Hard Money Lender Basics
Imagine you are a real estate investor with a golden opportunity: a fixer-upper in a prime location. But your bank turns you down because there are signs of mold from a leaky roof. Sound familiar? This is where hard money loans come in.​
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Not all hard money lenders are the same. In this article we will provide some basics of hard money loans and highlight our most popular hard money loan products.
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​What is a hard money loan?
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A hard money loan is typically a short-term loan secured by real estate, and funded by a private, non-government, non-banking source. Unlike traditional mortgages, which rely heavily on a borrower's income and creditworthiness, hard money loans are based primarily on the property's loan-to-value (LTV). These loans are often used by real estate investors for quick financing, such as for property flips or purchases.
Key characteristics of hard money loans:
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Short-term, typically less than a year
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Loan secured by real property
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Higher interest rates than government and bank loans, lower than credit card
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Faster funding
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Less stringent qualifications, often centered on loan-to-value rather than borrower's current income
Why hard money loan?
While it is true that some people turn to hard money loans when they’ve hit hard times, many also turn to hard money loans for more strategic opportunities or where other sources are simply not available.
We Abundance frequently work with borrowers who have excellent credit and ample down payment. Here are some of the reasons they’d choose hard money lenders like Abundance:
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The property is in poor condition and would not qualify for a conventional loan;
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Borrowers only plan to keep the property or the loan for 4 to 6 months, and do not want to get on the bad side of conventional lenders with “early pay-off” (EPO) penalty;
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Either the buyers or the sellers want to close escrow quickly;
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Borrowers already have too many (10+) residential loans under their names;
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Property is owned by several partners in an LLC;
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Borrowers do not meet the debt-to-income ratio requirements of traditional lenders.
Who uses hard money?
Many of our hard money borrowers are sophisticated real estate investors, flippers, or developers. They use hard money loans to seize opportunities. Even if they have idle cash for the entire purchase, they prefer to use leverage to give themselves the option to buy more properties if opportunities present themselves. They don’t want all their money to be tied up in one project. In a way, we Abundance serve as their “investor relations” so that they dollars can stretch further. This is our Fix & Flip Purchase Loan product.
Some Abundance borrowers choose hard money loans when they anticipate a very short-term need for the funds. For example, a retired couple own their existing home in Sunnyvale free-and-clear ($3,000,000), and want to downsize to a smaller home ($2,000,000) closer to family. They choose to buy their new home first, before they sell. They choose to borrow the $2,000,000 purchase price from Abundance, rather than selling their stocks and pay 35% capital gains taxes. Once they sell their existing home in 6 to 8 weeks, they’d pay off our loan, and own their new home free-and-clear. By using our bridge loans, not only do they save on the capital gains taxes, they save themselves the hassle of a short term rental, and they may get a higher sale price when selling their existing home refreshed and and staged. Banks want residual income and don’t offer short term loans like this. This is our Owner-Occupied Bridge Loan product.
Some Abundance borrowers are seasoned real estate investors. They want to upgrade their real estate portfolio through tax deferred 1031 exchange, but they don’t want the 45-day identification stress. They’d borrow our funds to purchase the replacement property first, and then do sell their existing investment property to pay off our loan. This is our Reverse 1031 Exchange loan product.
We Abundance also work with estates, where heirs or the successor trustees use our funds to divide the estate assets, before they dissolve the estate and re-finance to a conventional loan. This is our Estate Equalization Loan.
Some hard money lenders serve borrowers down on their luck – with poor credit or recent bankruptcies. While we Abundance will work with borrowers who had a temporarily dip in their credit scores (i.e., forgot to pay a new Nordstrom credit card while on vacation), we tend to shy away from borrowers who have recurring financial issues.
Who are hard money lenders?
Hard money lenders are often private individuals; a group of private individuals coming together in a “debt fund;” or Wall Street-based hedge funds using Wall Street or bank lines of credit. Each category of hard money lenders has its own cost of funds, and regulations.
In the case of Abundance, we do “fractional trust deeds” where up to 10 private individuals come together to do a hard money loan secured by a specific piece of real estate. These are not wealthy individuals; they are good savers and long-term investors. We chose this “fractional trust deed” structure so that our investors can pick and choose their loans for diversification; and to keep our administrative cost lower so borrowers can enjoy lower interest rate.
Some of the big hard money lenders use Wall Street or bank lines of credit. This gives them the opportunity to enjoy a bigger “spread” between what the borrowers pay and the cost of their lines of credit. Unfortunately, this also ties their hands when Wall Street freezes (as during the initial months of COVID) or when their line of credit interest rate spikes (as from the recent Federate Reserve rate hikes). These big hard money lenders generally have a more volatile business cycle as a result, and therefore must pass the cost of their money to their borrower through very high default rates and extension fees when a loan matures.
What are the typical hard money loan terms?
Hard money lenders are often more able and willing to negotiate on the terms – e.g., loan-to-value (LTV), loan duration, amortization period, payment frequency, etc. As such, there are more variations in hard money loan terms than in conventional government or bank loans. Most hard money loans have monthly interest-only payments and last only a year. Some hard money lenders will offer longer terms, 15 years or even 40 years. This is another reason why even financially savvy borrowers consider hard money loans.
Are hard money loan interest rates higher?
Yes, hard money loan interest rates are higher than conventional Fannie/Fredie loans and bank loans. Actual interest rate depends on a variety of factors - loan-to-value (LTV), credit scores, property type, market supply & demand for hard money, just to name a few.
Interest rate and loan origination fee are two of the many factors to consider when getting a hard money loan. A borrower should also consider these basics:
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What is the LTV?
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When does the loan mature, and would the lender be willing to extend if you need more time?
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Is there pre-payment penalty? If so, what is penalty schedule?
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Does the lender require interest reserve?
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What’s the lender’s track record of delivering the loan on-time? We often hear stories of private lenders who change their mind at the last minute, or who fail to deliver the loan on-time.
Are hard money lenders regulated?
Yes, very much! We Abundance are regulated by the Department of Housing & Urban Development (HUD) for fair lending; by Consumer Financial Protection Bureau (CFPB) for consumer loan disclosures; by the California Department of Real Estate (DRE) for business loan disclosures, investor protection, and trust account management. We are also regulated by the IRS for tax reporting for interest paid by the borrowers and to the investors. We submit our trust account statements to a 3rd party CPA for quarterly and annual reviews; and to both DRE and via the Nationwide Mortgage Licensing System (NMLS).
The big hard money lenders who use debt funds or Wall Street funds may also be regulated by the SEC.
Why Abundance for hard money loans?
Borrowers like Abundance because we are fast, dependable, and we believe in win-win. We usually make a “go” or “no go” decision within 24 hours. We have never, ever delayed escrow closing by even a day. We will tell our borrowers if we see red flags with the property they’re looking to buy. We will work with borrowers if they need more time to complete a project. We often help our borrower clients navigate between conventional loans and hard money loans so they can enjoy the best of both worlds. And yes, our interest rates and loan fees are more reasonable than most bigger hard money lenders.
Investors like Abundance’s trust deed investing because we use our decades’ experience in real estate to evaluate and structure these loans to minimize risks for our investors. We often invest in these loans alongside our investors, or even take a junior position to our investors.
How do you want to play?
Are you thinking of getting a hard money loan to do your first “fix & flip”?
Are you thinking of buying a small apartment community with your family and friends to build retirement income?
Are you thinking of investing in hard money loans?
Call us for a free consultation to see if hard money loan is a good option for you.
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