk would not be eager to finance 100% of your deal.
LTV stands for a “Loan To Value” ratio. Financial institutions use this number to determine the riskiness of a loan. It’s calculated as the amount of the loan divided by the appraised property value – for example, someone with a mortgage for $80,000 on a property worth $100,000 would have an LTV of 80%. As with most things, ideally the property is worth considerably more than what you owe on it.
GLOSSARY:
LTC stands for a “Loan To Cost” ratio. Financial institutions use this number to determine the riskiness of a construction loan. It’s calculated as the amount of the loan divided by the total cost of completing the construction project – for example, someone with a construction loan for $80,000 on a property needing $100,000 worth of work would have an LTC of 80%. The higher the LTC, the riskier the project is for a lender to take on.
The 70% rule is a formula many real estate investors use as a method to determine how much to pay for a fix and flip property. The rule states that an investor should pay 70% of the ARV, minus the renovation needed. For example, if a home’s ARV is $100,000, but needs $10,000 in repairs, the investor should pay no more than $60,000 for the property.
ARV stands for “After Repair Value.” This number is the estimated final cost of a property after it’s completely fixed up. Real estate investors and lenders use this number to determine how much money to spend on repair, as well as the sale price for the property once the renovation is complete. ARV is calculated using comparable sales in the area, industry experts, and market knowledge.
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