Creative Finance 101: Understanding Hard Money Loans For Real Estate Investing
Introduction
Hard money loans, like private money loans, are a vital tool for real estate investors. They offer unique opportunities but also come with their own set of benefits and risks. In this article you will learn the ins and outs of hard money loans.
What Are Hard Money Loans?
Hard money loans are short-term loans provided by private investors or companies. These loans are typically secured by real estate assets, making them a popular choice for real estate investors.
Where Do You Get Them?
Hard money loans are typically sourced from professional hard money lenders. These lenders are often real estate investment professionals themselves, and they understand the needs and risks associated with real estate investments.
Benefits of Hard Money Loans
Speed: Hard money loans can be processed and approved quickly, often within a few days. This speed can be crucial for real estate investors looking to secure a property quickly.
Flexibility: Hard money loans offer flexible terms and conditions compared to traditional bank loans. The loan amount, interest rate, and repayment schedule can often be customized to fit the specific needs of the borrower.
Accessibility: Hard money loans can be an accessible alternative for investors who may not qualify for traditional loans due to poor credit or lack of a consistent income.
Risks of Hard Money Loans
Higher Interest Rates: Hard money loans typically come with higher interest rates than traditional loans. This is because they are considered riskier by lenders.
Shorter Loan Terms: Hard money loans usually have shorter loan terms, often ranging from six months to a few years. This means that borrowers need to have a clear exit strategy in place.
Potential for Loss: If a borrower defaults on a hard money loan, the lender has the right to take possession of the property used as collateral. This could result in a significant financial loss for the borrower.
Hard money loans are typically used for real estate investments, including fix-and-flips, land loans, construction loans, and more. They provide investors with the capital they need to purchase and improve properties quickly.
Understanding the Terms
The terms of a hard money loan can vary greatly depending on the lender and the specifics of the deal. However, most hard money loans include the following components:
Principal: This is the amount of money borrowed.
Interest Rate: This is the cost of borrowing money, expressed as a percentage of the principal.
Loan-to-Value (LTV) Ratio: This is a measure of risk used by lenders. It’s calculated by dividing the loan amount by the appraised value of the property.
Points: These are fees paid to the lender at closing. Each point is equivalent to 1% of the loan amount.
Difference Between Hard Money Loans and Private Money Loans
While both hard money loans and private money loans are types of private lending used in real estate, there are some key differences:
Source of Funds: Hard money loans are typically funded by businesses or investors that lend money as a business. In contrast, private money loans can come from a variety of non-institutional sources, such as individuals or families.
Loan Terms and Structure: Hard money loans often have more formal and consistent loan terms because they are typically provided by professionals. On the other hand, private money loans can have more flexible and negotiable terms because they may come from friends, family, or personal connections.
Regulation: Hard money lenders are generally more regulated than private money lenders because they operate as businesses. This means they need to comply with state and federal lending laws.
Remember, whether you choose a hard money loan or a private money loan, it’s important to understand the terms and conditions, assess the risks and benefits, and consult with a financial advisor or attorney if needed.
The Fix and Flip Process in 5 Steps with Hard Money
Let’s walk through an example of how an investor might use a hard money loan to fix and flip a property.
1. Property Acquisition
Our investor finds a distressed property listed for $100,000. After doing their due diligence, they determine that the ARV of the property is $200,000. They approach a hard money lender, who agrees to lend 70% of the after repair value (ARV), or $140,000.
2. Renovation
With the loan funds, the investor purchases the property and sets aside the remaining $40,000 for renovations. The renovation process is where the investor can truly add value to the property. It’s crucial to focus on improvements that will increase the property’s value without going over budget.
3. Sale
Once the renovations are complete, the investor puts the property back on the market. Let’s say they sell the property for its ARV of $200,000.
4. Repayment
After selling the property, the investor repays the hard money lender the original loan amount plus interest. Assuming an interest rate of 12% over six months, the total repayment would be $148,000.
5. Profit
After repaying the loan, the investor is left with $52,000 ($200,000 sale price - $148,000 loan repayment), minus any closing costs and fees. This is their profit from the fix and flip project.
Conclusion
Hard money loans can be a powerful tool for real estate investors, offering speed, flexibility, and accessibility. However, they also come with higher interest rates and potential risks. As with any investment, it’s crucial to do your homework, understand the terms of the loan, and have a solid plan in place before proceeding.