When you first enter real estate investing, you hear a lot of terms that do not exist in other industries. One of these, hard money, sounds like it has to do with concrete deals, but it actually describes a type of loan specific to the real estate industry.
It does not refer to anything related to loan sharking although a lot of people assume that. I guess they think the “hard” half of the term must come from somebody’s brass knuckles or such.
Your bookie will not be involved in this loan, either. Although you could say you are gambling with your money investing in real estate, it really is not the same thing.
You could turn to search engines for loan financing information. If you used Bing or Google to search for hard money loans you probably got that idea though because most websites and blogs have even one word about it write in an extremely evasive manner. You know, I don’t do that. Ever.
I lay it all out for you and I am straightforward and honest. It freaks some people out, but I never care.
So, here is the straight truth about hard money loans. They can either save you and make your investment happen, or you can ruin yourself by handling it wrongly.
The best thing to do is to handle it as it traditionally was – individual to individual.
Hard Money Loans Defined
You probably wonder what that means. Well, a hard money loan is a one-to-one thing. Rather than going to Citibank, you approach a private lender. Okay, that probably also gave it the aura of mystery it has.
A hard money loan is a type of short-term real estate loan extended by a private lender and backed by assets, typically real property. These loans typically have a repayment period of six months to three years and charge higher interest rates and fees to enhance the return on investment (ROI) received.
Tell Me More About Hard Money Loans
Typical real estate purchases do not require this type of loan. For most purchases, you will obtain a traditional mortgage. You would take out a hard money loan when you want to purchase a fixer-upper, a house to flip or a dilapidated property to tear down the existing structure or structures and then construct something new.
A hard money loan then generally provides the funds not only to buy the property, but also to renovate or remodel it. Once the buyer has renovated or rehabilitated the asset to an acceptable level, the buyer obtains a traditional mortgage from a commercial lender, then pays off the hard money loan in full, if they had not already.
Where to Apply for a Hard Money Loan
If it is not your street corner and not your bookie and also not your credit union or Citibank, you probably wonder where the hell this loan is coming from and how they have all this money.
You will also probably be happy to learn that the hard money lenders consist of pretty normal sources in finance. It is typically one of the following three:
- Private individuals such as venture capitalists offer these loans for a higher-than-market (ROI).
- Privately managed funds that specialize in real estate developmental funding.
- Mortgage brokers working with non-traditional sources like insurance firms and individuals.
Specialty Loans within Hard Money Loans
Hard money loans are an enigma wrapped in a stigma as the cinematic line goes. If you thought only one kind exists, surprise! There are six types of hard money loans.
Applying for a Hard Money Loan
The awesome news is that the three types of financial lenders that offer these loans want to make them. They actively scout for new projects. They look for well-planned projects with a clear exit plan and some of the borrower’s own money invested.
While your credit history still matters, it does play a smaller role. You can have a few credit problems and still get the loan. That makes this a strong financing option, but you have to be prepared. You need to approach a financial lender with a statement of intent that concisely explains your need for funding and your means to repay it.
The Next Step In Application
You get your finances in order before you submit your application. If you have never applied for a loan before, let me warn you. It takes a little preparation.
If you ever prepared a budget before, you will go through many of the same steps. You have to be able to document your finances.
You have to prepare business documents, too. This means you need to prepare your business plan and your investment plan. That is at a minimum.
You also need to provide potential financial lenders with the project budget and the estimated project calendar. The lender needs to know the length of time the project costs because comprises one component of their algorithm. It will contribute to the loan term.
As much as the genius entrepreneur Elon Musk likes to wing it without a business plan, in real estate investing and development they are required in order to obtain a hard money loan. If you’re Musk, you simply fund your project by selling cute hats. If you’re not, you better get to work on your business plan, investment plan, and your project calendar.
Hard money lenders specialize. This is the only type of loans they typically make. That means they have experience. It also means that they know what to look for in a properly prepared project. They will sniff out BS quickly, but will be more than willing to fund a genuine project even if it is your first.
So, what are some other items you can bring to the lender when you apply for the loan to show you truly prepared for your project?
Whether you plan to flip a single house, build a street of townhouses or erect an entire planned unit development (PUD), you need to show the potential financial lender the plans. That means you bring the actual blueprints for a remodeling project for a house flip. In the cases of the row of townhouses or a PUD, you need the plat documents, the site plans, the development plan. That should take the form of hard copy plans or digital versions. The latter typically provides more information in a succinct format since it uses geographic information systems (GIS) to display the information.
GIS plans merge a map of the site or subdivision with a database of information. You probably have used a GIS map without realizing it. If you have ever used Yahoo Maps or Google Maps and clicked on a point of information – clicked on the address marker, for example. The information that displayed came from the database linked to the map.
You probably are not undertaking a project of that size alone, but if you were, even if it was just planning to flip a house, you need the blueprints. Maybe you were planning to function as your own builder, but you will still need plans. If you want the hard money loan, you do not get to wing it.
