06 Jun 2013
When hard money loans make sense
Across the globe, savvy real estate investors are buying up as much property as they can due to the continuing buyer’s market. Yet, funding multiple properties can prove challenging:
- New investors may lack credit or capital while those with larger portfolios may have exceeded their debt-to-income ratio.
- Investors seeking to flip houses often stumble over FHA’s guidelines limiting or prohibiting ‘flips.’
- Banks won’t fund properties that need a lot of work. They also don’t easily fund investors who draw 1099- versus W-2-wages.
A Hard Money Loan, or HML, can be an excellent solution to these and other funding barriers. How do they differ from traditional mortgages and how do you select the right one for your project?
Hard Money versus Traditional Loan
When investors seek hard money, they quickly realize that the lenders evaluate the property’s risk and potential earnings more closely than the applicants’ credit and income statements. Probably the biggest factor lenders weigh is what the property will sell for – quickly – in case the borrower defaults. The subject property also acts as collateral. Documentation is light for a HML but considerable for a bank loan. Using hard money invokes higher loan fees but quicker processing.
When shopping for a HML, you need to know how your loan is structured, how it is applied to your needs, and how to qualify for the best terms.
Structuring Your Loan
Hard money lenders first evaluate a loan based upon the property’s Loan-to-Value (LTV) Ratio. Lenders describe this as ‘the amount the property would yield at a fire-sale.’ The actual formula is shown as:
Loan to Value Ratio =
Appraised Value of Property
Lenders often seek percentages at or under 65%.
So, if you want to borrow $150K for a house worth $180K, the LTV is 87%. This deal would not be widely appealing. But if you supplied 20% cash or collateralized real estate, the LTV drops to 67%. The lender would find this more likeable, especially since you are not asking for 100% funding.
Note that some lenders won’t fund 100%. Kevin Amolsch, President of Pine Financial Group, Inc. says, “We loan 100% of the purchase and repairs so our clients get their projects with little or no money down. We only succeed when our clients (do) so (their) successful project is our top priority.” The company lends to fix-and-flips and new construction. They require that borrowers have some cash (for 100% loans) to minimize their risk.
Ways to use Hard Money Loans
Since HMLs are not tied to FHA, Fannie Mae/Freddie Mac, or other government-sponsored regulations, they are used in many situations. Contrast that to traditional, commercial loans: Acquisition Loans acquire property; Acquisition and Development Loans acquire and develop property; Development Loans, you guessed it, develop. There are dozens of commercial loans and what’s mind-boggling is that each one is governed by different sets of laws.
Note that some lenders won’t fund 100%.
Although the HML is usable for any loan that the lender allows, still do your homework. Just because you can get hard money for your construction project does not mean it is your best option. It is almost certainly the most expensive option. Get a couple of quotes from mortgage brokers. A traditional bank loan will be worth the paperwork-headache if you qualify.
Also consider that low documentation isn’t always desirable. Sherman Bridge Lending makes HMLs for acquisition and repair. Kurt Carlton, CEO, comments, “If a lender says, ‘I don’t even pull credit’ it should be a red flag. This means they are only interested in the property and the success of the investor means little to them.” You don’t want your lender to be championing your default, whereby they get the property.
Fees and Terms
Terms aren’t nationally standardized so comparison shop and negotiate. What are ‘the usual’ fees? Rehab Cash Now is a national lender that offers loans at median prices. Jeff Tesch, Managing Director, explains, “Our loans are interest-only with a balloon payment at maturity. Usually, terms are one year with 1% interest per month [12% annualized]. Closing costs vary.”
The Norris Group is another HML that charges typical fees, evidenced by their posted rates. However, VP Aaron Norris, reminds us that ‘terms’ means more than financial and that ‘professionalism’ can differentiate applicants. “When we get docs in a timely manner, correctly signed, it’s amazing how quickly we get things done.”
Putting it All Together
Although the HML is usable for any loan that the lender allows, still do your homework.
Borrowers should always compare various lenders’ qualifying criteria and terms. These include interest rates, annual percentage rates (APR), points, closing costs, LTV, work out solutions, prepayment penalties, and closing intervals. You should ensure you meet the basic criteria required, then spend some time to rate the lenders, and schedule meetings accordingly. Finally, prepare a formal presentation to pitch yourself and the property, ensuring you cover the following sections:
- The People: Bios of Borrowers, Loan Applications, Credit Reports, Identification, Brief Resumes, References.
- The Property: Purchase Agreement, Appraisal or BPO, Insurance Binder, Title Commitment, Photos, Repair Estimate.
- The Numbers: HUD1 including Acquisition, Repair, Purchase, Closing, Holding, Realtor Costs. Highlight the After-Repaired Value; Projected Profit and Timeline.
By taking the time to understand the characteristics, qualifying criteria and the best uses of Hard Money Loans, investors can maximize their purchasing ability during a buyer’s market and enrich their real estate portfolios.