What is Hard Money & Why Would You Use it?
A hard money loan (also known as a private money, rehab, equity-based or bridge loan) is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. Hard money loans are typically issued by private investors or companies.
Real estate investors can leverage hard money loans for many reasons, including:
• Property Acquisition & Rehab
• Land Acquisition & Development
• Residential or Commercial New Construction
• Investment Rental Properties
• Cash-out for Additional Acquisitions
• Fast Acquisitions due to Time Constraints
• Cross-Collateralization of Properties
• Multifamily Bridge Loan
• Foreclosure or Bankruptcy Bailout
• Recent Credit & Conventional Qualifying Barriers
7 Steps to Guaranteed Hard Money Loan Approval
Step #1: Find the Right Property
Depending on your real estate investment purpose, be sure to do your proper due diligence in evaluating a prospective property. For example, if your purpose is to “Fix & Flip” a property; you must know the neighborhood, maximize the value-add potential and have a clear vision of the exit strategy that is supported by sold comparables. It is widely known that you make your money on the acquisition, which means you want to acquire the property at the best price with room to add value. This due diligence process can also be used if your loan purpose is for new construction or development.
If your investment loan purpose is to cash out residential or commercial, be prepared to compile all the supporting documents to verify the current value of the property. That could include a Realtor Comps, Broker Price Opinion (BPO), or current Appraisal.
In summary, you need to have a process for success. This comes by following a duplicatable formula to guarantee success. If you do not have a formula, you may want to network with other like-minded professionals that have a proven track record of success. Reach out to your local real estate investment clubs or ask your Hard Money Lender in Sacramento or other location for referrals to possible mentors that may be able to help you.
Step #2: Executive Summary
A large percentage of your success in getting your loan approved is based on how you prepare the loan for review by your Hard Money Lender. Know your numbers! It is critical that you present a clear and concise summary of your project, which leaves little doubt as to your plan, purpose and exit strategy. This is most commonly presented in the form of an Executive Summary that explains the loan amount requested including any value-added costs or repairs, the timeline of the project including the term of the loan requested, and the exit strategy including whether you plan to sell or obtain long-term financing.
The Executive Summary should be relatively short while providing all the details necessary to have a clear overview of the project and purpose of the loan request.
Step #3: Loan Application
Most Hard Money Lenders will require a Loan Application. This can come in the form of a simple company specific loan application or a standard 1003 Loan Application. Either way, this loan application will provide the general information about you and the property. Although, most Hard Money Lenders are asset-based, the Hard Money Lender will want to make sure you have the capacity to repay the loan.
Many Hard Money Lenders in San Diego and most other locations in California will require you to complete a Borrower Authorization form in order for the Hard Money Lender to review your credit report. This credit history is a good indicator of your ability to make payments and repay the loan. Although a majority of the weight is based on the property, credit does play a role. Hard Money Lenders realize that you may have had credit issues in the past that prevent you from obtaining a more conventional loan. If you had credit issues like Short Sales, Foreclosures, Bankruptcies, or Liens, in the past, it is recommended to have an explanation of what happened, and what you have done since the credit issues to ensure your success and creditworthiness.
You may also be able to provide compensating factors to help strengthen the loan scenario. This could come in the form or putting more capital into the project or cross-collateralizing other properties that have equity. More on this topic later.
Step #4: Subject Property Pictures & Comparable Market Analysis
Since you should be completing your own due diligence in evaluating your property, be sure to provide the Hard Money Lender with interior and exterior pictures of the subject property. If the property is actively on the market, there may be pictures online. However, if you have more detailed photos of the subject property, it is highly recommended that you provide those to the Hard Money Lender. This will allow the Hard Money Lender to assess the current as-is value of the property.
You should also provide your Fix & Flip Comparable Market Analysis supporting your proposed After Repair Value (ARV). Most Hard Money Lenders will do their own value analysis in the form of their comparables review, BPO, or Appraisal. Therefore, if their numbers are in line with the information you provided, it will add more credibility to your submission and show the lender you have done your homework.
Step #5: Scope of Work & Contractor Bids/Estimates
Your team is critical to your success. This team includes your contractors and they are one of the many variables that can impact your profit margins. Contractors can make or break a deal for you if they go over budget and/or over their timeline, as time is money when interest is owed on a loan. Although many Hard Money Lenders can provide a loan quote based on your general repair estimate, the full loan approval will most likely be contingent on detailed and itemized Contractor Bids/Estimates.
