Why should borrowers choose private lenders over traditional banks? The short answer is that these lenders fill in the gaps where other lenders fail. Many individuals today have the ability and desire to invest in a new home, but they have an unproven track record.
Take, for example, the average millennial who is just now thinking about buying a first home at the age of 30-something, with limited credit and student loans. A typical bank may turn down these borrowers for the best possible options, but hard money lenders offer opportunities.
Versatility Is a Key Reason to Trust Hard Money Lenders
Perhaps one of the most important reasons to turn to private lenders is their unique ability to provide flexible, versatile funding for virtually any need. Whereas a traditional lender may need pages and pages of documentation and proof of a project’s viability, this is not necessarily the case with some private lenders. They have the means and the dedication to help consumers of all types to secure the type of financing they desire.
This includes construction loans to build expansive projects. It includes bridge loans that are typically hard to get otherwise but fill in the gap between projects and financing. Commercial loans are even more complex to today’s average buyer. Starting a business with a new loan for a building can seem out of reach and limiting. It’s hard to create a structure and build a business without access to necessary funding. Private mortgage lenders fill this gap, too.
Perhaps one of the most important reasons to turn to these lenders over others has to do with rehabs. Rehabs are the diamond-in-the-rough type of structure that has good bones but very little value at any given point. In some situations, they can become stunning new homes or commercial properties, but to make that possible, there’s the need to access the proper funding. Traditional banks tend to see just the “rough” and lack enough focus on the “diamond” to ensure rehabbers get the funds they need to transform these spaces.
Owner-occupied loans are another key area. Expanding a property can seem difficult in some situations. Banks typically have various federal and state regulations that must be met before they can lend. This complicates the process and slows it down. Private mortgage lenders free up that space considerably.
Private Lenders Provide Opportunities
It’s important to know that hard money lenders do not just give away findings and cash on hand. They still need documentation and proof of creditworthiness. They still need agreements on repayments and, in some cases, collateral to back up the investments they will make. This seems to be about in line with a traditional bank, but that is rarely the case. Rather, these lenders work closely with borrowers to provide them with more insight and opportunity into the options available to them. They also work to solve problems as they arise, working hand-in-hand with borrowers to help them to qualify for the funding they desire.
Whereas a traditional bank places restriction and documentation limitations on any loan, that is not the case with hard money lenders. There is an application process. There are a variety of steps that must happen before private lenders will lend. Yet, there are fewer restrictions and far more opportunities available to today’s borrower with these lenders than with traditional lending institutions. For those borrowers who may have been told “no” before, hard money lenders open the door to new potential and opportunities to create outstanding results for just about any type of project out there.
Hands-on real estate investors have been buying distressed properties for a quick profit for a very long time. Over the years, investors fine-tuned their methodologies, when it became quite apparent that the use of hard money was easily accessible and came with reasonable loan parameters regarding the working capital required to accomplish their investment objectives.
Generally speaking, real estate investors generate their anticipated profits from:
- Sweat equity, which helps build value and reduce the home’s Loan-to-Value
- Buying an underpriced house
- A bit of luck, or
- Even personal intuition as to an upcoming upgrade to a neighborhood or town.
The real estate market categorizes distressed properties into three primary types -a Short Sale, a Foreclosure, and a Real Estate Owned property. Each type of distressed property comes with unique benefits and risks that differ from the others. Hard money borrowers that are considering jumping into the distressed property pool must assess the specific risks and benefits before making a final purchase decision.
Purchasing an Auctioned Foreclosure
A foreclosed property that is bought from a public sale/auction occurs when the highest bidder has the opportunity to buy the property. Foreclosure sales usually have many competitive bidders, one of which can be the lender who is foreclosing the property. In fact, any lender holding a lien position can bid up to the amount of the debt owed on the property.
The primary benefit of buying a foreclosed property at auction is there is always a possibility of picking up a great deal. Real estate investors assess the value of any given property (including the Loan-to-Value) by using the valuation method that best suits their investment model. Buying a foreclosure include these risks:
- No inspection prior to sale
- The payment of delinquent property taxes
Defects of Title
Buying a foreclosure, especially at a public auction, is NOT for the faint of heart. Amateurs should enter these buying opportunities with a qualified agent or legal counsel.
Purchasing a Short Sale
When the real estate market faltered around 2008, short sales became a go-to option as home prices fell dramatically, and quickly. This was a time when properties were being sold for a price that did not even cover the existing debt on the property. This type of distressed sale:
- Allows the buyer a chance to inspect the property ahead of closing
- Typically has a clear title
- Requires the seller to pay the delinquent taxes
This type of distressed sale purchase requires patience as the lender must give their consent to the transaction -a sale where they receive less money than they are owed.
