Hard Money Lenders and How It Works

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What if you find a house that needs so much work, and needs so many repairs that you can't get a normal mortgage from the bank? The answer is Hard Money Loans.

What is a Hard Money Lender?

A hard money lender is a lender who will lend you money, not based on your income or your financials, but actually based on the project itself. Typically, they're going to lend to investors that are buying properties that need rehab.

Interest Rates

They are usually much higher in terms of interest rates. You can find hard money lenders lending as low as 6.5% and as high as 15% interest rate.

And, they also usually charge points. Typical points are anywhere from zero to as high as four points for new investors. This is where the hard money lenders actually get you.

Let's say from closing when you buy the house to when you refinance the house or sell the house, it's a six-month project. You borrow $100,000.00, and they charge you two points on the loan. That is $2,000 at the beginning of the loan, which you pay it off in six months.

Now, if you annualize that, it totals to $4,000 a year. You divide the $4,000 to the $100,000 that you borrowed, that's 4% annualized in points.

Moreover, if you're paying an interest rate of 12% per on the loan, and you add those two together and you're actually paying 16% in interest for that loan.

You will also need to add other fees that they charge which include underwriting fees or processing fees. The latter is associated with the loan and should also be counted as points when you're doing your comparison as you're shopping with hard money lenders.

Terms

The length of the loan for hard money loans can be as short as 9 months to 24 months, and with 12 months being a norm. These loans start on the day you borrow it, and you are given the same number of months on your term to pay them all back.

Most of the time, these hard money lenders will give you a three-month extension as long as you can show why you weren't able to do it. If the house is just sitting there and doing nothing, they might not take too kindly to that. But if you are working and you can show that progress is being made, they’ll most likely give you the extension.

When hard money lenders lend to you, they are going to underwrite your deal differently than a traditional bank would. They're going to look at your experience as a real estate investor. They want to see how many deals you've done, they want to know how much real estate you own, and that factors into the interest rate you get and the terms you get.

Consequently, the more experience with the type of project you're doing, the better the rate and terms you're going to get.

The Loan Amount

They are going to examine the deal itself with a focus on the ARV or the After-Repair Value of the house that you're trying to buy. What is it going to be worth after you fix it up after there's a new kitchen, new bath, new flooring, new paint, with all the mechanicals working and no safety issues? That is a question they need to answer.

They assess the ARV by either getting an appraiser to do a walkthrough on the property or by doing a Desk Review, which refers to hard money lenders pulling their own comps without the help of a licensed appraiser. The latter is not very common but some lenders do it.

Another area of the deal analysis is reviewing the As-Is Value of the property. What is the property worth if no work is done to it and it's sold on the open market right now?

And, the last piece of the puzzle is the scope of work. What kind of repairs or updates does it need to get from the As-Is value to the ARV value?

This information is something that you present to the hard money lender, which is then verified by the latter through a desk review or more commonly, through an appraiser to confirm it is worth the loan.

The next thing that they calculate is the caps on how much they're willing to lend you. Most of the time, these hard money lenders will lend you 65% of the ARV or 100% of the cost of purchase, whichever is lower.

But, most of the time, they lend you the total cost of the scope of work or the rehab costs. They opt to do that so that you have enough funds to finish the project and they can get paid back.

One thing to keep in mind is most hard money lenders put the funds in escrow until you're able to prove to them that work is being done. So, on your scope of work, you will need to indicate the specific work: the demo, plumbing, electric, kitchen, baths, paint, flooring, and the total cost of the project.

If the total cost is $50,000, then they are going to make you borrow that same amount. Until you can prove that you finished the demo, the water, and all that needs to be completed, they won't pay you that.

Your desired project will need to go through an inspection for a draw, which is when your funds are ready to be drawn out of escrow.

You will have to order an inspection for that draw, and they will need to confirm that you actually did the work. Basically, you have to front the money to do the rehab before you can take the money out.

Another thing you have to keep in mind is even though the funds are still in escrow, hard money lenders will make you pay interest and points for the loan. They are calculated based on the rehab cost plus the principal amount that you're borrowing.

Repayment of a hard money loan is usually done on a monthly basis, and you will be paying the interest only. The principal amount plus whatever you draw from the construction draw gets paid at the end of the loan.

Unlike traditional mortgages where you see the principal and interest on your statement, hard money lenders usually make you pay the interest only on a monthly basis. Sometimes you may run into a hard money lender who will actually let you make no payments. What they do is they'll capitalize the interest until the end of the loan and you just pay the principal amount plus whatever you drew on the construction part and all the interest that's owed. It's rare but there are lenders out there who offer that.

However, there are some small operations out there that loan to own, which is something you need to watch out for. Like any other hard money lender, they lend you money so they can make a good interest rate, but there they have a secondary objective.

These small operations of lenders want to see you default. They want you to not be able to make the loan or have your rehab go along so they can foreclose on you and take the property for themselves. They usually only lend a small portion of what the house is actually worth and so they’re able to take the equity. You will need to be cautious with lenders like that. It is best to find Hard Money Lenders through referrals.

Legit hard money lenders are experienced so do listen to them. They do tons of these deals and they know what numbers work. If they are telling you that the price that you're buying a house isn't going to work, then take that advice to heart because they've seen these deals. They underwrite these deals day in and day out.

Now, when you come across a house that needs a lot of repairs, a full rehab, a gut, and you can't get a mortgage, you should know that you have an option to find a hard money lender to fund your deal.