(This is the third article in our series Unconventional Financing. To start at the beginning, see Part 1 of the series on leveraging retirement accounts for real estate investing. Or if you’re looking for an actual hard money loan, visit our partner website SparkRentalFunding.com.)
Lending is the second-oldest profession, as they say. For as long as there have been resources that one person has and another wants, there have been those who are willing to lend their resources for a fee or favor.
In what seems like another life, I was an account executive and lender’s inspector for a hard money lender. He was as ruthless as they come, but he was also experienced and intelligent, and he knew how to make money. A lot of money.
Hard money lenders charge high fees and interest, on loans with a low loan-to-value (LTV) ratio. In plain English, that means they only lend 50-75% of the purchase price or value of the property.
But is there more to hard money than high costs and low LTV? What exactly are hard money loans?
The lines of definition for hard money loans have blurred over the years. One definition is that the focus is more on the collateral, rather than on the borrower. The idea is that the collateral property is so much more valuable than the loan amount that the lender will still recover their lent money even if they have to foreclose. But today, hard money lenders are scrutinizing borrowers more heavily than they once did.
By another definition, hard money lenders were often private individuals (or small businesses made up of a few individuals), who were lending their own or their investors’ private money. They were local people who lent money for local properties. But today there are also nationwide, corporate hard money lenders, using institutional money to make loans.
Another common definition is “lender of last resort.” Because really, why would anyone want an expensive mortgage that requires a lot of money down?
Yet that implies there are no advantages, which is not true. So why do people borrow hard money?
Advantages to Hard Money
Quick closings matter when bargain-hunting for properties. The best hard money lenders can move at lightning speed. I’ve closed hard money loans in as little as three days. Imagine making a phone call, and three days later having a check for $100,000. Few lenders outside the mob can move with such speed.
Beyond speed is flexibility: maybe you have a unique property you want to buy, that most banks won’t help you with? Perhaps you’re converting an abandoned factory into condominiums, or turning a church into a charming craft brewery. Or you have special needs for a draw schedule, for a renovation loan?
Hard money loans are short-term, so the high interest is very temporary. Often a real estate investor will use a hard money loan to buy a shell, take draws to renovate it, and then either sell it or refinance it. The latter is necessary if you’re keeping the property long-term as a rental property. Either way, the initial hard money loan is usually paid off within a year. And hard money loans are often interest-only, to reflect their temporary, bridge-loan nature.
And of course, there those who just don’t have a choice. Maybe the borrower has credit uglier than 1970s wallpaper, or has too many mortgages to qualify for conventional financing. Renovation projects pose problems for borrowers too, and hard money lenders tend to smile on rehab projects.
Big Brother Has Spoken – Who “Need Not Apply”
It is probably worth noting that most hard money lenders today will only lend to real estate investors, not to homeowners. In the wake of the Great Recession and foreclosure crisis, lending regulations grew much tighter on both the federal and state levels.
If you’re a homeowner, chances are no one will lend you hard money. Uncle Sam made that decision for you, to look out for your own best interests. Don’t you feel loved and protected?
But admittedly, Uncle Sam has a point that some people have no business being a homeowner. For example, people with such poor credit that no subprime mortgage lenders will touch them, or those whose income is so far under the table that they don’t even deposit it in a bank account. They should rent and build their credit, rather than pay 14% interest for a hard money loan.
Hard money loans are useful for real estate investors, when speed and agility matter more than cost. Most hard money lenders have seen it all, and will have no qualms about telling you whether they think your deal is a winner or loser.
You’d do well to pay attention, because they’re usually right. If they didn’t know what they were doing, they’d have been out of business years ago.♦
What kinds of experiences have you had with hard money loans? Do you usually use a local lender, or a larger national firm?