Purchasing a Real Estate Owned Property (REO)
An REO gives distressed property buyers a chance to buy a foreclosed property directly from the lender. This typically happens when a lender offered the highest bid at an auction and they become the property’s owners. Purchasing an REO is less risky because a buyer:
- Can inspect the property
- The title risks are mitigated.
- The lender is responsible for unpaid taxes
An REO purchase often requires the buyer to pay for purchase upfront, in cash. A drawback regarding an REO purchase is that the property may need significant repairs which remains the responsibility of the buyer. It is noted that lenders who own these REO’s prefer to sell to buyers who have available cash for a quick closing.
Hard money lenders are a great source of financing for distressed properties. Seasoned, insightful investors often find profitable opportunities using hard money financing. But, be forewarned, amateurs should think twice before choosing to go it alone.
Those seeking to borrow money to make a real estate purchase or another type of investment can turn to hard money loans as a feasible, solid solution. There are many reasons to make this decision. Key among them is the loan to value requirements available through hard money loans. Also known as LTV, this is one of the key features that can make all the difference in a home buyer’s buying power.
What Is LTV?
LTV is the amount of the loan borrowed compared to the value of the property. In a traditional, government-backed loan, most lenders want to see this a significant amount of free equity in the property. That is, they want to secure loans that are worth significantly more than what the borrower needs to purchase them. The problem here is that to achieve this, most borrowers must have a significant down payment. That down payment can be hard to obtain.
In a hard money or private loan, this level may be slightly different. Most offer a 70 percent LTV. However, more extensive and higher LTVs are also available to some borrowers. What makes a hard money loan different is that there are fewer other restrictions and more flexible lending requirements available on these loans.
Whenever possible, borrowers should secure the purchase they make with a down payment. It reduces risk. It also helps to improve a property owner’s investment in that real estate. It creates built-in equity. But, it also helps private lenders to feel more confident lending to those who do not otherwise qualify for a loan.
What Is the Valuation Method?
To determine what this ratio is, home buyers must secure an appraisal. This is the most common valuation method. An appraiser is a third-party professional not affiliated with the investment or any party within it. This appraiser uses market information to determine the current value of the property. This can change over time. It definitely changes when the home has significant renovation. This method allows for a clear, non-biased opinion of the property’s value to be understood. With this information, it is clear if the loan is ideal for any investor.
What Other Parameters Are Present in These Loans?
Every private loan will have specific parameters. These are requirements the borrower or the property must meet in order for the investment to occur. Most loans will require a lien position, for example, of the first or second position. That means that the loan must be the only or potentially the second lien or debt on the home.
Other factors to consider include the interest rate, origination fees, loan term, and document processing fees. Loan types can differ from one provider to the next with options such as owner-occupied loans, fix and flip, rehab, commercial, and construction loans being available through hard money lenders.
Key Advantages of Private Loans
The loan to value component of any private money loan is just one factor. Individuals considering the investment in these loans need to realize the other advantages as well. Typically, the loans offer affordable interest rate, loan amounts that are sizable (to fit most needs well beyond that which is required by other lenders) and offer a variety of fast-closing opportunities. These loans typically can be used for most types of real estate including single family properties, residential developments, small commercial properties, and apartments.
Hard money loans provide a wide range of benefits to buyers. This includes access even when creditworthiness may be a concern. Though there are qualification requirements, buyers typically benefit from these loans.
The investment in a new building requires careful planning and access to a high level of capital. Several funding options are available for this type of loan. Two common options include a bridge loan and a construction loan. Both have different purposes and benefits. Those considering these loans should think about the length of the project. Hard money lenders provide access to both options.
What Are Construction Loans From Private Lenders?
The goal of construction loans is to provide capital for the construction of a building. This includes small commercial, apartments, and single-family homes. Generally, these loans are designed to provide capital right away to fund the building process.
They do not remain on the property after the completion of the build. Typically, the property owner secures a home loan to cover this cost or another type of property loan.
These loans are available only after a construction timetable and a full detailed plan of the process is complete. There will always be the need to provide a detailed budget that outlines what the funds will be used for. It should include all aspects of the cost to construct the building. This includes all building materials, all appliances, all finishing, and all fixtures. It should also include labor costs.
There are a few things to know about this type of loan:
- They generally remain in place for a year or less.
