A common mistake for many real estate investors is that they focus on only one way of putting together a transaction. There are many different strategies and many different financing options. Knowing when to use each technique will make you a better investor.
Each strategy and technique is effective when used correctly. Hard money loans are a very common financing option for investors, but they also have their time and place.
What is a hard money loan?
The easiest way to explain a hard money loan is that it is private financing. Hard money lenders are people that have access to a pool of money that they loan out on real estate. This pool is usually the result of a group of investors pooling their money together to finance real estate. They are investing in the financing behind the property rather than the property itself.
Since this is private financing, a hard money lender is going to charge higher interest rates for the money. These loans usually charge credit card type interest (10-18%). Because of the high interest, this is not a long-term financing option. Most investors use these loans for short-term financing.
If the loans have such high interest rates, why would you want to use this method? Keep in mind that most loan programs have their place and time. You are not going to use this financing option to finance every deal you do, but it is just another option. When it comes to creatively financing a deal, having multiple options is what it is all about.
Just because the loan is a high interest loan doesn’t mean that this isn’t useful. If you are going to turn around and resell the property, then the interest rate is not a primary factor in whether you’ll do the deal or not. The return on your money is far more important than the interest rate. You are not going to have the loan long enough for the high interest to make a large impact. As long as your profit is still in the deal, it makes sense to use the hard money loan.
If you are going to be using a longer term exit strategy like holding the property as a rental, you might use hard money to get into the deal, and then refinance the property with a traditional loan. Someone might do this if they are unable to get a traditional lender to finance the purchase.
Hard money loans are short-term loans. The majority of hard money loans will be 6-24 months in length. This will give you enough time to do what you need to with the property to make the deal work.
The reason that it is called hard money isn’t because it is difficult to obtain. It is called hard money primarily for three reasons:
- The higher interest rates can make the loan more costly than other types of financing. Even though it is high interest, the other benefits will help outweigh this problem.
- It is difficult to buy the property at a price that will qualify for hard money. Most hard money lenders do not want to exceed 65-70% of the ARV (After Repair Value). The hard money lender will determine what the property would be worth in its best condition, and they will finance up to 70% of that figure.
- The lender is going to give the loan based on the value of the asset (the property) rather than the financial strength of the borrower. The lender is going to be more concerned about the deal than they will be about you as a borrower.
However, there are great benefits for using hard money loans.
- Fast turnaround time. It usually takes a traditional lender 30-45 days to complete a loan. Hard money lenders can do a loan in a much shorter period of time. Most of them can do it within 2-3 weeks and some can even do it in a matter of a few days depending on the resources they have available. If you need to come up with money quickly for a deal, you will want to keep this in mind.
- Hard money lenders will finance 100% under certain circumstances. Most hard money lenders are not willing to finance more than 65% of the After Repair Value (ARV). If your purchase price is less than 65% of the ARV, then they could finance 100% depending on the lender. This could be another solution for getting into a property for as little down as possible.
- Most hard money lenders will also include repair costs into the loan. If the purchase price plus the repairs is less than 70% of the ARV, they will include the repair costs into the loan. Since most traditional lenders will not include the repair costs into the loan, this is a great option if you are planning on rehabbing the property.
Here is a quick example of how this could work:
Purchase Price: $87,500
Value of Property After Repairs (ARV): $150,000
Cost of Repairs: $10,000
Since the lender would be willing to finance up to 65% of the ARV, they would loan $97,500 as their maximum loan. This $97,500 would cover the $87,500 purchase price as well as the $10,000 needed for the repairs. In this type of situation, you could finance 100% and have the necessary money for repairs. This could be a very attractive deal.
How do you find a hard money lender? There are quite a few ways that you can do this:
- Ask your traditional lender. Many lenders already have these connections set up. This is another way for the traditional lender to finance their clients if their traditional loan programs will not work.
- Real estate investment clubs. These investment clubs are a great way to network with other people. Hard moneylenders frequently go to these investment clubs as it is a way for them to get additional contacts and business. You might also want to ask some of the other investors in the club for additional referrals.
- Internet. The Internet is another great tool for finding hard money lenders. Search for “hard money lenders” or “private financing” or even “rehab loans.” You can add the city or state name to find something local.
Hard money loans are just another solution for you to finance a property. You will not use hard money loans on every deal that you do, but if you are going to be flipping the property and it needs some rehab, then this is a great option to keep in mind.