The Ultimate Guide to Hard Money Loans
Hard money loans may not be difficult to get, but they can be expensive. Despite the cost, they're an absolutely essential tool for investors. Knowing when to use hard money and how to get it is critical.
Here’s everything you need to know about using hard money loans for real estate.
What is a Hard Money Loan?
Investopedia refers to hard money as a "loan of ‘last resort' or a short-term bridge loan" that is "primarily used in real estate transactions." While hard money loans do tend to be short-term, "last resort" is a bit of a stretch. Many investors use hard money as an integral part of their financing strategy—particularly those who need loans to fix and flip.
In a previous post on BiggerPockets, investor and flipper Mike LaCava notes, “The word ‘hard’ just means asset. So when you borrow money from the hard money lender, he secures his interest with collateral, which is the ‘hard' asset—in our case, it would be the real estate."
How a Hard Money Loan Differs from Traditional Banks
A hard money lender, as opposed to a traditional lender, is much more interested in the asset than the borrower borrowing against that asset. And thus, as you might expect, hard money loans are usually quite a bit more expensive than a standard bank loan.
Investopedia goes on to say that “the increased expense is a tradeoff for faster access to capital, a less stringent approval process, and potential flexibility in the repayment schedule.”
Banks normally have very strict and arduous criteria for conventional mortgages, especially mortgages on an investment property. This is particularly true once you’ve acquired over 10 properties in your name and are no longer eligible for a Fannie Mae-backed loan.
When it comes to owner-occupied properties, the type of loan that banks are interested in are of the cookie-cutter variety. Most real estate investors don’t make their money with cookie-cutter properties though, so hard money can be extremely useful.
While most hard money is lent out for investment property and residential property, hard money lenders can do loans on multifamily apartments, commercial office buildings, industrial property, and retail—and even on things that aren't a real estate investment, such as equipment purchases.
Hard Money vs. Private Money
At first glance, hard money loans and private money loans appear to be the same, but they are quite different. Hard money lenders are effectively brokers for short-term loans, mostly on real estate.
Private lenders, on the other hand, can be just about anyone who has money. A private loan is relationship-based; the lender could be a private company or even a friend or family member.
My company generally places private loans on properties when we purchase them. Then, after we have rehabbed and rented out the property, we take it to a bank and refinance into a long-term loan. In our opinion, this is one of the best ways to finance buy and hold real estate.
Still, we have used private loans for flips, as well. Generally, with these types of loans, we pay 8 to 9 percent interest-only with zero to one point (a point equals one percent of a loan’s value) and provide a first-position mortgage or deed of trust on the property. This is substantially cheaper than the normal hard money loan, but those terms will depend on what you can negotiate with a private lender.
That being said, private lenders don’t grow on trees. It takes time and energy to find them and earn their trust. If you don’t have a track record, it will be difficult to convince anyone other than friends and family to loan to you.
So, if you have a private lender, that’s great. If you don’t, then hard money is a very good alternative.
Standard Terms of Hard Money Loans
As I noted above, the standard terms for hard money loans are expensive. But since these are short-term loans, they can still be absorbed with room for a healthy profit. While each hard money lender is different, normal loan terms look something like this:
- Loan to Value/Loan to Cost: 65-85 percent
- Lend on Rehab Costs: Yes
- Interest Rate: 12-16 percent
- Points: 2-6
Other Fees (will vary by lender):
- Appraisal/Brokers Price Opinion
- Title Fees
- Application Fee
- Document Processing Fees
- Term: 6 months to 1 year
- Prepayment Penalty: Usually none
For example, Taryn Kendrick, president and co-owner of Kansas City-based Worcester Financial (who helped me put this article together), notes that while they do not charge an application fee or document processing fees, many lenders do. BPOs usually range from $150 to $250, and an appraisal can range from $400 to $650 (or substantially more if it’s a multifamily or commercial property).
The loan amount ranges widely from lender to lender. Indeed, while Worcester Financial goes up to 75 percent of the loan to value (LTV) or loan to cost (LTC), they are willing to loan up to 65 percent of the after repair value (ARV) if that value is higher.
