What is Hard Money?
Are you interested in Real Estate Investing but confused by various financing options and terminology? Have you heard the term “Hard Money” but not sure what it means? Ever heard the idea of getting rich with “other people’s money”? Well, Hard Money is something along those lines but no money is ever free and a hard money loan is like any other loan – there are important characteristics you should understand and which could be costly.
One way to think about a hard money loan is this, a real estate investor may have time to find a home, rehab a home, and sell the home – but not a lot of capital. The hard money lender may be someone who has very little time but may be very wealthy with plenty of capital and looking at taking on a higher risk for greater reward. Hard money loans are methods of bringing these two entrepreneurs together.
Imagine a bank or traditional financing method. They will loan you money based on the price you buy a home, not what it could be worth after repairs or including the money to make those repairs. Traditional methods are also very slow and not flexible. Traditional methods consider your credit history, your income and more.
Hard Money loans are typically private loans from a private investor vs. a bank. They are favored by real estate investors because obtaining hard money from a private investor can be faster and more flexible than more traditional methods. Additionally, some homes do not meet conventional underwriting guidelines.
Hard money loans often go by several names or variants such as:
- Cash out Loan.
- Rehab Loan.
- Bridge Loan.
- Asset based loan.
- Buy, Fix, and Sell Loan.
When To Use Hard Money
There are many different situations in which hard money is a great option if available to the real estate investor. Most important is speed – many deals are made or lost based on time and having financing lined up. Hard money is also a great option on distressed properties.
Hard money loans are great for taking a “cash out” or when being used as a “bridge”.
A good real estate investor has to be able to move fast on quick deals and often needs cash in hand. Additionally, the real estate investor may need money to borrow to repair or rehab an ugly or distressed home (think bad foundation, bad roof, termites, hoarder home, etc). This is where Hard Money Loans become important.
How Hard Money Loans Work
First, all hard money lenders have different rules and requirements. The following is a basic guideline of how many will operate.
There are three basic numbers you need to know (or have a really concrete estimate of):
- What are you buying the home for?
- How much will it cost to rehab / repair the property?
- How much should the house sell for after repairs (ARV – after repaired value)?
If you are new to real estate investing, number 2 and number 3 can be scary. You have an idea but without a track record and experience you only have a semi-educated guess. This is why hard money lenders prefer investors with a positive track record. The more homes you have flipped with them and the more money you have made with them, the better your loan terms will be.
The hard money lender will loan you enough money to cover the purchase price of the property and will sometimes include rehab funds and all carrying costs including interest typically for 6 months. Six months should be plenty of time to bring a property back to market as a sale property or rental. If not, hard money loans can be a bad idea.
The lender will balance their risk typically with a first lien on the property. Therefore they are protected by the equity in the property. This means the borrower’s job history, credit history, assets and such are less important. So the amount of equity for each specific deal is extremely important because that and your track record will make the lender more comfortable with a hard money loan.
Different lenders will operate in different ways. Some may loan a percentage based on the appraised repaired value, or just a percentage based on the purchase price. It is better to find the lenders that will loan on appraised repaired value. Most will loan no more than 70% ARV. There are three important numbers the hard money lender will share that are important:
- Loan Points.
- Closing Costs (Escrow Fees, Document Fees, Notary Fees).
- Interest Amount.
The best way to explain this is with an example.
Sample Loan Amount Calculation
- Purchase price = $70,000
- Rehab budget = $30,000
- Total capital = $100,000
- ARV = $120,000 (amount house should sell for after repairs)
- 70% of ARV = $84,000 (amount of loan)
- 5% down at closing = $4,200 (“points” the borrower has to pay for getting to use the lenders money).
- $500 document fees (to pay for paperwork processing and filing fees).
- Some loans may have an interest only balloon payment when the home is sold or 6 months is up.
If the loan amount is less than 70% of the ARV, the investor may be able to borrow money for the repairs as well.
Here’s the typical hard money lending process:
- Talk to the private investor or hard money lender. Find out what they need to qualify you, how much they would be willing to lend, and what types of deals they prefer (usually whichever ones make the most money the quickest).
- Find a good home for sale that you think good money can be made on and put it under contract.
- Talk to the lender again and inform them of the deal you found, the sell price, the cost of repairs you have estimated (make sure you add some wiggle room), and what you believe the ARV should be.
- Typically the lender will either send out an appraiser or have you get the property appraised from an approved list of appraisers.
- Documents – at this stage, various escrow documents and more may be required. The less experience you have with a lender, the more that may be required.
- Decision time – the lender will agree or not to fund the loan and if agreed should provide the amount and their terms.
- Close the loan. This is just like a typical loan at a title company. The loan amount is in escrow at the title company. The title company ensures all paperwork is completed correctly and timely and will issue checks as needed.
How to Find Hard Money Lenders
There are many sources of hard money. A simple search on the internet may turn up several local lenders as well as many online directories of lenders.