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The Ultimate Guide To Hard Money Lending

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Hard money loans can be a highly successful way to invest in real estate and build financial independence. The key is understanding how they differ from traditional mortgage loans, what type of projects they are used for and what the benefits are for the investor.

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Buying into real estate is one of the safest ways to invest and build wealth, as long as the investor is informed and has the right funding. The US real estate market has remained consistent throughout the pandemic, with only minor decreases in property prices and sales volumes reported in the majority of metros. Investors have already hit the streets looking for their next investment property, and that means that financers like hard money lenders have also been back in action. 

When it comes to purchasing real estate to flip, there are a variety of funding options available but that don’t always include banks. Traditional lenders like banks are particularly stringent when it comes to house flips, and may reject your application right out the gate due to perceived risk. Banks are mostly in the line of borrowing to primary homeowners due to strict guidelines that limit them to dealing with low-risk clients only. 

The alternative is to work with a hard money lender, an option becoming increasingly popular with real estate investors today. Hard money lenders may provide capital sourced from individual investors, hedge funds, or even raised from the crowd. Financing your property with a hard money loan may be the right move for those in the real estate business, but finding the right lender for a development project can be a big challenge in itself.

But what is a hard money lender, how do their loans work, and is it a good idea to use one for your real estate project?

This is the New Silver ultimate guide to hard money lending for new borrowers:

What Are Hard Money Loans?

Hard money loans are short-term, asset-based loans in which the property acts as collateral for the funds that are borrowed. These collateralized loans are granted by hard money lenders, which commonly fund fix and flip investors, landlords, and even commercial project developers. 

Typically, hard money loans are used as a source of funds with which the investor can renovate their property and improve the after-repair value (ARV) before selling it for a higher price later and making a substantial profit. By putting together loan funds from private, non-bank sources, hard money lenders can offer more flexibility and speed when it comes to granting the loan, but at a cost. Compared to bank loans, hard money loans can have higher interest rates and origination fees. This is because the lenders are usually private investors that have to offset the risk of the loan. As a result, it’s common for the hard money borrower to have to provide a down payment – these lenders prefer the investor to have some skin in the game too. That way, both parties are motivated to ensure the project succeeds.

One of the key differences between traditional mortgages and hard money loans is that banks base the loan value they are willing to grant on current property values, while hard money lenders take the future value of the property into consideration. They calculate the future value of the property by taking the ARV into consideration.

The ARV of a property is calculated by evaluating comparable homes in the same neighborhood and factoring in current market conditions that could affect the home value. Real estate investors can also use the ARV formula to determine whether a property is worth buying or if a better deal should be found elsewhere. New Silver has a free ARV calculator that factors in all the comps in the investor’s selected neighborhoods.

Why Use Hard Money Loans?

There are several key reasons why real estate investors prefer to use hard money loans even if they can be more expensive than normal bank loans. To start with, the borrower may not qualify for a loan from a traditional lender. Finding a bank that does not make a decision based on the borrower’s credit and financial history, for example, can be a significant issue. Bank loans typically have strict rules and loan terms, meaning borrowers with less than perfect credit and financial records may struggle to get approved. 

Hard money lenders on the other hand are more concerned with the value of the property being borrowed against than they are in the borrower’s financial history. Of course, they ultimately want to take on borrowers that will complete their house flips successfully, but having the property as collateral means they have more flexibility in who they grant loans to.

Hard money loans are applicable to a variety of projects beyond fix and flips, including construction loans, commercial loans, and other real estate projects. In the same breath, the borrower could take out multiple hard money loans at the same time and stagger projects. Many real estate investors follow this strategy for their full-time businesses.

Another reason why hard money loans are beneficial to use for real estate projects is the speed at which they can be granted. The amount of time that goes into the loan application, underwriting, and approval process can make or break any project, and loan applications from traditional lenders can take up to 45 days or more to complete. During that time, it’s possible for a competing investor to swoop in and make an offer on the property, costing the original investor the deal altogether.

In contrast, hard money loans can be approved much faster and close within only a week. Because these lenders are more concerned about the collateral (the home) than they are about the investor, their borrower requirements are less stringent and they are also subject to fewer lending restrictions. Lenders like New Silver offer easy online loan applications that can be completed in 10 minutes and closing completed in just 7 days.

Other Hard Money Loan Benefits

Apart from providing borrowers with fast loan applications and closing, there are a variety of other benefits that make hard money loans highly beneficial.  For one, these lenders require less paperwork to get started and many hard money lenders will fund investors with no prior experience and provide them with resources like general contractor referrals, property appraisals, and others to help them succeed. 

