A hard money lender is a type of lender who provides short-term loans to business entities that are secured by real estate. Unlike traditional banks, hard money lenders focus on the value of the property being used as collateral and the quality of the deal rather than the income of the borrower.
Hard Money Lender - Overview
Hard money loans are typically used by full time real estate investors and landlords who need access to funding to purchase or renovate properties because they don't have a W-2 income typically required to work with a bank or already have extensively leveraged portfolio and their traditional lender has tapped out. The interest rates on hard money loans are higher than traditional loans, often in the double digits, and the loan terms are typically much shorter, ranging from a few months to a few years in order to compensate the lender for higher risk associated with typical deal used to fund by these loans.
While hard money loans can be expensive on relative basis, they can be a useful tool for real estate investors and landlords who need real estate funding to pounce on a deal or who may not qualify for traditional financing due to poor credit, existing leverage, or lack of income documentation. Hard money lenders can be individuals or companies, and they typically have their own specific criteria, a 'credit box', for approving loans.
What is a hard money lender?
A hard money lender is a type of lender that offers short-term and long-term business purpose, non-owner occupied loans that are secured by real estate. These loans are typically used by real estate investors, landlords and developers who need access to funding to purchase or renovate real estate. Unlike banks and traditional lenders, hard money lenders are less concerned with the borrower's job income and more focused on the value of the property being used as collateral, quality of the deal and borrowers operational track record.
Hard money loans are generally more expensive than traditional bank loans, with higher interest rates and fees. However, they can be a useful tool for real estate investors who need to move quickly on a deal or who may not qualify for traditional financing due to poor credit or lack of income documentation. Hard money lenders may also work with borrowers who need bridge financing, which is a short-term loan used to bridge the gap between the purchase of a new property and the sale of an existing property.
While hard money loans can be a good option for real estate investors, borrowers should be aware of the risks involved. If the borrower defaults on the loan, the hard money lender can foreclose on the property and take possession. Therefore, it's important for borrowers to carefully consider their ability to repay the loan and to work with a reputable hard money lender who is experienced in the industry.
Benefits of working with a hard money lender
Easier to qualify for a loan
A hard money lender is more likely to approve loans for borrowers who may not qualify for loans with traditional banks. This is because a hard money lender is not subject to the same strict lending standards as traditional banks. A hard money lender typically focuses on the value of the collateral being used to secure the loan, rather than the borrower's income. However, its a common misconception that hard money lenders don't consider borrowers credit worthiness. If a borrower lacks track record, conventional measures of creditworthiness such as a credit score or financial history is the only thing left for a hard money lender to make decision on. This makes it easier for borrowers with no W-2 income to qualify for a loan, such as any self-employed professional such as real estate investors, contractors, real estate agents or landlords.
Main reasons why it is easier to qualify for a loan from a hard money lender are:
- Hard money lenders are not subject to the same strict lending standards as traditional banks. This means that they are more likely to approve loans for borrowers without W-2 income. However this doesn't mean that the borrower can have bad credit, since credit score is still an important metric used for loan underwriting
- Hard money lenders typically focus on the value of the collateral being used to secure the loan. This is another reason why W-2 income plays a smaller role when it comes to borrower qualification
- Hard money lenders are more flexible with their offering. Unlike banks that have very rigid, product specific, lending criteria, a hard money lender may have their own pull of capital meaning that they are more flexible with products that they can offer from the perspective of loan duration, rate, collateral class and any other metric used to quantify a loan.
Faster timeline to closing
Banks and private money lenders have different lending processes and requirements that can affect the speed of the lending process. Here are some factors that can hold up banks' lending process compared to private money lenders:
- Strict Underwriting Process. Banks typically have a more rigorous underwriting process compared to private money lenders. They often require more documentation and verification of the borrower's financial information, such as tax returns, credit reports, and employment history. This can take longer to collect and process, leading to a slower lending process.
- Income Verification. Banks typically require a higher credit score and income verification to approve a loan. They may also have stricter debt-to-income ratio requirements. These additional requirements can delay the lending process as the bank spends more time assessing the borrower's financial background.
- Regulatory Compliance. Banks are subject to a wide range of regulations designed to protect consumers and ensure the safety and soundness of the financial system. These regulations can be time-consuming to comply with, which can slow down the lending process. Private money lenders may not be subject to the same level of regulation, which can make the lending process faster.
In contrast, a hard money lender can often offer faster loan approval and funding times due to their streamlined processes and flexible underwriting criteria. However, due to these factors and higher risk faced by investors in this lending space, a hard money lender may charge higher interest rates and fees compared to banks to protect themselves from increased likelihood of not getting repaid.
Risks of working with a hard money lender
Borrowers must carefully weigh the risks and rewards of working with a private money lender and ensure that they have a clear and viable plan for repaying the loan before entering into any loan agreement. It's important to do your due diligence and research potential lenders, as well as seek advice from trusted advisors such as other real estate investors, developers or landlords.
- Higher Overall Risk. Hard money lenders generally operate in a higher risk environment than traditional lenders such as banks. As a result, the terms of the loan may be less favorable to the borrower, including higher interest rates and fees, shorter repayment periods, and lower loan-to-value ratios. Borrowers must carefully consider the risk versus reward of taking out a hard money loan, and ensure that they have a clear and viable plan for repaying the loan.
