Investing in real estate is one of the easiest and most secure ways to earn income. There are many different options for investing, from construction and commercial properties to refinancing, cash outs as well as land and rental property purchases. While all of those can be profitable, by far the biggest market in real estate is fix and flip properties. These properties can often provide the best return on your investment and as such can be a great source of income.
According to Bloomberg, even with the added stress of the pandemic the profits on fix and flip properties are at an all time high, averaging $66,000 per home. (Source: https://www.bloomberg.com/news/articles/2021-03-19/house-flipping-is-suddenly-a-hot-market-for-america-s-lenders) As enticing as those types of profits may seem, however, real estate investment is not without its risks.
As with most types of investment, getting in on the action requires financing up front and that often means needing to secure a loan. There are many different types of loans available but for fix and flip investors in particular, where being able to close a deal quickly is imperative, a hard money loan is usually the best option.
What is a Hard Money Loan?
A hard money loan is a short term, asset-based loan that uses the property itself as collateral. The term “hard” in the title refers to an asset that is used as a concrete form of collateral. The funding for this type of loan comes directly from the lender’s own money, meaning they usually have a much quicker turnaround time than standard loans. This can be extremely advantageous, especially when there are multiple potential buyers for one property.
In general, hard money loans are short-term loans, usually with a 1-year limit, although in some cases they may be extended for as long as 3-5 years. The borrower makes monthly payments, often at a higher rate than they would with a standard bank loan, with one balloon payment due at the end of the loan term. The higher monthly payments can certainly be a risk but in the case of fix and flip properties, the potential profit usually outweighs that risk.
Since these are collateral based loans the borrower’s credit history and personal finances aren’t as critical to securing the loan, which can make them much more attractive to borrowers. In short, hard money loans can be the perfect answer when you need an outside source of financing to secure a property purchase on short notice.
How Can You Use A Hard Money Loan?
As mentioned above, you can use a hard money loan for a variety of real estate investments, many of which are considered too risky by banks, meaning they will be hesitant to provide a loan in these cases. Aside from real estate investing, hard money loans can be used for other purposes where you may need a direct source of funds. One such example is an estate or inheritance loan, where heirs can borrow against property that is part of an estate until the assets of the estate are distributed.
For fix and flip properties, the funds secured through a hard money loan can be used to help cover the cost of repairs and renovations that will ultimately improve the property’s after-repair value or ARV. It is that ARV which hard money lenders use to determine the viability of the loan in the first place. By estimating what a property will potentially be worth after renovation, it is possible to estimate how much of a profit you can make. This not only tells you whether a deal is worth undertaking in the first place but also tells a lender whether the property is a viable asset to base the loan on.
Once you have secured a hard money loan, you can then funnel those funds into the property to increase its value and make money both for yourself and the lender, so it’s a win-win proposition for both sides. In fact, the potential for “forced appreciation”, or the ability to increase revenue through your own investment in a property, is one of Forbes Magazine’s reasons to consider investing in real estate.Source: https://www.forbes.com/sites/forbesrealestatecouncil/2021/02/17/eight-reasons-you-should-consider-real-estate-investing/?sh=668d0abc5c51
How Do Hard Money Loans Compare To Traditional Loans?
The most obvious difference between hard money loans and traditional loans is the quick turnaround time. This is possible because hard money lenders don’t need to do an extensive check of a borrower’s credit history the way banks do. That doesn’t mean that hard money lenders won’t look at your financial status and credit history at all, but since they are more focused on the ARV of the property itself, they may be more willing to overlook a weak credit score or other financial issue.
Since banks take a much closer look at your financial history that translates into a much longer turnaround time for approval. Banks can take as many as 30 days or more to approve a standard loan, where hard money lenders may be able to provide approval within 3-4 days. This ability to get almost immediate financing can make a huge difference, particularly when there are multiple offers on a property.
Another big difference between standard and hard money loans is that hard money lenders are far more likely to take a risk on a borrower with a shaky financial history provided there is a solid ARV on the property. At the same time, they may be more willing to negotiate on terms if they feel that the ARV is strong enough. All of this gives you much more flexibility as a borrower, which can also make a huge difference when you need to secure financing in a hurry.
