You’ll hear plenty of real estate investors use the term “hard money” or “private” lender, but it’s surprising how many people in the real estate industry don’t fully understand what hard money lenders are all about. They are sometimes hated, sometimes loved, but they are neither last-minute miracle workers nor are they usurious bastards; rather, they are simply another outlet for borrowing money.
First of all, what is hard money? Hard money is money borrowed from a private individual or small lending firm that lends out their own cash. Put differently, it’s borrowing money from a person rather than a bank, and is subject to that person’s whims, not the bank’s loan programs or rate sheets.
Practically speaking, this means that hard money loans are very expensive and very fast. Interest rates range between 12-20%, and points, or percentage charged up front as a closing cost, range between 2-8%. These loans are not for everyday home buyers, as you can probably appreciate.
The terms are usually very short, usually no more than a few years, and loan to value (LTV) ratios are extremely low. So, if a property is worth $130,000, a hard money lender may only lend $75,000.
So what’s the appeal of a hard money loan, with all of these drawbacks?
Hard money loans are FAST, for one thing. While the bank will usually take a month to close, a hard money lender can generally close in a week, sometimes less. So if you need money to buy a property quickly, for example from a distress sale, you might need a hard money lender in order to settle in time.
Aside from their speed, hard money loans are much easier on the borrower, since they require far less documentation and paperwork. The reason for this lies in the lender’s security: hard money lenders are lending against the collateral, not against the borrower. If you default, they know they’ll get their money back, because they’ve only lent out a small fraction of what the property is worth. So, borrowers with bad credit or income that’s hard to document might go to a hard money lender because they will be less discriminating about these factors.
So who should use hard money lenders?
Homeowners really have no business borrowing from hard money lenders, due to the high expense and short terms of the loans. Seasoned real estate investors, on the other hand, may decide that a hard money loan is worth the added expense, if they need to settle quickly and efficiently. Some investors may not have a choice, given their bad credit or un-provable income, and have to use hard money lenders because banks won’t talk to them.
Hard money loans are particularly conducive to renovation or construction loans, because they’re quick and flexible. When a developer or real estate investor has a tight timeline to finish the work on their investment property (which is always), they may not want to wait a week for the bank to get an appraiser out to the property, send the draw check through processing, etc. every time they need a draw, and opt for a hard money lender for a quick turnaround times. Landlords who buy shells to renovate and hold as rentals may choose hard money loans, since they’ll be refinancing as soon as the house is finished anyway.
Anyone considering real estate investing as a career should establish a relationship with at least one hard money lender and at least one small, local bank, as local banks can often provide similar loans as hard money lenders without the expense. There will come a time when you’ll need money fast, and there will be others with a cheaper loan through the bank will work fine, so be sure to have several types of lenders in your speed dial, and make sure they know who you are.
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