Secrets of Hard Money Lenders

Secrets of Hard Money Lenders

Obtaining a rehab loan from hard money lending as a temporary bridge loan is a favorite strategy among real estate investors who want to use leverage. Since the hard money lending industry is not highly regulated, there are many nuances in the programs offered by different hard money lenders. Of course, my experience of transacting more than $1 million in hard money lending are limited to the Central Texas market, but we are guessing that these points are applicable across the nation.

Secret #1: Interest on Rehab Draws

Not all hard money lenders’ cost structures are the same. We have discovered a key hidden cost structure that only a few would realize and not advertise. Most of the time, many investors, both newbies and seasoned pros, do not realize this until they work with different hard money lenders and discover inconsistencies among them. The funny thing is that even with the more favorable cost structures, hard money lenders do not realize their competitive advantage that their program offers. If you are not aware of this cost, it can cost you a few thousands of dollars in your real estate endeavors depending on your project size. It’s important for you to know the unadvertised charges as part of your hard money lender’s selection criteria.

The cost that we are talking about is the interest charged to pre-draw rehab funds. Assume that you buying a $50k house with a $30K rehab cost. Your total hard money in the deal is $80K. The criteria that almost all hard money lenders require is that the draws are made after the work is completed. On the day you close, your hard money lending loan is $50K, and the remaining $30K will be made in a few draw cycles as the rehab progresses. Let’s assume your rehab requires a period of 2 months with 50% (draw of $30K / 2 = $15K) with project completion during the first month and another 50% (draw of $30K / 2 = $15K) during the second month. What we found out is that there are two types of lenders that charge interest differently.

Lender A would charge interest on the total purchase + rehab amount from day 1 after closing until you get out of their financing.

Lender B would charge interest on the purchase amount on day 1 but would adjust the loan amount interest based on draw amounts. To clarify, Lender B would charge $50K+ $15K ($30k divide by 2) at the end of the first month and $50K + $30K in the second month.

If you have gone with Lender A, you would have paid interest on $30K for 2 months without even having the money work for you. If a lender charges 14% interest, that would amount to $700 in extra interest that you have paid them for a money that you have not used money during the rehab phase.

Imagine a higher interest rate, if the rehab spanned across 3-6 months, or if the rehab cost is $30K-$50K. It can be thousands of dollars.

Many hard money lenders will say that charging full interest upfront on pre-drawn money is common. It’s our job as real estate investors to be aware of this and choose the best program.

Secret #2: Hard Money Is a Risk and Relationship-Based Business, So Negotiate!

To understand this secret, one needs to understand how most hard money business is set up. The hard money is generally a pool of investor money. Believe it or not, but they use SEC guidelines to raise money using private offerings as well. Very few hard money lenders use personal funds. When their offerings are made, there are specific guaranteed returns. The guaranteed monthly interest rate goes directly to investors. So what about the origination fee?

The origination fee mostly goes to the person or company that is doing the marketing and operations. On a $100K loan, a 3% origination fee will be $3,000 upfront.

The secret is that this fee is negotiable based on your experience. After 2-3 smooth hard money lending transactions, you have a good, proven track record. You can always ask for a discount on the origination fee for the next transactions onwards. Convince the hard money lender that you have a proven track record, and since hard money is a risk and relationship-based business, they should reduce their risk tolerance in working with you. We got a reduction of 30% off an origination fee after my third or fourth transaction. If you do that for 10 houses, you can get more than $10,000 just by merely negotiating!

Secret #3: Ability to Get a Tax Deduction on Mortgage Interest

One of the biggest advantages of taking a mortgage loan is the ability for us to deduct interest from our overall income. When you do a lot of financing using hard money lenders, you will receive Form 1098 (Mortgage Interest Statement) from your lender every tax year. This deduction can be significant, as rehabbing a house can cost up to $20-$30K per house. Imagine if you do 3 houses with hard money loans of $100K each and paid 14% interest for 3 months on each. That’s a total interest payment of $10.5K for all the 3 houses. That’s a lot of free tax deduction while investing in real estate. Here is the secret: not all hard money lenders will issue Form 1098.

Even though many hard money lenders use conventional methods of raising money for their businesses, there are a few that get their funds using credit lines from community banks While the conventional lenders are able to issue Form 1098 detailing the interest, the lenders that get their funds from community banks do not issue Form 1098. I don’t know the reason; maybe one of the readers can enlighten all of us. I am just providing information so that an investors are aware of this option before choosing the hard money lender.

Secret #4: You Don’t Need Hard Money Lenders to Get Hard Money

What? Yes, you can avoid hard money lenders and get superb term deals without them. The secret is private lenders. Private lenders are individuals who have money in the form of cash or in a self-directed IRA. The best way is to ask all your friends and family if they have money that they want to lend. As usual, investors can collateralize their real estate in exchange for lending terms.

Since this is private lending, the private individuals usually do not care about an origination fee. Many private individuals are happy to receive terms such as 5-10% interest. We have tried this method, and it really works! You can find private lenders in most of the real estate investment meetups.

The legal documentation to get this setup costs approximately $400, and almost all title companies are able to prepare loan documentation with simple lender-borrower agreed terms.