How Hard Money Loans work in detail

9 Replies

Hello BP!

Can someone please explain to me IN DETAIL how Hard Money loans work? I understand that they look at the ARV of a property and then lend you x% of that (usually 70%), but what are the actual steps of getting the loan? Once you get the loan, do they just give you a stack of cash and then you just buy the property using the cash? Do they send the money directly to the listing company and then there's no mortgage on the property but you just have a private loan to repay? Do you just get a mortgage with the HM lender? I'm looking for a really detailed response so I can fully understand this option.

Thanks in advance.

Every hard money lender is different. But this is how mine works. I send them the details of the property including ARV, projected repair costs, details of the repairs being undertaken, how I will be funding the reparis & any comps I am using to determine value. Mine will not fund over 70%. They let me know if they will loan on it. I put the property in escrow. They fund the deal through the title company just like a conventional loan. I make my payments to them. I have to pay taxes & insurance separately. The house is collateral on the loan. It is a lot like getting a conventional loan except for the qualifications are different.

The funding is done just like any other mortgage. The lender sends the money to the title company the day before or day of the closing. If there is a rehab budget in the loan most HMLS hold back most or all of that rehab budget. The HUD-1 settlement statement will show the loan going to you, then the rehab money going back to the lender to hold in escrow until you do the work and get it inspected. Some will give you an increment of the rehab budget at closing.

Yes, the HML will have a mortgage or deed of trust from you giving them security interest in the property. If you default, they will take your property.

The title company will prepare the HUD-1 and let you know how much cash you need to bring to closing. Typically that's in the form of a cashier's check you bring to closing.

When you make your offer you make it as "financed" and include a pre-aproval letter from the HML.

HMLs will typically do an appraisal, at your expense, to verify the value. 

Some HMLs will lend a fixed percentage based on ARV. Some also impose a specific down payment requirement. Say your purchase price is $50K and your rehab budget $20K and ARV is $100K. If a HML will lend 70% of ARV with no minimum down, they would lend you $70K. If the HML says you must put in 20% of rehab plus 20% of purchase, up to 70% of ARV, then they would lend you $56K on this deal.

HMLs usually charge several points plus some origination fees. Those are collected at closing. So if the HML charges you four points and a $500 fee then that would be a charge to you at closing.

Some HMLs want monthly payments, some defer the payments until you  sell or refi.

As you do the repair work the HML will inspect it. If it passes their inspection, they will give you the rehab money in "draws". You would work out ahead of time how many draws and for how much each one will be.

@Jon Holdman  

Thanks for all the details. For the rehab part, are you saying that I would need to front rehab costs and then based on the HML inspection I would be reimbursed through the draw schedule? Or are you saying that will give me the first part up front, say 1/2 or 1/3 or whatever, and then as work progresses and the inspections are made, they will give out the rest of it through the draw schedule? That's typically how most contractors work, right? Some money up front, and then the remaining part after the job is finished.

Again, it will vary from HML to HML. May also depend on your experience. You should plan on fronting at least some of the costs out of your own pocket, then getting the rehab money from the HML.

When you first purchase the property it is worth roughly what you're paying. The HML wants the amount of money you're being given to be in line with the value.

My rule of thumb would be that if the HML will lend you 70% of ARV, and your purchase plus rehab costs is 70% of ARV, you will need at least 15% of ARV of your own cash. If the HML requires, for example, 20% of rehab plus 20% of purchase of your own cash in the deal, then add that to the 15% rule of thumb.

Also, if you go over budget, which you certainly will at first, then that's out of pocket, too. The rehab budget you agree to up front is all you're getting from the HML.

It varies - my HML keeps the property in their name. The reason being, if I stop paying they don't need to spend $50K to foreclose on me. It's a risk on my end, but I trust my lender as a partner.

@Alexander Merritt   I have one private lender with the same setup as @Zoran M.   mentioned.  My lenders all give me purchase and rehab money up front, but that is after significant experience and trust being build over a period of time. 

HMLs typically have their standard structure and protocol. With  private lenders you tend to have more flexibility to vary the terms of the deal. 

Most typical HMLs will be structured similar to what @Jon Holdman  described, each with their own variation on the basics. 

You can also Google rehab lenders, many will have their criteria on line. 

The best way to get comprehensive multiple answers to your question is to prepare a deal sheet with a HML in mind. That means all the information, planning, strategy and financials regarding your deal, especially your exit. For good measure, throw in your Resume. Then put a list of hard money lenders for your area together and submit your deal and ask for terms.

It will take a fair amount of effort and time to do this, but it will give you a very clear idea of how the HML side of your business functions and you will get some interesting proposals. You also need to take into account that private lending is fast moving and changing all the time, so you have to pay attention as you go.

Best of luck with it!


Originally posted by @Zoran M. :

It varies - my HML keeps the property in their name. The reason being, if I stop paying they don't need to spend $50K to foreclose on me.  It's a risk on my end, but I trust my lender as a partner.  

Well, technically, this is not lending. Lenders do not take ownership interest... they take a security instrument with a power of sale upon specific default(s) detailed in their recorded document. There is nothing wrong with a 'partner' taking an ownership interest... but this is not HML (and not private money lending either). If anything ever goes wrong, an entirely different set of statutes applies in partnerships (de facto or otherwise) vs. a lender seeking recourse.

@AlexanderMerritt - Great question... it opened the gates for all these great answers. 

So many people don't know what hard money or private lending involves. To many it seems like loan sharking. Consequently, they are intimidated by it and miss opportunities. 

If only more realtors and other real estate professionals (eg. accountants and lawyers) would understand this they could help more of their clients. Especially, when they're clients are turned down by banks and mortgage brokers.  

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