How does hard money lending work?

Question

Hello everybody! I am newer to the real estate game and trying to understand how hard money lending works. In particular, the ins and outs of the interest payments. If anyone had some input they could add it would be greatly appreciated. Thank you!

Mike Klarman · Answer

Ok, so there are three types of loans out there to use in order to flip, scale your portfolio, or cash-out and get liquid to buy more.

When people say "Hard Money" they usually are referring to a Bridge Loan.  Bridge loans are used on value add properties because the loan will include the funds to fix the house up.  These loans are typically for 12 months but have no pre pay penalty which means you can sell or refi pretty much right away as soon as the work is done.  These loans allow an investor to buy a property that needs work and supply the money to get the work done.  It's a bridge from the old property to the new.  Once it's renovated inside you either sell it or rent it.  This is essentially step 1 of the BRRRR.  Buy something that has potential but needs work.  Terms for these loans vary across lender and parameters like experience and credit.  I can get people with no experience 90% of the purchase and 100% of the rehab if their credit is 720 or better.  If lower they will get 80% on the first few then 90% thereafter.

If you are buying a turnkey property that needs no work and you intend to rent it out then you need a DSCR purchase loan.  These usually have a 75%/80% leverage to them.  The 80% leverage loan has higher rates.  The loan requires that your rent is 1.1x of the loan payment.  So if the loan payment is 1,000/month then your rent must only be 1,100.  The better your rent, the better your DSCR rate.  I've seen houses as high as 2, they are usually multis in small markets.  I closed a deal for an investor for a Duplex in Alabama.  The property was only 130k.  He put down 25%, so his mortgage was only for 97,500.  His payment was only like 800/month and he was getting 800 per side.  So he's collecting 1600 per month and paying an 800 note.  That's a sweet deal.  A good rule of thumb is to divide the rent by 1.1 and that number is your max loan payment.  That max loan payment translates to a max loan amount.

If you own a property that has appreciated well or has no mortgage then you can do a DSCR cash-out for 75% of the appraised value.  Same DSCR rules apply as above.

Scott E. · Answer

A hard money lender will typically fund ~70% of the purchase and 100% of the rehab. This of course assumes that your construction numbers and ARV comps are solid.

The interest payments in my experience are always interest only, due on the first of the month just like any other mortgage. And the payments are based on the balance that you have borrowed (so for example if you borrowed $400k for the purchase and have used $34k of your construction holdback, you will pay interest on $434k that month).

Some hard money lenders will offer an 'interest reserve' account which is awesome because it basically just stacks the payments due onto the loan balance and does not require you to make a payment every month.