The Required Asset
You also already have to own property to obtain a hard money loan. That is because you must provide an existing property asset in order to qualify for a hard money loan. Hard money is secured money and you cannot access the money, i.e. avail yourself of the loan, without the asset to secure the loan.
So, collateral required.
The property does not have to perfect. You just have to own it. Some hard money lenders will actually still loan to if the property you own is in foreclosure or if you or your company is in bankruptcy proceedings. The house equity or home equity matters, too. It really has to be yours free and clear to qualify for use as collateral.
You mean you did not realize that I was only discussing the items you had to get ready before you go to apply? Dang. Yep.
So far, we have only covered the things you need to have on hand and ready so you can go apply for the hard money loan.
Now, you get to go to the potential financial lender and actually apply. That is the paperwork to which I am referring.
You really want to get into real estate development and investing, right?
See, they make it look so fun and easy on TV. Remember that those TV shows encapsulate weeks or months worth of work into an hour or two of TV time.
Maybe life would be better if those “reality” shows actually showed the dates and project milestones on the screen like Law and Order do the trial parts. Because real estate, construction, and development do not really work as they show on TV. To be honest, the folks on the TV shows do not even really know what shiplap is.
Once you have the blueprints, plans, budgets, project calendar, and more plus your property asset in place, you can complete your application. Depending on your lender, you may need to fill out a paper application or an online application.
The terrific news is that you typically only have to wait 24 to 48 hours to find out if you were approved. The potential lender quickly checks your bank balance, credit score, income, your collateral documentation. Once approved, you typically receive the money immediately which lets you move quickly on a specific property.
How Much You Have Decides How Much You Get
While market conditions change, in the current climate, you can borrow up to 70 percent of your collateral property’s value. That means if you own more than one property and you need to fund a large project, your best bet would be to use the most valuable property you have. That would guarantee you can obtain the funds you need.
Caveats to Hard Money Loans
A few caveats exist to hard money loans.
Every hard money lender establishes their own loan guidelines. Private investors also have their own requirements. That means one may provide you with a one-page application while another may require five pages. One may only require a business or investment plan while another may require every piece of preparation paperwork discussed above including blueprints and GIS.
You have to be prepared to pay back the loan. Unlike a mortgage, you will not get 20 or 30 years to pay this back. You have to make the monthly payments and you start the month following the loan application acceptance. The financial lender does not really want your property. They want their money back.
If you do miss payments or do not flip the property, the financial lender will assume your collateral. That means it will take possession of the property you already own to pay for the money you did not payback.
You will pay high-interest rates on hard money loans. Cheap hard money does not exist. We are talking 12 to 18 percent interest rates. You will pay dearly for this short-term loan, but you can typically obtain these when other loan types would remain out of reach.
You will also pay closing costs. Getting the loan costs you between 2 to 10 points. One point equals one percent of the hard money loan amount.
Other Investment Strategies
The unfortunate thing about real estate is that it requires fast money. You need funding quickly and hard money lenders can provide it.
What if you can only get part of the money you need from the hard money lender?
Well, you have to find another funding source, of course.
You may not have the time to apply for soft money – a traditional loan. It does remain an option though. Those loan approvals can take up to ten days.
You could obtain a business partner. Maybe you have a family member or friend who would like to also invest some funds and they would willingly invest in the project.
You could – okay and this would be A LOT of work – entertain funding from a venture capitalist or angel investors. You already would have the business plans, blueprints, and other nifty items you need. And you need the elevator pitch and the appointments. Get cracking.
If none of that works for you, you can try selling hats like Musk. Or you can incorporate and sell the stock. Or you can form a partnership with a number of small investors.
You can also crowdfund. The great thing about crowdfunding is that you do not have to have a specific project in mind, but you do have to have a genuine business. Most crowdfunding platforms let you unofficially sell a tiny piece of your business. The people who contribute do not own a piece of the company like stock. That would require far too much IRS and SEC paperwork to remain feasible. Instead, they typically receive the product you create or an advance copy of your book or, in this case, some gift or token from the project.
You can get creative with that part. Let’s say you want to buy houses to flip them. You specialize in brick homes. You can make the demo bricks the gift. This works well if they were dated or stamped with some old brick company’s name, etc. It makes the bricks memorabilia.
You might work with a publicist or author to create an e-book on remodeling, renovating, home updates, going solar, converting a home to a smart home, etc. This can be the item the crowdfunding investors get when they contribute. This method also lets you set contribution levels rather like those you might see at the end of a film for producers – executive, assistant, associate.
The good thing is you will usually only need about 30 to 35 percent of the project cost from these other methods. Most of the funding comes from a hard money loan. They can take a lot of work to land one, but you will quickly have the funds to purchase the property you want to flip and buy yourself the time to raise the remainder of the funds for the renovation.