Hard money loan is a short-term loan that many flippers or investors use to get in or out of a project. It’s a leverage for investors to get the most that they can on a particular project.
However, most hard money loans are only good for three to four months with higher interest rates compared to the traditional 30-year amortized mortgage. But investors often use this leverage to purchase properties that they can’t normally afford in the rush.
Here in the Bay Area, for example, most properties cost at least a million dollars and most people don’t have that in cash. Choosing the traditional route of long-term mortgage will take a couple of weeks to close escrow.
A lot of times property sellers are in financial distress which makes it very important to close quickly. Hard money loans allow buyers to purchase a property and close within ten to fifteen days. This is more convenient than the traditional loan that sometimes takes over a month.
If you’re a first-time investor, understanding how to make hard money loan work for you will give you the biggest advantage to purchase more properties and close more deals.
If you’re a brand new, don’t expect that you can get as much leverage as the more experienced investors. For example, because you’re a first-time investor you will be given an 85% -90% LTV (loan-to-value ratio). This means that if you have a million-dollar property, the largest loan you can get will only be around $850,000 to $900,000.
For brand new investors, you will typically have interest rates like 10% annualized plus 2% for the origination. This means that for a $900,000 dollar loan, 10% is due every year at an annualized rate. So if you’re holding on to the loan for a year, you will have to pay $90,000 dollars on interest alone.
Although this might sound like a lot, if you can make $200,000 dollars on the deal then it’s worth it.
This is the fee the hard money lenders charge the borrower. To put it simply, to originate means to create the loan for you. This is the fee you have to pay the people working for you to close the loan on time. They get a commission from every origination they produce.
For new investors, they could charge 2% of the entire loan. So if you have a $900,000 loan on a $1 million dollar property, you’ll be charged an added $18,000 just to close the loan.
Sometimes, hard money lenders would give you a smaller loan of $882,000 instead of the $900,000 (minus the 2% origination). But on the backend, you owe them $900,000.
Often, they would require you 10%-15% down payment but you also need to have liquid capital for other expenses such as origination fees, notary fees, title fees, and other miscellaneous expenses.
Beware of any prepayment penalty. Sometimes they will charge you 4 months of payments even if you have closed in just one or two months. If the contract is a four-month minimum, you will be charged for four months of interest.
Make sure that the loan you’re getting doesn’t have a prepayment penalty. If there is, make sure that it will not affect you in the long run.
This is the fund that a hard money lender gives to fund the actual project. Most of the time they give this to you as reimbursement. They call this “draws”. You can do this by providing a scope of work to inform them what you needed to do for the project, how much each item costs and in what phase will you be using it.
There are many draws options you can choose from. What’s interesting, however, is you have to do the actual work first and then they will reimburse your money. When you show this to the hard money lender, they will send an inspector to make sure everything is valid before they grant you the loan money.
Construction loans can be a little crazy. Some construction companies charge you upfront even though you haven’t got the money yet. This means that if you have to pay them a 10% annualized rate plus 2% of the $100,000 construction loan you applied for. Remember, you haven’t got the money yet but they will charge you on day one.
I don’t get construction loans if I can help it. For me, it’s a waste of money. Instead, I prefer to use my own liquid capital so that I can do whatever I want with it.
If you’re doing a very fast project, go to a lender that charges a higher interest rate but a very low origination fee. For example, if you can complete a project in one week the annualized interest rate will not matter anymore if your origination fee is ZERO.
Compare this to having low-interest rate but you’re getting charged with 2 points. Soon you’ll realize that it’s not worth it because you’re not capitalizing on the time.
When you apply for a hard money loan, they will require some documents about yourself but for the most part, they will look at the property itself. You have to provide them with the address and they also want to see neighboring comps.
The key is, you have to justify why lending you the money is a good deal for them. That’s how you get them to grant you the hard money loan you need to buy the property.
It’s also good if you have a credit score of 630 and above, otherwise, they will charge you with more interest rates and more points. In the worst case, they won’t grant you the loan at all. If you have a good credit history to show them it’s going to speed up the process.
It’s also better to come in prepared with proper documents such as the scope of work, the kind of work the property needs with the actual numbers attached to it. Hiring a contractor to take a look at the property and have an accurate bid before you come for the hard money loan is also one of the best steps you can take.
They want to know about your experience in the space. If you have already closed a property before then you’re in a much better position. If not, tell them the truth, don’t lie. Remember, the more experience you have the more likely they’ll give you more discounts.
They also want some of your bank statements from the past months. This is because they want to see your liquidity. Liquidity is the money you can use right away. They don’t care about the money you have in real estate because you can’t sell the property and use that money right away.
They want to see enough liquidity for your down payment, construction costs, closing costs and six months of monthly payments. Until you can wrap this all up, you should be able to close in 10 – 15 days or they can rush it for emergency purposes.
Hard money loans have higher interest rates of 10%, they have origination fees of 2% (mostly), shorter periods (three or four months), construction loan option, and they have a prepayment penalty that you need to be careful of. Don’t go for construction loans, instead go for liquid capital to avoid any trouble with the construction company.
If you’re a first-time investor, it’s better if you wrap up all the necessary documents beforehand to make sure you can justify to the lender that giving you the loan is a good business for them. But for experienced creditors, they’re judged by their credibility and experience.
Securing a hard money loan will let you purchase the property of your choice faster than the traditional long-term mortgage. Although they have higher fees, securing the property and making more profit than the interest is more important. And it’s worth it.
P.S. If you’re looking for a hard money loan, contact me and check out Conventus Lending at https://www.cvlending.com/. If you have a project that you’re looking into and you need hard money loan fast, ask for Brenda and let her know that Sean sent you guys for $1000 off of your processing fee.
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Thanks for such an informative blog, Sean. And I totally agree that securing a hard money loan will let us purchase the property of our choice faster than the traditional long-term mortgage. Let aside the higher fees as we eventually end up earning more profit than the interest amount we pay. Totally worth it.