Recently, I was having a discussion with someone who was pretty adamant that hard money rates were too high. He even felt that hard money interest rates were the reason that some investor projects failed. Several years ago, there was a time and place where I probably had similar feelings about hard money, and I did everything in my power to avoid using hard money or private money. Instead, I would more or less try to self-fund. I mean, why is hard money so hard, right?
In hindsight, I realize that I was just looking at things like interest rates and some of the hard money terms, but I’m not so sure I was looking at the potential lost opportunity cost. By that, I mean that I could have built wealth and grown my portfolio faster if I had only used more hard money sooner.
Why Hard Money Exists
So, what exactly is hard money, and why does it exist? Not sure I know where the term “hard money” came from, but it’s money that is lent to someone looking to purchase a renovated property that traditional bank financing normally won’t fund. Typically, it’s a short-term rehab loan that’s backed by the property more so than the borrower.
The other day, I was speaking with a young man who had gone through my recovery house a few years back, but he was doing much better in his job and side business, and he wanted to try to buy his first property. He was thinking about buying a bank owned — or in other words, a real estate owned (REO) — property. I had to explain to him that these were often sold for cash “as is” and that traditional banks won’t normally lend on them, unless you’re in the commercial real estate development business with a track record. I also told him that although banks won’t typically lend on a deal like this to newbie real estate investor, a hard money guy might.
When I first heard of hard money (and its usual terms), I wasn’t all that crazy about it. Today, after doing private money for the last 15 years to rehabbers I know (private money is very similar to hard money, just with easier terms), I realize that every one of these terms is there for a reason. First of all, hard money interest rates are based on what the market is paying and are oftentimes negotiable. They’re usually short-term. They have penalties built in (for a reason). If you go over the timeframe, there could be more points involved (a point is 1% of the loan amount) due to the additional risk and tie up of capital.
Some require pre-payment penalties for paying the loan off too soon. Otherwise, the hard money person wouldn’t make any money for all the hassle of setting up financing for the deal.
Fees and terms can also be based on the track record and experience of the borrower. A really good clue to whether you’ve found a good deal or not is if a hard money lender will lend on your project. If they won’t, you usually don’t have a deal.
Many of them want you to have skin in the game, and oftentimes they will only lend up to 65% of the after repair value (ARV). Some even require money in escrow until the project is completed.
Of course, they want a note, a mortgage, usually a deed in lieu of foreclosure, and sometimes a confession of judgment, as well as title insurance and to be named insured on the homeowner’s insurance policy. The good news for the newbie borrower is that hard money lenders usually have expertise in the space and that they can stand to learn a lot from the hard money lender.
Part of a Deal is Better Than No Deal
About two weeks ago, I funded a private money deal for a buddy of mine, and the numbers were pretty good on it. His purchase price was $35K and repairs were approximately $45K, which includes three $15K draws (a draw is an amount of the loan disbursed usually after a portion of the work is completed), and it’s worth approximately $130K after it’s fully renovated and rented.
Does my borrower have the money to take down and renovate this deal on his own? The answer is probably not since my buddy is doing several deals at once. This is a deal he plans to keep, and I don’t blame him — it’s in a nice part of town with good rents.
For me, a tired landlord, it’s a good, safe deal with a high yield. For my buddy, after refinancing through B2R Finance and getting all the capital back to pay me off for acquisition, rehab costs, and closing costs (0% out-of-pocket), it’s an infinite rate of return.
So, after all, what’s so hard about that?
Making Money on the Draw
I’ve probably mentioned this before in previous articles, but I never really understood hard money until one day I was having lunch with a buddy who had well over 100 properties and was more experienced than me in this area. He was telling me how he had bought his first 39 properties with hard money, and that’s what really jumpstarted his business and enabled him to eventually leave his day job.
I remember asking him what would possess him to do so many hard money deals. He said that it just became easier over time. He and the lender got into a rhythm, and they trusted each other. The terms became more favorable. Most importantly, he began to make money on the draw.
Related: 4 Ways to Use Hard Money & Private Financing for Your Rental Business
Looking back, this was really an “ah-ha” moment. When I asked my buddy what he meant, he explained, “Well, if the next draw was $10K (for the next block of rehab work to be completed) and I got the work done for $6K, I’d get to put the $4K in my pocket tax-free since it was a loan. Then, the bank would refinance me (after I put the tenant in the property) with a more normal term loan since it’s fully renovated and rented now, and that would give me the money to take out the hard money lender.”
Now everything began to make more sense, and I started to realize how much time and money I wasted not using more hard money.
Today, as a private money lender and owner of many notes, I think I’ve gotten over it. But as a note guy, I’ve always had a special respect and place in my heart for the successful real estate investor turned hard money lender — because after all, they’re giving back (and making money, too) by helping other real estate investors do deals. They also help society by turning around blighted properties and neighborhoods.
So, let me ask you, when are you going to use hard money, or private money, to do more deals? Will that lead you to one day becoming a hard money lender yourself?
Let me know your thoughts with a comment!