This means that on rare occasions they have financed 100 percent of the cost of the property. This only happens for particularly good deals, however. Don’t go into a deal expecting this.
And to reiterate, what each hard money lender is willing to do is different. Some, for instance, may be willing to use other assets (say, another property) to “cross-collateralize” a loan. This type of flexibility is another advantage of hard money lenders.
Other hard money lenders may max out at 65 percent LTV, while some will go up to 85 percent. Remember to get clarification on whether a lender is referring to the LTV (what the property is worth) or the LTC (how much money you will be putting into the property).
Regardless, you will almost always need to find a way to raise the down payment. Potential sources include savings, a partnership, or a personal loan from friends or family. In certain cases with some lenders, as mentioned, another free and clear property can be cross-collateralized.
The bottom line is hard money lenders are generally more flexible than banks, and applicants have a better chance of negotiating adjustments to the terms or repayment schedule with a hard money lender than they would with a bank.
Example: Hard Money Loan by the Numbers
Despite its costs, a real estate investment will still usually work with a hard money lender if you use the popular 70 percent rule. The rule refers to the maximum an investor can pay for a property in order to make a profit.
The formula for calculating the 70 percent rule is:
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(ARV x 0.7) – Rehab
So, let’s say you had a deal with the following numbers:
- ARV: $200,000
- Repairs: $40,000
- Time to Rehab and Sell: 6 months
- Loan: $105,000 (75% of $140,000)
- Points: 5
- Interest Rate: 12%
- 70% Rule Value: $100,000 ([$200,000 x 0.7] – $40,000 = $100,000)
If you factored the costs of the hard money loan in, your analysis would look something like this:
Now, this isn't exact. The cost of the appraisal, document processing fees, and closing costs are approximate. And, of course, you would have to find a way to raise the down payment (in this case $35,000).
But still, a $32,750 profit is nothing to sneeze at. And while it’s less common, the same kind of approach can be taken for holds.
How to Get Approved for a Hard Money Loan
The best part of getting a hard money loan is that it is much simpler than getting a standard real estate loan from a bank. Banks can ask for an almost endless series of documents and can take several weeks to months to actually get a loan to committee. Most hard money lenders can close a loan in only five to 10 business days.
It is generally best to start building relationships with hard money lenders before you start making offers. This increases the likelihood of getting a deal done, as much of the groundwork has been laid before you need the money (ASAP!).
Many hard money lenders will also provide a conditional approval letter, which acts in a similar way to a bank's pre-approval letter and which many sellers require to sign on the dotted line.
Hard money lenders still have a loan application form to fill out. They also generally still request two years of tax returns and two months’ worth of bank statements, as well as a schedule of your real estate owned, a copy of your driver’s license, and other such things. They look at your credit score, too.
That being said, there isn’t nearly as much paperwork or detail as a traditional loan. The main purpose with these things is to make sure the borrower has an exit strategy and isn’t in financial ruins. But many hard money lenders will work with people who don’t have great credit.
According to Taryn, "We will work with individuals who have had past credit issues, especially if it was due to something like a foreclosure during the market crisis between 2007-2009. We just want to make sure that the borrowers are working to resolve those credit issues and it's not a never-ending problem."
The most important thing hard money lenders will look at is the property itself. Hard money lenders will request a Broker’s Price Opinion (BPO) or appraisal to assess the property’s current as-is value or to determine the ARV.
They will also evaluate the borrower’s scope of work and budget to make sure it’s realistic. Sometimes, they will stop the process at this point because either they believe the property is too far gone or the rehab budget is unrealistic.
Finally, they will evaluate the BPO or appraisal and evaluate the sales comps and/or rental comps to make sure they agree with the evaluation.
So, it’s not as simple as filling out a form and pulling out money. But still, there is another advantage built in to this process: you get a second set of eyes on your deal, and one that is materially invested in the outcome of the project at that!
If a deal is bad, you can be fairly confident that a hard money lender won't touch it. However, you should never use that as an excuse to forego your own due diligence.
It’s also important to note that there is the occasional bad apple amongst the hard money lenders out there (just like every other industry), which we will discuss how to avoid below.