One of the often-overlooked advantages of working with a hard money lender is the flexibility that they can offer in loan terms. Traditional lenders like banks are much less forgiving when it comes to repayment, and the option to negotiate doesn’t come to the table. Hard money lenders do not have to ascribe to the same lending practices, which means that their loans are much more flexible than traditional loans are in repayment terms. 

With hard money lenders, every borrower is treated on a case-by-case basis, allowing them to negotiate better terms than the lenders using standardized underwriting will allow. This can be an invaluable way of getting a loan that has terms suitable to the investor’s budget.

Lastly, these lenders are able to provide the borrower with a proof of funds letter that they can include in their offer to buy. This proof of funds adds gravitas to the investor’s offer and give the seller additional assurance that the buyer has access to the funds needed to close the deal quickly.

In short, hard money lenders tend to stick to real estate investments that have strong underlying value, and like borrowers with some past investment experience but it’s not a deal-breaker if they don’t. Comparably, banks prefer to play it safe, dealing mainly with borrowers with secure, documented incomes, low debt to income ratios, and robust credit histories. This may be an advantage for the bank more than it actually is for the borrower.

Summary of Hard Money Loan Benefits

  • Flexible loan terms
  • Easy loan applications
  • Less stringent financial requirements
  • Speedy approval and closing

Hard Money Loan Disadvantages

With all the benefits in mind, there are some things that can be disadvantageous about this type of funding that need to be taken into account prior to getting started. One such example is in the cost of hard money loan interest rates. Interest rates on hard money loans are higher than on traditional bank loans, as mentioned above. These higher interest rates are due to the increased risk the lender has to take on to grant the borrower immediate access to capital. The borrower effectively makes a trade off between getting funded quickly and having to pay slightly higher loan repayments every month. 

If the borrower is unable to make these payments reliably they may find themselves losing the property and seeing all the time spent purchasing and renovating the property go to waste. For less experienced borrowers that are unable to stand strong in the face of challenges and pitfalls, losing the property can lead to a disinterest in trying anything related to real estate investment again. 

Another potential downfall for some borrowers considering this method is the need for a down payment. While there are lenders out there that will grant up to 100% of the loan value, many prefer the investor to put their own stake into the project in the form of a partial investment or down payment. For prospective borrowers that don’t have a lot of access to seed funds from their own pockets, this can be a barrier to entry. 

One thing to consider that is less of a disadvantage and more of a cautionary tale is that not all hard money lenders are of the same quality. Some of these lenders have given the hard money industry a bad reputation due to providing poor service or working with predatory lending practices. Real estate investors interested in using hard money to fund their projects should take the time to do their due diligence before selecting the lender they want to move forward with.  

Summary of Hard Money Loan Disadvantages

  • Higher interest rates than traditional mortgages
  • Some form of down payment is required
  • Not all lenders are equally reliable
  • The loan terms are very short compared to normal loans

How To Choose A Hard Money Lender

The first step to choosing a hard money lender is to set clear investment goals. While this can be easier said than done, it’s key for the investor to think about what they need from the lender to successfully complete their flip or whatever real estate project they have on their hands. By narrowing down the needs, it will give the prospective borrower a better idea of what type of lender will be best suited for them. 

Next, it’s important to look for a firm that specializes in hard money loans and has a proven track record in the area the investor is planning to buy into. Look for lenders that have reviews from previous borrowers and pay careful attention to their feedback about their experiences working with them. 

Most essential of all, make sure that the lender you choose is transparent in all their loan terms. If their advertised rates do not correlate with the rates they actually offer, move on to the next option on the list instead. In addition to that, the investor needs to ensure that the lender they choose to work with has the relevant licenses needed to operate in that state and that everything is above board. 

Lastly, go for a lender that you can see yourself building a long-term relationship with. Many real estate investors make a career out of flipping houses and having a lender on the team that can provide ongoing support can be a differentiating factor. Working with the same lender for longer periods of time can help the investor in several ways. For one, the lender will already be familiar with their financials and they can move through the application and funding process faster. The lender may even be willing to offer them more beneficial terms due to their repeat business and loyalty as a borrower.

Final Thoughts

There are many reasons why hard money loans are a good funding choice for investors today and they have enough versatility to be suitable to multiple different types of real estate projects. With benefits like fast approvals and closings, flexible loan terms, and instant proof of funds, it’s no surprise that these loans are becoming more prominent with investors. While there are some drawbacks like higher interest rates, these can be minimal when compared to the benefit of being able to close a real estate deal quickly.

The key to success using this financing strategy is to choose the right hard money lender and pre-vet them to ensure suitability. When all the steps are followed carefully this can be a highly profitable way to become financially independent.

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