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Hard Money Lending – A Primer

Hard Money Lending – A Primer

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.

Which Documents Are Most Important When Investing in Trust Deeds?

Which Documents Are Most Important When Investing in Trust Deeds?

Trust Deeds – A Brief Intro

Trust Deed investing, like most investments, involves some sort of risk. The most relevant ways to reduce the risk involved in a real estate trust deed investment is for each investor to educate themselves and, to work with a licensed, experienced financial expert. A skilled broker is adept at providing the following information regarding first trust deed investments:

  • The Property’s Equity Level and Market Value
  • The Borrower (the individual required to pay the trust deed) Credit Profile
  • The Title Insurance Policy
  • Loan Payment Service Options, and
  • The Financial Instruments used to secure the debt

Relevant Financial Instruments Used to Manage and Enforce Trust Deeds

The Promissory Note

A Promissory Note identifies the lender(s) and the borrower(s).  

It is the written promise a borrower (and a lender signs) to commit to repay (or an investor to provide) a specified amount of funds to be repaid over time. A Promissory Note can be structured as an installment plan or, as a lump sum payment due at a future date.  It is a legal instrument that carries the weight of a common law contract if specific legal criteria are met: i.e. an offer, and an acceptance of said offer. Similar to other written contracts, a well crafted promissory note will delineate the conditions and terms established between two parties. This note delineates the interest rate, the initial amount of money lent,  the due date, or the penalties for violating any provision of the loan’s repayment terms.

When both parties to the promissory note have executed the financial instrument, the promissory note will have met the minimum requirements to form a legally binding contract.

Trust Deed- The Promissory Note’s Security

A Trust Deed secures a Promissory Note. This is the legal document that is recorded as a lien on the title of the property – that which was financed by funds denoted in the promissory note.   A Trust Deed (and its close relative, the mortgage) is the primary method of offering security when financing real estate. This is the way in which a Trust Deed works:

  • A Trustor (aka the borrower) transfers the subject property, in trust, to a trustee, who is an independent 3rd party.
  • The Trustee maintains the ‘conditional’ title for the note holder (aka the lender, or the beneficiary).  

A Trustee is authorized to:

  • Reconvey (i.e. detach) the Trust Deed from the property’s title when the lien is satisfied in accordance with the provisions delineated by the promissory note.
  • Sell the property should the borrower default on the loan and find themselves facing a foreclosure

Foreclosure

As noted above, a foreclosure is a legal action that occurs when the obligated borrower defaults on the promissory note upon which they are legally bound.  A Foreclosure action begins with a filed ‘Lis Pendens’, which is Latin for ‘suit pending.’   A foreclosure is a legal action that involves the note holder’s ability to sell the subject property to a third-party bidder or, simply take title to the property. Generally speaking, a completed foreclosure action satisfies the defaulted debt.

Trust Deed investing always carries some risk, however, trust deed investors can use this legal method to recoup all or some of any losses experienced. Foreclosure is an intricate process but the most prudent way to attempt to minimize losses. Foreclosure matters are best guided by attorneys who specialize in real estate matters.  

The Takeaway

Investing in a trust deed essentially places the investor in the shoes of a lender. It is a great way to gain insight into how a bank underwrites and assesses the risk they are agreeing to undertake.

Is Trust Deed Investing Profitable?

Is Trust Deed Investing Profitable?

With any type of investment, there is the possibility for great profit and for great loss. It’s the nature of investing. There are things you can do to minimize your risks while maximizing your potential. If you want to consider trust deed investing, for instance, there are a few things you can do to boost your potential for profit.

Get to Know the Local Market

It’s not enough to know what’s going on in real estate nationally if you’re looking to make your first trust deed loan. You need to understand what’s going on locally. More specifically, you need to do your homework and know how quickly properties are moving within the community where the investment is being made and how much those properties tend to go for (and in what condition). These key details will help you understand which types of loans you’re willing to invest in a specific real estate market too.

Trust Your Broker, But Verify the Deal

It’s always good to develop a mutually beneficial relationship with a mortgage broker if you’re looking to invest in hard money loans for real estate. But, it is even more important to protect your financial interests. After all, brokers have a stake in making the deal as well. Make sure you do your homework on the property and avoid the temptation to let the broker do all the heavy lifting for you when it comes to researching the deal.

Be Specific in the Details

There are many moving parts involved in trust deed investing that go beyond the basics of offering the money and being repaid. You need to establish the terms of the loan before the deal is done including the repayment period, how often and how much you will be paid and who will hold the title during the repayment period.

Make sure that all terms are spelled out in the agreement and that all parties understand their roles in fulfilling those terms. Never sign if there are details that seem unclear to you. This will help to avoid any confusion after the fact.

Protect Yourself and Your Stake in the Investment

The beauty of hard money lending, like trust deed investments, is that you can earn a substantial return on your investment, however, if the deal goes south you might be left holding nothing if you fail to stay on top of things like property taxes that could provide another entity, such as Uncle Sam, a claim to the property if the borrower defaults.

If the borrower begins to get behind in notes with you, it is likely that he or she may be getting behind with other stakeholders who may have a claim to the property securing the loan as a result. You may need to step in and make these payments in order to protect your interest in the property should the borrower default. You should be prepared for that possibility when offering the loan as a trust deed investor.

Vet Your Borrower

While the real estate is your security when investing in trust deeds, it’s important to understand the creditworthiness of the borrower as well. This will help you lend with confidence that the borrower has a history of responsible borrowing and repayments. However, even the best vetting processes in the world can’t foresee every possible outcome or problem. Always invest with caution.

Can Trust Deed Investment be Profitable?

Absolutely! In fact, many investors prefer this type of investment because it offers a far better, and faster, return on investment than other investment opportunities allow. Before you dive in, though, it’s important to take steps that minimize your risk and reduce your exposure should things go south.