- Some hard money construction loans can cover some of the lot purchase prices. Generally, the lot lien must be in hand prior to the construction loan’s funding.
- There is a down payment requirement in most cases. This loan to value amount depends on the individual circumstances of the loan as well as the lender’s preference.
- The fees and interest rates on these loans vary per project. However, they are typically competitive.
Keeping this in mind, other solutions are available. For example, for an owner-occupied loan on a new home, it may be possible to obtain new construction loans without any down payment. This is not always available, though some private lenders offer it.
What Are Bridge Loans from Private Lenders?
A bridge loan is a bit different but still offers the same qualifications and availability. The major difference here is that a bridge loan is very short term. They work to cover the gap that occurs between the time that the property buyer needs to make a purchase of the property and the time work on the property is complete.
For example, a bridge loan can help to provide more flexibility so that a tenant or a home buyer can be found. It allows for time for builders to make the required repairs and renovations necessary. This is short-term financing. There are a few things to keep in mind.
- Bridge loans are typically beneficial only for short periods of time under a few months.
- They are available as both commercial loans and residential loans.
- Most often, these loans have slightly higher interest rates than construction loans. However, they are rather easy to obtain for well-designed projects.
Hard money loans for these needs can be readily available often sooner than traditional loans. Additionally, other types of construction loans are available to meet specific goals. This includes residential rehab loans, fix and flip loans, distressed property loans, and cash-out refinances.
Generally, borrowers need to work closely with private loan lenders to ensure they have a clear plan forward in both options. Borrowers must be able to show them what the end goal is and how the home will be sold or how another loan will be obtained to repay these existing short-term options.
Hard money loans are financial tools used by savvy real estate investors; those who purchase real estate for reasons other than buying a home for one’s growing family or to live out one’s golden years. Hard money lenders offer loan products that are intended to be used as short-term solutions. Hard money loans have a very specific usefulness for certain types of real estate investors and, are offered by financial specialty companies or private lenders, not traditional lending institutions.
There are some very good reasons to consider using hard money loans for real estate opportunities that have hit your investment radar. Examining example scenarios might help clarify when it is best to opt for a hard money loan.
- When a distressed property is available for purchase and it is obvious that there is significant profit to be made when flipped, but you need to act quick.
- All your funding sources have been exhausted; you need money to buy the property!
- If you would be able to participate in more profitable investments if you had a free-flowing conduit to quick money.
Do Hard Money Loans Have Underwriting Guidelines that must be met?
Underwriting criteria vary among lenders, as does the cost of a hard money loan. To receive the most favorable hard money loan terms, a potential borrower should meet the following criteria:
- A Debt-to-Income Ratio (DTI) that does not exceed 45%
- Verifiable liquid assets sufficient to consummate deal
- A credit score of 680 or greater
How Do Hard Money Lenders Evaluate a Hard Money Loan Application?
The hard money approval process primarily focuses upon the collateral of the subject property: That is, the home’s condition, and a conservative estimate of the home’s value when the repairs have completed. The value of the property being financed (as evaluated by the lender’s approved appraiser) is used to calculate the down payment that will be required for this loan.
Hard money lenders generally offer around 65% of the subject property’s Value. The property value that calculates the requirement is called the After Repairs Value (ARV)
For obvious reasons, hard money lenders often scrutinize a first time investor’s loan application more intensely. Wouldn’t you?
Newbie real estate investors should begin their real estate empire with a loan scenario where the repair costs are less than 25% of the ARV. Historically, this LTV ratio generally keeps new investors out of trouble.
Avoiding Rookie Errors
The list that follows are some of the errors that eventually contribute to longer completion times, reduced profitability, and significant pressure maintaining cash flow requirements.
- A faulty initial budget
- Project modifications occurring during the renovation that become out of control
- Being ill-prepared for unexpected contingencies, unanticipated cost overruns, unforeseen repairs, or a dangerous weather event. As a general rule, the contingency reserve rarely ends (at the project’s end) with something other than a zero balance.
- Overpricing the sale of the rehabbed property, for the wrong reasons, like greed – this counter productive tactic ultimately extends the completion of the ‘quick-flip’ transaction.
Investing with hard money loans is most successful when the investor understands the fundamental technique to maximizing profit – expediency, and speed. Additional time to complete the sale generates additional costs which eventually erodes profits.
The reality is, a reasonable price offered from the initial listing date just might be the one item a serious buyer needed to make an offer. As it is often said, everyone has one chance in which to make a good impression. As the seller, use it to your advantage.