- Personal Guarantees. Private money lenders may require borrowers to provide personal guarantees for the loan, which means that the borrower is personally liable for the loan if they default. This can put the borrower's personal assets at risk, such as their home, cars, or savings. Borrowers must carefully consider the potential consequences of a default and ensure that they have the means to repay the loan before taking out a hard money loan.
- Higher Monthly Payments. Hard money loans typically have shorter repayment terms, usually between 12 to 24 months. This can result in higher monthly payments than traditional loans, which can increase the risk to the borrower if they experience unexpected expenses or a drop in rental income produced by the property. Borrowers must ensure that they have the cash flow to cover the monthly payments throughout the loan term.
- Prepayment Penalties: Some hard money loans may come with prepayment penalties, which can make it difficult for the borrower to refinance the loan if interest rates fall. This can leave the borrower with limited options if they need to exit the loan before the end of the term. Borrowers must carefully review the loan agreement and ensure that they understand the terms of the loan, including any prepayment penalties, before signing on the dotted line. However, this is a much lower risk since most hard money loans are short term in nature.
What questions should I ask a hard money lender?
When you are considering a hard money loan, it is important to ask the lender a number of questions to make sure that the loan is right for you. These questions include:
- What are the fees associated with the loan?
- What is the interest rate on the loan?
- Do I need to provide a personal guarantee?
- Do you require a business entity as a the borrowing entity?
- Do I need to pledge shares?
- What is the term of the loan?
- Are there any prepayment penalties?
- What is the collateral for the loan?
- What is the lender's experience in real estate lending?
- What are the appraisal fees?
- What is the optimal Loan to Value (LTV) on this loan to get the best interest rate?
- Can I buy down the interest rate?
- How many points do you charge?
- Why should I go with you versus other hard money lender if your rates and fees are the same?
- What is the loan application process like?
When you are choosing a hard money lender, it is important to compare different lenders and their terms to find the best loan for your needs. You should also make sure that the lender is licensed and insured.
How does hard money lender work?
A hard money lender typically act as intermediaries between borrowers and capital providers, underwriting the loans and managing the loan servicing process. The capital providers may be a network of individual or institutional investors who compete for borrowers' loans. The hard money lending supply chain may vary depending on the lender, with some lenders using their own capital to fund loans and others relying on a network of investors.
- Borrower Requests Loan: A borrower seeking a hard money loan submits a loan application to a hard money lender, usually including details of the property being purchased or refinanced, the borrower's credit history, and the proposed loan terms.
- Lender Evaluates Loan: The hard money lender evaluates the loan application, including the borrower's creditworthiness and the value of the collateral property. They may also request additional information or documentation to help evaluate the loan.
- Loan Underwriting: The hard money lender underwrites the loan, determining the loan amount, interest rate, and other terms. Unlike traditional lenders such as banks, hard money lenders typically focus more on the value of the collateral property than the borrower's credit history.
- Loan Approval: If the hard money lender approves the loan, they provide the borrower with a loan commitment letter outlining the terms of the loan, including the interest rate, repayment period, and any fees or prepayment penalties.
- Capital Providers: Hard money lenders may be intermediaries who connect borrowers with a network of individual or institutional investors who provide the capital for the loans. Alternatively, they may use their own capital to fund loans.
- Loan Servicing: After the loan is funded, the hard money lender services the loan, collecting monthly payments from the borrower and managing the loan account.
- Loan Repayment: At the end of the loan term, the borrower repays the loan in full, including any interest and fees. If the borrower fails to repay the loan, the hard money lender may foreclose on the collateral property to recover their investment.
How to find a hard money lender?
Finding a hard money lender can be a daunting task, but there are several resources available online that can help you identify potential lenders. Here are some tips on how to find a hard money lender and what to look for.
The most effective way to find a hard money lender online is to use search engines and variety of key word terms such as:
- "Hard money lender"
- "Private money lender"
- "Hard money loans"
- "Private money loans"
- "DSCR loans"
- "Fix and flip loans"
These are just some of the key words that you can use. Once you search a handful of these, on the first page of the results you will see some repeating company names. Visit those sites and build a list of potential lenders you want to reach out to to start your evaluation process.
How to pick a hard money lender?
When evaluating potential hard money lenders, consider the following criteria:
- Experience: Look for lenders who have a proven track record of successful lending in the real estate industry.
- Reputation: Research the lender's reputation in the industry, including reviews from other borrowers and industry professionals.
- Loan Terms: Consider the loan terms, including interest rate, loan-to-value ratio, and repayment period.
- Fees: Check for any upfront fees, such as application fees or appraisal fees, and ensure that they are reasonable.
- Communication: Look for a lender who is responsive and communicates clearly throughout the loan process.
- Warning Signs: Be wary of lenders who require large upfront fees, make promises that seem too good to be true, or pressure you to make a quick decision.
- Positive Signs: A high-quality hard money lender will have a reputation for transparency and honesty, and will be willing to answer your questions and provide references from other borrowers.
- Don't Overlook the Details: Review all loan documents carefully and ensure that you understand all of the terms and conditions of the loan. Don't be afraid to ask questions or seek advice from trusted professionals such as attorneys or financial advisors.
In summary, finding a hard money lender requires research and due diligence, including evaluating their experience, reputation, loan terms, fees, and communication. Look for warning signs such as large upfront fees or unrealistic promises, and seek out positive signs such as transparency and honesty. Don't overlook the details of the loan documents and seek advice from trusted professionals as needed.