Do your due diligence in selecting the right contractors for your project. These contractors and sub-contractors should also be licensed for their profession. For Fix & Flip Projects, have your contractor provide an itemized cost breakdown for the repairs needed. If the repairs will be included in the loan request to be funded through an Escrow Fund Control Account, the Hard Money Lender will most likely want a draw schedule from the contractor as a timeline for how repairs will be completed and paid for throughout the project. Many Hard Money Lenders can provide you with a Rehab Budget Sheet to include the Estimated Repairs as well as a Draw Schedule for the Contractor. This will be the same process for Ground-Up Construction Projects.
Step #6: Compensating Factors
There are several factors that Hard Money Lenders consider when evaluating a loan for approval. If you are not as strong in certain areas, you may be able to strengthen your review by adding value in other areas. Here are a few compensating factors:
• Cross Collateralization
Property: The loan request application starts by securing it against real estate. If you are able to find a property and purchase it at a great price that is under the current market value, that is a nice start. Those opportunities are difficult to find in competitive markets. If you are able to discover a higher and better use for the property, that is a fantastic way to add value. For example, you may be able to build an addition to a property, or you may be able to add additional units if the designated zoning allows.
Capital: If you have additional capital to put as a down payment, the Hard Money Lender will have a more secure equity position, which results in less risk for the Hard Money Lender. This also demonstrates to the Hard Money Lender that you have “more skin in the game”, and you are willing to invest more of your own money in the project. You are less likely to default if you have your own funds invested in a project. You may also be able to strengthen your evaluation if you can show liquid cash reserves available. This helps to ensure that you will not have any issues making the payments on the loan or covering additional cost overruns or holding time.
Credit: As mentioned before, Hard Money Lenders base a majority of their evaluation on the property. They also understand the Borrower may have had credit issues in the past. However, if you have a strong credit history, this can be a great indicator of your creditworthiness as a Borrower. This strong history of timely payments, and repayment of loans helps assure the Hard Money Lender that you are likely to continue to make payments on loans in the future. This strength can help compensate for other areas of weakness when evaluating your loan request.
Cross Collateralization: The process of cross-collateralization involves including other real estate that has equity to be secured along with the subject property. By improving the equity position of the Hard Money Lender, this may allow you to have less money come out of pocket. Therefore, you may be able to leverage other properties you own, which then requires less cash needed to close. One example is using a property that you currently have listed to sell and it has substantial equity based on the improvements. If you have other properties you own, be sure to include those on the schedule of real estate owned on the Loan Application.
Experience: If you have a strong track record of successful projects, this can definitely add credibility to your review. Including a portfolio or website of your past projects is a great way to showcase your experience. If a Hard Money Lender feels confident in your projects along with the team and systems you have in place, the project may be considered less of a risk from a lending perspective. A Hard Money Lender bases their evaluation on the risk analysis of the project. The less risk correlates to more favorable terms to the Borrower!
Step #7: Performance
Do what you say you are going to do when you say you are going to do it! This is a priceless key to success and will work wonders for you and your relationship with the Hard Money Lender. Performing as agreed will set the tone for a great relationship and possibly more favorable terms as you build upon your experience as a reliable investor known for completing successful and profitable projects.
Your performance perception begins when you submit your loan request and continues throughout the loan process. With that being said, it is important to be prepared when you submit your loan request. Keys to success include providing all the requested information and documents in a timely manner and promptly returning phone calls and emails. This is ultimately a people business, so if you are honest, open, direct, and organized when it comes to communicating with your Hard Money Lender, it will definitely improve your odds in obtaining a loan approval for your project.
In summary, if you follow these 7 Steps, the Hard Money Lender will be able to quickly evaluate your project and hopefully Approve Your Loan! If there are concerns from underwriting, don’t be afraid to ask if there are any aspects of the loan you could improve that would result in a loan approval. Hard Money Lenders have the ability to think outside of the box to explore creative ways to secure their investment. You never know unless you ask.
Once your loan is approved, it is very important that you maintain a strict timeline, stick to your budget, make timely payments, and payoff the loan as agreed. This will help build the relationship for future business. If circumstances change during your project, it is imperative that you stay in communication with your Hard Money Lender.
Hard Money Lenders understand things may happen that were not expected and they rely on you to be honest and direct in addressing them promptly so the issues can be resolved. Hard Money Lenders want you to succeed, and your obstacles have probably been encountered with other deals, so they can be very helpful in providing viable solutions when you communicate with them. If they do not have an immediate resolution, they may have resources that can help so take advantage of their experience.
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