Hard Money Lenders - Why do you not use them to leverage your deals?

28 Replies

Hi All,

I have found the vast majority of Real Estate Investors do not use a Hard Money Loan as a source of funding their deals simply due to the fact that they do not know enough about the process. In the RE Investment industry, it can be very difficult to qualify for a conventional loan, especially in the flipping business. Given the competitive nature of the business, leveraging your deals and increasing ROI seems like a great way to strengthen your offers. So, my question is, what is the main reason you do not consider private or hard money loans as a viable option? 

Thank you all!

Ben

@Ben Stoodley I would be more inclined to use HML if the points and fees weren't so ridiculous with most. The high interest rates aren't a deterrent to me, but I would need to be pretty desperate to pay over 2-3 points if I was also paying double digit interest rates.

David Begley, Real Estate Agent in GA (#357208)

We work some hard money lenders who charge typical rates for the area and they are easy to work with.

As @David Begley and @James Wise point out though the cost of $$ associated with HML's can be the one thing that turns people away.

For us at this point in our business we need the HML in order to even be in the game and make somewhat competitive offers.

I am sure we lose out on some properties we offer on because quite simply they can pay all cash and the cost of our $$ alone (interest plus points) runs between 10 and 12k in the price range we buy in.

Michael Noto, Real Estate Agent in CT (#RES.0799665)
860-384-7570

Margins on flips have become very tight and are getting tighter. Too tight to sustain a HML situation that comes in at up to and sometimes over 50% of the profit on the deal.

For example, my rule of thumb on a hard money loan is the minimum cost will be 10% of the retail value of the end product. So, on a property closing at $250k, the cost of funding via HML will be at least $25k before anyone else gets a dime. That is expensive money! 

Plus there's also the personal guarantee you have to give to most HMLs, so if your deal goes sideways in any way, there is huge exposure.

So in summary, the deal has to be really sweet before you can afford hard money. Hope this helps!

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Hey all - I REALLY appreciate all your comments. Definitely seems like you all are in agreement with eachother on the cost being the main deterrent. It is expensive. No doubt. However, when you don't have another option, demand is high, HML can charge more. Yes, it breaks into your margins. On the flip side, you put out LESS money, so your CASH on CASH ROI has increased. Therefore, yes, you may only make $15k on a flip versus $23k (or something, just an example), however you are only spending money on the 20-30% down payment and interest (and points). The total you spend on the project is way less, ratio wise, your ROI has increased. This will allow you to do MORE VOLUME at once. In a 12 month period, you may now be able to flip 25 homes compared to 12. So overall, your total income has certainly increased in a 12 month period for example.

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I do private money on all my flips. 2pts, 12%. glad to pay that when I get 100% funding (up to 70% LTV) and no payments until they close.

I know my lenders well, though. I used to get the same deal without the points back in the day. Lenders are a little more tight these days, that or I don't have the same contacts. I just offer the 2 & 12 when I pitch it, it fits my business model and keeps them happy.

The institutional guys around here are off their rocker. Most are 5 pts, 15% up to 65%, with 20% down and monthly payments, AND they have the balls to ask for a credit app. Pretty hard to do any volume with those terms, plus, like has been said the deals are too thin to allow i8t these days. With that said, I'm not nearly as sensitive to the cost of money as I am on terms. Ill do some out of cash if I've got it laying around (doing one now), but usually I have none of my money in my deals unless it goes over budget or something.

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Hard money loans are a tool to leverage and grow your business. Most investors lack a good HML partner... meaning not just some broker selling you a loan, but someone thats actually dedicated to your success because they understand that as you grow so will they. I think the lack of true relationship between investor and lender soil any deal, just like the investor hiring a bad sub contractor.

@Darrell Shepherd  @Ben Stoodley I could not agree with Darrell more and coincidentally the terms he mentioned - 2pts and 12%, all paid at closing, is where my private money lender lends to me. As I mentioned earlier, I would probably pay a little higher interest rate but absolutely will not pay the ridiculous 4 to 6 pts and even higher some HML charge, and then expect you to complete a credit application, furnish income, have min credit score, etc., as if you'd walked into SunTrust. That's okay though, they'll be back in their previous line of work once the regulatory environment softens some and banks ease up on their current ultra strict underwriting standards. Those HMLs that are now ripping their customers a new one do not have a business model aimed at repeat business and when credit eases, and it will, they'll find themselves having to drop their points and interest rates to compete and then will scratch their heads because their phones aren't ringing even though they are now competitive. I also expect the pressure to decrease the points especially, if not the interest rates, will increase as debt crowdfunding becomes more popular.

David Begley, Real Estate Agent in GA (#357208)

All makes sense. Glad to know our terms and rates are in what you all consider to be acceptable. Also very happy to see @Jeffrey Reyes  and @Darrell Shepherd  said about the relationship part. That is HUGE when it comes to reducing points and rates. 

Many investors just don't know how it works, most of them are new. So, I was just wondering. All your feedback is appreciated. Thanks again.

@Ben Stoodley It does appear that your rates and terms are what I'd consider acceptable, if your points/loan origination fees are likewise reasonable. So, the big question,what is the maximum points/fees charged for a 6-month loan with a 65% LTV? It's always a big red flag to me when one advertises most all terms, but glaringly omits the one or two key terms that may keep a potential borrower from picking up the phone. So, as Paul Harvey would say, what's the rest of the story? (and do you lend in Georgia?)

