Mortgages & Creative Financing

Why Do Some Real Estate Investors Become Hard Money Lenders?

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
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First of all, there are many reasons that a real estate investor might shift from utilizing traditional bank financing to using a hard money lender. Many real estate investors start out with a regular bank when acquiring their first few doors. Especially for those moving from property to property while they're still young, before settling down to raise a family, it makes sense to keep buying properties as an owner occupant. Doing so allows you to take advantage of the more favorable terms (i.e. low down payment and lower interest rates).

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Once you hit a certain number of doors, where the mortgage originator can no longer sell off that loan (due to Fannie May or Freddie Mac guidelines), most banks will begin to cut you off from the traditional, residential financing. So, at that point, what's an investor to do?

Turning to Commercial Financing

With commercial financing, a deal really needs to be a deal in the truest sense of the word. By that, I mean the investor usually needs private or hard money to make the acquisition, then they do the fix-up, oftentimes with skin in the game, only to turn around and refinance with a commercial loan just hoping to get their capital back (acquisition and fix-up costs).

Related: 4 Ways to Use Hard Money & Private Financing for Your Rental Business

If for some reason you can't sell the flip, or it was your intention to build your buy-and-hold portfolio, the end game of the commercial loan or adding one more property to your commercial blanket may leave you with a deal where all your profit is tied up in the equity of the deal that's backing the commercial lender. Other than the long term cash flow play, it's like working for nothing.

Commercial plays, financing wise, for larger real estate deals, such as apartment complexes, mobile home parks, storage centers and new construction developments, tend to make much more sense, especially since real estate values are based more on an NOI (Net Operating Income), instead of nearby residential comps.

If commercial financing doesn't look appealing to you, there is another option, which is to start lending hard money loans to fellow rehabbers.

Why Become a Hard Money Lender?

Let’s say you’ve been down the path of building your residential portfolio, and you’ve utilized the traditional bank, the commercial banker and even the local REIA hard money lender, learning a lot along the way.

Take my buddy who locally has over 250 rental properties. When is it time to say enough is enough?


Obviously, it takes a certain skill set to be a hard money lender, but most of that skill comes from years of experience. Anyone who’s used hard money knows intimately how it works.

For most experienced long-term investors, with large portfolios of rentals, it's possible to get a large commercial line of credit at a favorable interest rate.

Related: 8 Things The Real Estate Experts Won’t Tell You About Hard Money

Now, it's just a matter of "what's the worst that could happen?" You'll access the line, lend a secured, short-term, first mortgage, rehab loan in an area you're familiar with, possibly to a rehabber you know. Even in the event that they default, you could end up with a property at $.60-$.65 on the dollar and just send your own crew over to complete the rehab. But trust me, this rarely happens. Plus, you are the one collecting the high, hard money interest rate, along with some points.

So, whether you plan to graduate to lending hard money by tapping into your own line of credit, or better yet by hitting up your self-directed IRA, it may start to make more sense being the bank.

My buddy said he’d had enough after owning 250 doors, and he’s not likely to own 500. He’d just rather be the bank. Many of us real estate investors don’t think of our hard money lender as being the bank or as being in the note business, but they are.

So, as you accumulate more and more properties, would you ever consider becoming a hard money lender?

Let me know with a comment!

