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.