Related: The Ultimate Guide to Due Diligence
Hard Money Loan Closing and Exit Process
A hard money loan closes in the same way a bank loan would; in fact, most of the process works similarly.
When doing rehabs, most hard money lenders will generally escrow the construction loan and release it in draws. Once the project has been completed up to a certain point (one that’s agreed upon beforehand), the borrower can request a disbursement.
The hard money lender will require that the borrower submit invoices and sometimes pictures, as well. They will often send out a third party to inspect the project’s progress, too. But disbursals tend to come quickly after that, often within 24 to 48 business hours.
Hard money loans are usually short term, so the exit process is always critical. Taryn actually recommends conventional lenders for those who are looking to hold the property. This is because hard money lenders don’t want you to exceed your loan term, even though if you do, you’ll surely be charged a fee.
Should You Use Hard Money Loans for Real Estate?
Given that hard money lenders are more expensive than banks, if you can get a bank loan up front, it makes more sense to go that route. Traditional purchases or properties that don’t need much rehab are not the best candidates for hard money loans.
On the other hand, properties that you intend to flip or that need a substantial rehab are good candidates. This is particularly true if you have some hiccups on your credit report or don’t have a W-2 income.
Banks are obsessed with W-2 income. While many will lend to full-time real estate investors, many will not—at least not to anyone without a long, proven track record, which newer investors obviously don’t have yet.
Top 5 Advantages of Hard Money
Some of the biggest perks of using hard money loans include:
- They’re quick.
- The loan review isn’t as arduous as with banks.
- Borrower(s) who can’t get a conventional loan often qualify.
- Properties that need too much work for a bank to be interested often qualify.
- They’re available if a traditional loan falls through while the property is under contract.
The biggest disadvantage is obviously the cost. If what you’re looking for doesn’t fall into one of the scenarios mentioned above, it’s probably best to look elsewhere.
What Hard Money Lenders Look For
Hard money lenders are most interested in the property, but they also need to evaluate you as a borrower. Therefore, it’s still critical to have your accounting in order.
They also want to know if you’re capable of doing the deal, so I would recommend setting up a lunch with them or something similar, the same way you would with a bank. You want to build rapport and establish trust with them, just as you would with a banker.
But, of course, the most important thing is to have a good deal. Hard money lenders are asset lenders after all, so a good deal is the most important thing they will be looking at. Conveniently, it’s the most important thing a real estate investor should be looking at, as well!
What to Look for in a Hard Money Lender
As with any business, you have to be careful regarding hard money lenders.
“Sure there are some hard money lenders who are predators and want to see you fail so they can take advantage of you. I’ve met a few, so I know they’re out there,” Mike wrote in his previously-mentioned article. “But those guys are way in the minority.”
Indeed, I’ve seen one or two unscrupulous hard money lenders myself. And while they definitely are the minority, you want to avoid them like the plague.
I know many more top-quality hard money lenders and have worked with several in the past. The key thing is to vet them in the same way you would any other key member of your team. (They will certainly be vetting you.)
The best place to look for hard money lenders is in the BiggerPockets Hard Money Lender Directory or at your local Real Estate Investor’s Association. Remember, if they’ve done right by another investor, they are likely to do right by you.
Don’t be afraid to ask for referrals either. Good lenders won’t have a problem providing them.
Hard money is an expensive but flexible way to acquire properties. And while it’s usually best for flips, it can be used for holds, as well.
Real estate investor and entrepreneur Jamie Turner, for example, wrote a great article for BiggerPockets, discussing how he was able to acquire a highly profitable 33-unit deal (where only 14 units were occupied) with the help of a hard money lender. Because of the low occupancy, banks wouldn’t touch it. Hard money made that great deal possible.
My company has acquired profitable deals with hard money, too, and there are many such stories out there. Therefore, if you run your numbers carefully, hard money is a great tool to add to your real estate investing arsenal.
Special thanks to Taryn Kendrick with Worcester Financial for helping me put this guide together.
Why are you considering using hard money? Have you heard any other hard money loan success stories?
Leave a comment below.