Real estate is a wise and popular investment option for several reasons including great returns, tax benefits, and increased value over time. When hopeful investors think about obtaining financing for real estate, the set conditions from traditional lenders stop many of them in their tracks. These include high credit scores, low debt-to-income (DTI) ratio, and a down payment of up to 30%.
Banks put these stringent requirements in place after the economic downturn in 2008 and sadly, not everyone can meet them. Even with all the necessary requirements, it can be a lengthy and agonizing process. Fortunately, non-conventional methods of financing have enabled eager investors to realize their dreams of becoming property owners, and in a short time.
These financing alternatives are hard money and private money. Although they both have advantages over traditional lending, they also have downsides. Borrowers must thoroughly research each alternative and each lender to ensure all is a good fit and to avoid disastrous situations.
What is Hard Money?
Hard money is a short term, asset-based type of loan. A hard money loan is suitable for purchasing land, construction, fixer-uppers, and flips. You can get it from a group of investors or a company. Unlike usual lenders, hard money lenders are more interested in the value of the property than your credit report.
The words ‘hard money’ does not imply that this financing is difficult to acquire. On the contrary, it’s quite easy. It actually defines the property being a hard asset. When borrowers have been frustrated by the banks, or they require quick financing, this is a great alternative. The typical payment period is 1 year although it can be increased up to 2-5 years.
Other requirements by lenders may include:
- Property type
- The geographical location (some lenders provide their services locally or to particular states)
- Some may even ask you how many homes you flipped; the higher the number of homes you flipped that have had good repayment records lowers your interest rate
- Borrower’s plan for the property. The lender may want to know the borrower’s intentions, for example, whether they plan to renovate the property or obtain further financing over the long run.
Properties Financed by Hard Money Loans
Any kind of property can be financed by a hard money loan, including commercial property, land, residential property and industrial property. A few lenders may specify a niche, for example, commercial and not residential. Very few lenders will transact with owner-occupied properties. They involve extra requirements and include loads of paperwork.
What is Private Money?
Private money is short-term financing borrowed from an individual who could be a friend or family member and can be used for financing real estate transactions. The characteristics and benefits are basically similar to those of hard money.
Benefits of Hard Money and Private Money
Quick Approval Process
The process of obtaining the loan from www.justrightloans.com is quick and straightforward. It can take a maximum of two weeks as opposed to a bank’s usual 30-40 days. No time is wasted on filling and signing piles of paperwork or checking your credit history. Lenders make decisions fast. They focus more on the property.
As long as the collateral has good value, they are not worried about whether you will make the payments or not. They will simply sell off the property and probably make more money than what you would have paid back.
Unlike traditional lenders who have their rules set in stone, hard money lenders assess borrowers on a case-by-case basis. This means that you can come to terms about extending your repayment period based on your state of affairs.
Downsides to Hard Money Financing
Interest rates differ for each lender and each geographical location. Areas with several money lending firms will charge lower because of competition. Loans from hard money lenders are high risk, and so they will charge high-interest, usually between 10% and 15%.
High origination free
Hard money lenders will charge a high fee for processing your loan application because the loan is risky. They can charge as much as 5% of the loan compared to banks, which might charge only 1%.
Short Repayment Period
While mortgages typically have long repayment periods of 30-40 years, these loans have a very short period of up to a maximum of 5 years. Real estate properties are not cheap and normally require a longer period to pay back unless the property is highly profitable.
Before taking on a private or hard loan, borrowers should ascertain how long it would take for the property to become profitable. Then they can see whether the repayment period is feasible.
Risk of losing the property
Since the property is the only collateral for the loan, it will end up belonging to the lender if you fail to pay it off.
Hard money lenders use a loan-to-value (LTV) ratio to decide on the amount of the loan. Most of these lenders provide between 65 and 75% of the total value of the property. They maintain a low LTV ratio so that it’s easy for them to put the property on the market with the likelihood of getting back their money.
Some lenders will use the after-repair value (ARV) to determine the total amount of the loan. This is the future value of a property after it has been renovated by the borrower. A few lenders may even offer to cover the rehabilitation costs of the property on top of a high percentage of the ARV. This would seem attractive to the borrower; however, it makes the deal riskier because of even higher interest rates of up to 18%. If the property is highly profitable, it would be better for the borrower to cover the rehab costs.
Lenders You Should Avoid
Some hard money lenders have ruined the industry’s name with predatory lending actions. They intentionally provide high-risk loans so that the borrower is in a position of not being able to pay. They exploit the borrower’s inability to understand certain financial terms regarding loans.
Sometimes lenders will bait borrowers with attractive schemes and then, later on, switch the scheme without the borrower knowing.
They only discover these several months later when their subsequent payments are much higher. After a thorough investigation, they realize that there was a modification on the interest rate that they were not informed about. Eventually, the lenders end up owning borrower’s property when borrowers fail to pay, as was their intention all along.
Be careful not to fall prey to predatory lenders. The loan may be quick and easy to get, but you need to do thorough research, preferably with referrals if possible. Check your documents completely to make sure that they are consistent with what was agreed. Getting educated with financial terms can save you from a predatory lender.
The US Department of Housing and Urban Development has put on controls to eliminate this unscrupulous behavior. Many money lenders have adjusted their operations by further assessing the eligibility of borrowers through income documents.
Finding the Right Hard Money Lender
You can find the right money lender by starting with a Google search. Type in ‘your area’ + ‘hard money lenders.’ This will bring up a list of lenders that you can contact. If you have real estate clubs in your neighborhood, you could attend the meetings and find out from other investors.
The lender should ideally have a great track record and should cater to customers’ needs first. You can check out their website for reviews and meet with them to decide if they are the right fit for you. Stay away from lenders who have no reputation to speak of.
If you’re new to private lending, the lender should have several years of experience as well. You need to deal with a transparent, qualified professional who will provide sufficient knowledge about these loans, including the good and bad. This will help you weigh your options.
Although alternative lenders typically charge a high-interest rate, they aren’t all the same. You can still do some digging around to compare and find the one with the best rate for you.
Every lending opportunity has a good and bad side. The point is that you choose the one that works for your situation. If you are an investor looking for lending alternatives, hopefully, the above information has given you some confidence. You can now approach hard money and private money knowing what to expect.