What is Hard Money?
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What is Hard Money?
This is a source of ongoing debate throughout the real estate investment community. What is hard money financing and why isn't what real estate investors expect it to be? The source of all of the confusion is a lack of understanding of what hard money lending really is.
In a nutshell, hard money lending is equity based lending. This means that the lending decision is based mostly or entirely on the amount of equity within a particular piece of property. The lender is
taking their risk on the ability to sell the property at a discount price and still make back the money that was loaned on it, should foreclosing on the property becomes necessary. Hard money is designed as a last resort financing for borrowers with severe credit issues that even sub prime lending can't help. This includes borrowers with sub 500 credit scores, facing foreclosure, trying to avoid foreclosure, etc.
What hard money is not designed for is investment properties and investment property rehabs. While some hard money lenders will provide investor rehab products, they will typically require minimal credit
scores, no foreclosure history, an appraisal, a property inspection, etc. Any one of a number of different requirements that are designed to protect the lender from a very risky transaction. As a matter of fact, 7 or 8 out of every 10 hard money lenders won't even touch investment property deals, simply because they are considered to be much too risky.
So what about the lenders that offer investors loans with no credit check, no appraisal, and LTV's between 70% and 80%? Almost without exception, you will find that these programs are limited to
local, private lenders. These are usually investor wholesalers who have several lines of credit available that they can lend against. Private lenders will only cover a small geographic area and are more inclined to do business with minimal paperwork (I've even known a couple of private lenders that would do business on a hand shake and nothing more.) These types of lenders protect themselves by getting to personally know the borrower and the project they are working on, hence why they usually only work a very small geographic area. For private lenders, the prospect of foreclosing on a property is a win-win situation, because all they are doing is adding another property to their wholesale
inventory. They have very little risk of losing the property once they gain it through foreclosure because that was lent out against the property is secured by different collateral.
So why can't the hard money lenders provide the same programs as the private lenders. The answer to this boils down to risk management. All lenders (hard money, private, or conventional) will protect
themselves in some way. Conventional lenders will have strict guide lines based solely on a borrower's personal credit. Hard money will base their lending decisions or a mix of property equity and borrower's credit. Private lenders cover a small enough geographic area that they can become personal involved in the individual borrower's projects. Many of them will also based their decisions based upon whether or not a particular deal is something they would be themselves, because they
know that they may very well get stuck with it. Most hard money cover very large geographic areas, including multiple and some are even nation wide. They simply cannot be involved in every deal to the level that a private lender can, so the compensate for the increased risk, they offer lower LTV's and require credit checks, appraisals, etc.
So the next time you want to find some rehab financing, consider looking into your local private lender community. They are a great way to leverage your purchasing power. Just remember that these lenders provide for very short term financing, so plan your exit strategy accordingly. And if you plan to hold your newly rehabbed investment for a rental, remember that you will need to plan for the conventional financing. This means keeping track of your cancelled mortgage payment checks (as private lenders almost never report to the credit bureaus) and keeping track of your contractor invoices and repair receipts (to document the work completed to the property). I recommend having
an appraiser do a "subject-to" appraisal of the property before buying it (even if your private lender doesn't require it). There are a couple of reasons for doing this. First, it gives you a very good indicator of what the FMV of the property is (instead of you and the lender just guessing at the comps) and second it gives you a good comparison tool for the appraisal that the conventional lender will have done when you refinance. "That's $800 out my pocket", you say. Well which situation would you rather deal with, $800 out of pocket (average $400 x 2 appraisals) or being short several thousand dollars because you misread the comps when you bought the property?