How does Hard Money Lending work?

12 Replies

Your holding costs are going to be much higher with a hard money lender and the term of the loan is going to be much much shorter. Some people on here really seem to push the idea of the high-risk hard money lenders for newbies because their requirements are much more relaxed. So, that part is nice. But the risk is very high because the note is usually 12 to 18 months long. At least, that's how I feel about it. I may be way off there. But I'm very new to this. Also, it seems like there's a lot of companies out there that claim to be hard money lender that could be scamming you. Just be careful and do your research. Don't ever hesitate to ask people on here if they have to use a certain company you're looking at.

@Demeko Morgan The provided link earlier is a great resource. I work for a "hard money" lender but we really position ourselves of more of a bridge between traditional hard money and crowd funding. I know in a previous post the words "high risk" were used but the risk are really  the same as a traditional mortgage just a way shorter time line as previously mentioned (with my company anyways).

I wouldn't recommend hard money for a first time flipper (just personal opinion) even though the speed and ease of the transaction may be appealing, too many things can go wrong on your first 1-3 flips that you really haven't encountered yet that could slow your liquidity event and cause defaults or costly extensions. My view is hard money lenders are great resources to have in your back pocket to help scale your real estate business when you get into that position that you want to take on more deals but either your private network is tapped out or you want to move your personal money into another long term investment vehicle. Now of course there are many different strategies and opinions out there. 

To answer your question on it works. You submit your project application ( we lend based on project merit ) once its reviewed and meets the criteria we issue a term sheet for your review ( rate and term of loan ) once that is accepted then we require the initial upfront cost of the appraisal, etc... Once that comes back then it is like a standard mortgage were there title work is done and the closing is scheduled. 

This is our process in a nut shell but this can vary widely depending on what lender you use. Hope this helps you some. 

@Ryan Stout I like how you worded it better. High risk wasn't the correct wording, but I was just thinking of the high holding costs along with the much shorter term for someone that is brand new to REI. For someone with no experience (myself included) it feels like it is "riskier", even though the loan itself is not any higher in risk in general. Hope that makes sense. Thanks for your input! It helped me out too.

@Ryan Stout

I usually recommend the opposite of what you're saying.  One of my biggest regrets when I started out in flipping was not partnering up with someone that had more experience.  It would have helped me avoid a lot of the painful lessons I had to learn myself.

I see hard money lenders as my partners. They check out the area, they confirm my ARV, they vet my contractors, they ensure that everything looks good with title, that I have the proper insurance in place, etc. I have had hard money lenders make suggestions to the kind of rehab I should do: "I think you might be over-rehabbing in your area; I don't think you should do hardwood there." And if my hard money lender won't lend on the deal, I'd probably reconsider whether it is a deal.

@Nghi Le that's great you found a good partner in your lender. I think maybe there was some misinterpretation to my statement. I believe everyone when starting out should have a great partner to lean on. Some of what you describe is the lenders due diligence and underwriting. We have lots of data to pull from so confirming ARV, rehab budgets, looking at contractors and the etc... help protect our position in the deal (all lenders do this, well at least the ones I have worked for) and are derived from the portfolio of projects that lender has done. This shouldn't be substituted for a mentor/partner.

I was referring to more so delays with permitting, construction delays, and generally the unforeseen that no lender can help with can become costly due to cost of funds as @Brian H. noted. So learning how to navigate the deal and building a winning team of professionals around you ( a good lender as you pointed out is a valued member of any great team) are key before using short term high cost funds in my opinion, by doing this it leads to shorter flip times and more money in the investors pocket, not that he or she shouldn't seek a experienced partner. I am lender so I don't ever want to advise anyone not to take my money, ha.

Just my personal experience.

@Ryan Stout

I guess I was focusing more on the acquisition side.  They say you make your money when you buy, and a hard money lender helps to make sure you buy correctly due to their underwriting process and criteria.  They're an extra set of eyes on the deal.  Helps you to not be in the hole from day 1, which is what I've seen happen to a lot of investors who use their own cash.  I honestly believe that whether you use hard money to finance the project or not, you should still account for hard money; that's what ensures you have enough margin and to stay conservative.

Now what happens during the project... that sometimes can't be fully prevented, even with a partner.  But I do agree that partnering or receiving mentorship from an experienced flipper is the best way to start.

This is from my experience from as both a borrower and a lender.

My biggest issue when I was looking at hard money lenders was trying to figure out which ones didn't seem out to get me. Just in lending in general, there so many bogus companies that are out to screw people. Here we're talking about lots of money and a property that they have first right to. Established conventional money lenders just feel safer even if they're not allowing me to grow as quickly.

That being said, I want to grow quickly so I'm not sure the best route to go to really figure out which hard money lenders stand out as the best. I see the two of you both weren't for hard money lender so I know you're probably partial to your company's but it would be great to have sort of a response from some people with experience as to some other hard money lenders that really stood out as a great option.

I would really love to find some as you were discussing that seemed almost as much of a partner as they do a lender in the process.

Probably the toughest thing for a new investor to cope with regarding hard money is the holding/financing costs. 

We all know that deals are hard to find. That being said, most hard money lenders are going to charge you 3-4 points up front, plus processing/appraisal/underwriting fees (let's say $1k for these since it's a nice round number), plus about 12% interest only. This cuts into the profits considerably, and the pickings are slim to begin with.

So, let's analyze a potential deal with and without hard money. Let's says it's a $100k purchase, $30k rehab, and $165k ARV, it takes you six months, and you put $20k down on the financed purchase:

Without hard money:

$165k ARV

minus $100k purchase

minus $30k rehab

minus $15k closing/holding costs and commissions

= $20k profit 

With hard money:

$165k ARV

minus $100k purchase

minus $30k rehab

minus $15k closing/holding costs and commissions

minus $4k (4 points on the loan)

minus $1k lender fees

minus $4800 (1% per month ($800) interest only payments on $80k loan amount, for six months)

= $10,200 profit 

And your financing costs increase by about $26/day in interest ($800/30) for every extra day you hold the house. So what happens if you finish the flip, then the buyer's home inspections reveal a bad sewer line (or some other big surprise), which costs $8k and takes 60 days?

Let me clarify - I am not opposed to hard money. I use it all the time (even in the scenario above, an $10k profit is way better than doing nothing!). But inexperienced investors need to understand what they're getting into and need to have a financial cushion to absorb the carrying costs and inevitable surprises. When you do, hard money is a great way to scale up.

Usually when people ask how does hard money work?, it's because they don't have any money themselves - and that can be a disastrous combination.

I agree with @Ryan Stout that the loan itself is no riskier than any other mortgage loan (in fact, that's exactly what it is, a mortgage with high interest and a short term). The risk lies in the rehab, the financing costs, and the time it takes you to flip the house and get it sold.