David Begley, Real Estate Agent in GA (#357208)

Hi @David Begley  . For 6 months 2-2.5 points max depending on the type of deal. Not sure how much I can talk about without "promoting" my business and having my post edited or deleted. Feel free to email me and I can provide you with more info. But, unfortunately we do not lend in Georgia haha, thanks for the interest though!

It's good to see the competitiveness of our rates/terms. More importantly, my goal is to educate borrower's on how to use Hard or Private Money Loans in the correct way to maximize returns. No doubt it's expensive, but it's better to pay a little bit and make and still make good money than to not have a deal at all. 

As an active investor, I have about 5 available source of funds at any one time.  Each source has its own cost and fees that impact the net profit on my deals.  It only makes sense to use the lowest available cost of funds to do a deal.  When I have multiple concurrent deals going on, I keep moving down the list until I run out of options.  So far, I have never had that problem.  Hard Money would not make my top 5 list of available funds because margins can be thin and every dollar I save in holding cost goes directly into my pocket.

My take:

HMLs will often talk about how, by use hard money, investors can scale their business from one or two deals per year to 20-30 deals per year.  In fact, the OP makes that same argument earlier in this post.

The issue with that reasoning is that any investor who has the experience, skill and motivation to do 20-30 deals per year likely has sources of money that are cheaper than hard money.  Personally, I borrow money at 10-12%, so there's no reason to spend 3-5 points and 12-16% that most hard money lenders charge; most other serious/experienced investors I know feel the same way.

Now, for newer investors, hard money might be a good alternative. The issue is that HMLs know that new investors are big risks, so the terms tend to be very skewed in the favor of the HML -- from the LTV to the rates to the conditions and due diligence process.

If more HMLs were willing to underwrite experienced investors and provide loans at rates more commensurate with private money, I think HMLs would find that they could ultimately make more profit with less risk.  But, that involves flexibility and creativity on the part of HMLs, two things we don't tend to see...

Too expensive. 

Regarding @J Scott  comment "If more HMLs were willing to underwrite experienced investors and provide loans at rates more commensurate with private money, I think HMLs would find that they could ultimately make more profit with less risk. But, that involves flexibility and creativity on the part of HMLs, two things we don't tend to see..." Indeed. As a PML via SDIRA I stick to local seasoned investors with good track records and low LTV (and/or Loan To Purchase)  deals. Why the HML don't figure it out is a mystery to me. From what I can tell, HML is virtually non-existent where I am. PML is small, but tangible, in my market.

Originally posted by @J Scott:

If more HMLs were willing to underwrite experienced investors and provide loans at rates more commensurate with private money, I think HMLs would find that they could ultimately make more profit with less risk.  But, that involves flexibility and creativity on the part of HMLs, two things we don't tend to see...

 I usually agree with everything you say, but I'm going to have to disagree here.  To my knowledge, most HMLs have investors whose funds they loan out.  They make their money on the points and pass on most/all of the interest to the investor.  Lowering their rates would mean investors would have to settle for less yield.  Not necessarily a problem, but lowering the points will cut directly into the HMLs profits.  Is it worth their time/effort to earn 1-2 points?  I'd guess no...

Originally posted by @Bryce Y.:
Is it worth their time/effort to earn 1-2 points?  I'd guess no...

 The situation we're talking about is loaning to experienced investors.  If you loan to a new investor, you might get one or two deals out of that person ever -- in which case you're working hard for the points and 1-2 points probably isn't worth it.  

But, if you loan to an experienced investor, you may make 20 loans per year to that investor. For example, if I were to borrow all my money from an HML, I'd probably borrow $2M per year.

Is it worth 1-2 points on $2M per year for most HML middlemen? If I were them having to deal with someone like me, I would think so...

Originally posted by @J Scott:
Originally posted by @Bryce Y.:
Is it worth their time/effort to earn 1-2 points?  I'd guess no...

 The situation we're talking about is loaning to experienced investors.  If you loan to a new investor, you might get one or two deals out of that person ever -- in which case you're working hard for the points and 1-2 points probably isn't worth it.  

But, if you loan to an experienced investor, you may make 20 loans per year to that investor. For example, if I were to borrow all my money from an HML, I'd probably borrow $2M per year.

Is it worth 1-2 points on $2M per year for most HML middlemen? If I were them having to deal with someone like me, I would think so...

Yes, perhaps I misspoke a bit. What you described goes on a lot more than you think, it's just not advertised. I work for a HML and I've seen this happen. Negotiating a lower rate and points is possible if you bring a proven track record (with them) plus volume. I just don't think it's reasonable to expect this right off the bat. If going rates are 4/14%, and you get them down to 2/12% for example, the question then becomes can you find cheaper money? I think most successful investors (like yourself) probably could.

So if a HML is generally too expensive (and from what I've found most won't do high enough LTV for a newer investor with limited funds) then where do you go to get cheaper money? Peer-to-peer type relationships? Or get equity partners? I am trying to put together a flip in CA now and an LTV of even 90% leaves me needing a lot of cash to do the whole deal. Once I have the 'where's the money coming from' part answered for me I'm off to the races and I can find many deals! But I've been a Realtor in CA for years and haven't found an HML that will do what I need to make any deals feasible. Just getting into my local REIA's to try to get an answer there.

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