Are There Any Requirements for a Hard Money Loan?
One of the things that make hard money loans so attractive is that, unlike traditional loans, there aren’t many requirements. As noted above, approval is based on assets used as collateral which means the borrower’s credit and financial history have much less bearing on the loan. The only real requirements, therefore, are a strong ARV on the property and the ability of the borrower to show proof that he or she can make monthly payments and also make the necessary improvements to achieve that ARV on the property.
Benefits of Hard Money Loans
There are many reasons to opt for a hard money loan rather than a traditional loan and the specific benefits can depend on individual circumstances and the particular reason for the loan. In general, however, there are several main benefits to securing a hard money loan:
- Speed – This is by far the main benefit and cannot be emphasized enough. Applying for a traditional mortgage can be tedious and time-consuming. According to Investopedia, this is particularly true in today’s market due to the latest regulations stemming from the Dodd-Frank Act governing mortgage lending. (source: https://www.investopedia.com/articles/wealth-management/040216/using-hard-money-loans-real-estate-investments.asp). With so many hoops to jump through, it can take banks a month or more to finalize a loan, whereas hard money lenders can give you final approval in weeks or in some cases even days. This is an invaluable asset when it comes to potentially time sensitive real estate deals.
- Flexibility – In general, there is much more room for negotiation with a hard money lender. This means you may be able to tailor the payment schedule to better suit your needs or get fees reduced or eliminated. This may not only allow you to move faster to close a real estate deal but also allow you more leeway as you work to perform the necessary renovations that will help achieve a better ARV.
- Collateral – Hard money loans are collateral based and the primary source of collateral is the property itself, but it may also be possible to use other types of assets to secure a hard money loan, including other properties you may own or a retirement account. Since they have their eye on the ARV of the fix and flip, hard money lenders are as interested in turning a profit as you are, so they are much more likely to work with you in order to make the loan fit your needs.
The Risks of Hard Money Loans
Though hard money loans have obvious benefits, like any other type of loan they are not without their risks. Before you opt for a hard money loan it is important to consider the potential downside so that you can determine if this is the right choice for you:
- Higher Interest Rates – While hard money loans may be easier to secure, they tend to carry much higher interest rates than traditional loans. According to Investopedia, interest rates on hard money loans can be up to 10 percentage points higher than those of standard loans. (source: https://www.investopedia.com/articles/wealth-management/040216/using-hard-money-loans-real-estate-investments.asp). This is due to the fact that hard money lenders are taking a greater risk in providing borrowers immediate access to cash. For a borrower, that means you’ll need to weigh the benefits of getting the cash you need quickly with the reality of having to pay more.
- Shorter Loan Terms – Because hard money loans enable borrowers to get a property fixed and on the market as quickly as possible that means that the terms of these loans are generally much shorter. Most hard money loans are 1-year loans and that can be a big risk for a borrower. You’ll need to carefully consider whether you can realistically meet the term of the loan before you jump in with both feet.
Choosing A Hard Money Lender
Fortunately for prospective borrowers there are many potential hard money lenders out there. As with most businesses, though, not all lenders are created equal. Unfortunately, there are some unscrupulous lenders who may take advantage of desperate borrowers and if you don’t choose a lender wisely you could end up in worse financial condition.
With that in mind, it’s important that you carefully consider all of your options and choose a lender that you can trust. This begins with determining exactly what you need from a lender so that you have a better idea of whether a particular lender can meet those needs adequately.
You’ll also want to look for a lender that specializes in hard money loans so you know they have the expertise necessary. Look at reviews for a lender and see what other customers have to say as this can be a great indicator of what you can expect when you deal with this lender. Most lenders shouldn’t hesitate to provide referrals when asked for them, so if you encounter a lender that does this should be a pretty big red flag.
Since a hard money lender is using the investment property as collateral, they’ll be just as interested in improving it and making a profit as you are. This is a good thing, but you also want to make sure that they aren’t putting their own interests ahead of yours.
The bottom line is that you want a lender you can trust, with a proven track record and the ability to help make your investment pay off. Whether you need a fix-n-flip, commercial, construction or estate loan, Lantzman Lending is the name you can trust to make your hard money loan work for you.