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Why Real Estate Investors Need Access to Quick Capital
Often, the most challenging obstacle for a real estate investor isn’t spotting a great deal, but securing the financing to make it happen.
The difference between landing a deal and missing out on it often comes down to the lack of speed of funding.
This is where hard money loans, otherwise known as bridge loans or private money loans, come into play.
These asset-based loans can be funded in as little as 5 to 7 days, versus traditional bank loans that can take months to approve.
This can give you an advantage over a competitor in today’s fast-paced marketplace.
Bridge loans require minimal documentation from the borrower, whereas banks ask for a mountain of paperwork.
By the time the bank’s requirements are met, the great deal you once had in your sights is long gone.
An offer on a home or commercial property using a hard money loan is usually in the form of an all-cash offer, which makes the offer stand out from other non-all-cash offers.
To better understand this financial tool, we will break down what a hard money loan is, the advantages and disadvantages of these types of loans, and how to qualify.
What is a Hard Money Loan?
Hard money loans are typically short-term, interest-only loans, ranging from 6 to 24 months, that are funded by private investors or small lending companies instead of banks or large lending institutions.
The primary factor in determining whether or not you are approved for a hard money loan revolves around the asset being used as collateral.
While traditional banks are concerned with a borrower’s credit score, income-to-debt ratio, and a myriad of other factors, hard money lenders are more concerned with the value of the property being borrowed against.
Factors such as the location of the property, property type, and loan-to-value ratio (LTV) will all play important roles.
Lenders typically don’t like to lend on rural property or land, but would rather lend against a home or apartment in a major US city.
Keeping the LTV below 65% will show the borrower has substantial skin in the game, reducing the likelihood of a borrower defaulting on their debt obligations to the lender.
Lastly, a borrower must show they have an exit strategy to repay the lender, whether it be through the sale of the existing property, refinancing into a traditional bank loan once the property is stabilized, or through the use of other funds.
Pros & Cons of Hard Money Loans
Similar to other financial tools for real estate investors, hard money loans come with advantages and disadvantages to the borrower. It’s important to know when and when not to use them.
Hard Money Pros:
- Speed of Funding: Hard money loans can be funded in 5 to 7 days.
- Flexible Lending Criteria: High credit scores and income are not required to receive funding.
- Asset-Based Lending: The focal point of the approval process is based on the underlying asset being borrowed against, not the borrower.
- Short-term Solution: Perfect for fix-and-flips, bridge loans, or the purchase of a temporarily distressed property. Once an investor stabilizes a property, they can refinance into a long-term bank loan.
Hard Money Con’s:
- High Interest Rates: These interest-only loans usually come with a rate of 8 to 15% and 2 to 4 points for origination fees (lender’s fee).
- What are the Plan’s Fails: If an investor’s project takes longer than anticipated to renovate or doesn’t sell for the desired asking price, repercussions such as default or bankruptcy could occur.
- Short Length of Terms: Most hard money loans expire anywhere from 6 to 24 months. Suppose borrowers are unable to sell the property due to market conditions or still can’t obtain a traditional bank loan. In that case, they might have to refinance into another hard money loan and have to pay additional origination fees.
How to Qualify for a Hard Money Loan
Pre-qualification from a hard money lender can be done over the phone in a matter of minutes.
They will gather information about you as the borrower, your situational needs, and details of the property.
Once pre-qualified, the lender will begin the underwriting process to approve your loan request.
Lenders will be most interested in a borrower’s equity in the property, the loan-to-value ratio, exit strategy, and the borrower’s experience.
- Equity in the Property: Hard money lenders like Crescent Lenders, based out of Los Angeles, typically want to see borrowers with a minimum of 25% equity in the property, but 30 to 35% is preferred to protect against a downturn in the real estate market.
- Exit Strategy: Having a clear understanding of how the funds received from the hard money lender will be utilized and when they will be repaid is extremely important for qualification purposes.
- Financial Capacity: Lenders like to see borrowers not stretched too thinly and therefore want to see bank statements showing reserves as well as proof of income or other properties owned
- Borrower’s Experience: While not a requirement, lenders are more hesitant to lend to a first-time fix-and-flipper than they are to someone in need of a bridge loan. Having experience could be a determining factor to push your loan across the finish line.
Conclusion
Hard Money lending, while not for everyone, is a great financial tool to help real estate investors build wealth.
These loans are beneficial when investors come across a great deal they know will sell quickly, but they don’t have the liquidity to execute themselves.
Investors should be wary of the short terms and higher interest rates that are attached to this loan product, so be sure to have a lawyer examine the documentation before signing on the dotted line.
If a borrower has cash reserves, a steady income, and a clear exit strategy, they will put themselves in a position to succeed and to strengthen their real estate portfolio.