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nat...
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    Charles Worth Investor from New York City, New York
    Replied about 5 years ago
    Good article. I also think its interesting that a good number of HMLs probably have returns comparable to owning many properties I see out there now. True, it is taxed at ordinary income (if its not an IRA) so the returns are not comparable for all but a lot less long-term risk than no appreciation cash flow plays and if you have a portfolio throwing off depreciation or a good amount of “expenses” your tax rate may not be that high. Its also become easier than ever to lend at high rates.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Hi Charles, Thanks for the comment! I agree there are many situations where Hard Money Loans have comparable returns to property but I do think there are a few other factors to consider when comparing the two investments: – Hard money lending unfortunately doesn’t have appreciation BUT it’s important to keep in mind property has the depreciation re-capture tax when it comes time to sell, affecting the overall return. – For me where my capital comes from is just as important as what I’m investing in. Although I started out using my own capital to purchase property, today it would be extremely rare I would do that. Personally, I now like using the bank’s money or OPM (other people’s money) for my all of my residential and commercial properties whereas with Hard Money Loans and other notes I invest in, I like to use my own money (savings, HELOCS, IRA capital, etc) because Hard Money Loans are often shorter term and more liquid than hard real estate investing. And like I said, I can do it all through my IRA tax free. The big thing for me, is that hard money lending doesn’t have any maintenance or property management expense (whether you’re doing it yourself or hiring someone else). Overall, Hard Money Loans are a lot less aggravation and a lot less of time consuming especially as you acquire more property. As I get older this is a big one for me! I should also mention the idea of repeat business. For instance, say I lend an acquaintance money for a property at 18% with 6 points, for only 6 months. Well if he or she is successful, what will they likely do next? I’ve found they usually ask for more hard money for their next property. So for another 6 months of an 18% return plus 6 points. Meaning with this return twice in one year, I’m now at a very high ROI that’s very passive, with very little time commitment on my part. I’m just speaking from my personal experience, and of course, there are limitless Real Estate Investment strategies and investors with different preferences. Do you prefer more active investment strategies than passive? Have you considered any of these factors when comparing the two investments? I’d be interested to hear your thoughts. Best, Dave
    Joseph M. Flipper/Rehabber from Los Angeles, CA
    Replied about 5 years ago
    Good article. It seems to make sense to become a lender once someone gets to amount of capital. Returns are good and risk is low with the right LTV. You don’t benefit from the appreciation of the property, but there are a lot of markets where appreciation might be pretty slow anyways. The higher interest rate can make up for that. Is your friend with 250 doors going to sell all his properties and then become a lender ? Or is he just going to stop buying properties and instead use that money to create loans? I imagine there would be not much headache with loans unless there was as default or foreclosure to deal with versus managing 250 doors.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Hi Joseph, It’s actually the opposite of what you might think, he probably won’t sell many of his properties at this point. The last time I talked to my friend, he was utilizing the properties he owned as collateral to obtain a business line of credit for over $10 million that he uses for his Hard Money business. He definitely has a lot less headaches, that’s for sure. I know he has safe guards in place in relation to default. For instance, my friend doesn’t lend to individuals or owner occupants because he would have to foreclose, so instead he only lends to LLCs – therefor it’s a commercial loan and usury laws don’t apply. Then his strategy is to draw up a deed in lieu of foreclosure at closing. So in Pennsylvania, if a borrower were to default on a commercial loan where the deed is being held in escrow in case of foreclosure, my friend the lender can record the deed and take ownership of the property. He can also get the borrower to personally sign or cross collateralize other properties, in case of default. Best, Dave
    Jeff Rabinowitz Investor/Landlord from Farmington Hills, Michigan
    Replied about 5 years ago
    Dave, your article mirrors the way I became a lender except that I started doing it when I had acquired much fewer houses. There are risks well beyond just having to take over and completing a rehab (something I have not yet had to do). I was brought into a lawsuit by a borrower’s former lender. It was frivolous to include me but he did and I defended the suit for nearly 4 years. In the end the plaintiff withdrew so, technically, I prevailed but the properties attached had been vandalized (one was lost to back taxes) and the legal bills were significant. I’m sure this was an unusual occurrence but it was an expensive one. I have had good results with all the other projects I have been involved in as a lender and am certainly glad I started down that path.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Hey Jeff, Interesting story, we live in a litigious society and I’ve been in similar situations myself. But hey, that can be the cost of doing business sometimes. Have you considered utilizing trusts? You may be able to limit exposure to lawsuits that way. Best, Dave
    Anna Watkins Investor from Atlanta, Georgia
    Replied about 5 years ago
    Dave, your article is timely as this is exactly where I’d like to head. I have few, but enough properties to manage, want to let the dust settle on them, and all my RE is focuses on retirement income. My capital is low at the moment, so I’m working on building up $$ in a Roth IRA that I can use for lending. Keep writing!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Thanks Anna! Good idea, I think one of the best sources to lend out hard money is from a Roth IRA!
    John Thedford Hard Money Lender, Broker Associate, Investor from Naples, Florida
    Replied about 5 years ago
    I do both. I hold SFR for cash flow, appreciation, and tax advantages. I do HML inside my SOLO 401K. HML is an excellent way to make high returns with little to no work. I recommend it for anyone looking for a new form of income.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Amen to that!
    Deanna Opgenort Rental Property Investor from San Diego, CA
    Replied about 5 years ago
    My parents have started to do this (they now have two well-secured small loans out). The return rates are good (8%), but I have some concerns about liquidity due to my parent’s age. Any advice/war stories from the more experienced hard money lenders?
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied about 5 years ago
    Hi Deanna, Can you elaborate more on the duration of the loans, as well as what your concerns might be? Is this more of an estate question? If the loans are long term, they can be sold easily at any time. Although most hard money lenders don’t utilize servicers, on a long term hard money loan it could be a good idea and alleviate many common concerns. A servicer such as not only handles collections, but also specialty servicing (such as the foreclosure process). Best, Dave
    margaret smith
    Replied about 5 years ago
    Hey Deanna- I am a hard money lender, having morphed there from rehabbing. I hope your parents’ paperwork (the lending docs set) was created by a real estate attorney. The note and mortgage should have been filed with your county clerk immediately, and must be a first position, hopefully with lender’s title insurance. The paperwork will show that the deal survives the parties (lender and borrower) by reverting to their successors and assigns (would that be you?) The time has come for you to see the file and look it over yourself, as you may well be managing it for your parents, and eventually inheriting it. Make sure you have the proper estate paperwork to be able to step in instantly, as needed. Once the loan has closed, there really is no “management” to pay for, unless you get a total deadbeat borrower who doesn’t pay, at which point it is time to go back to the original closing attorney for advice. Some attorneys specialize in foreclosure, and that is always a possible outcome in the event of a huge downturn a la 2008. Bottom line- time for you to get educated in all this. You will feel so much more secure once you have a handle on this, with your parents’ help and (hopefully) appreciation!
    Tiffany Farrow Investor from Carrollton, Virginia
    Replied about 2 years ago
    We’re also interested in getting in to hard money lending, especially with our Roth IRA. Can you guys tell me what the going rates and terms are for this type of lending? I’ve read the interest rates are usually 12-18% with points. We are considering lending about $40k to a flipper and he asked for 17.5% interest for 5 months. Isn’t there also a fee or points we would charge as well and many points is usual for this amount/time frame? We wouldn’t do it without charging points or some type of ‘finance fee’ on top of the interest. Any help or advice is appreciated, thanks!