We as investors advertise ourselves as cash home buyers. However, the most successful house flipper most likely does not use their own money. Why you may ask? Because it is very difficult to flip more than one house at a time using only your own cash. Investors see the opportunity to scale by using other people’s money.
So what is a Hard Money Loan?
Hard money loans have terms based mainly on the value of the property being used as collateral, not the creditworthiness of the borrower. Hard money loans are typically used by real estate investors and developers and can be arranged much quicker than a loan through a traditional bank. Hard money lenders usually lend up to 65%-75% of the properties After Repair Value and the loan terms are generally short 6-18 months. Interest rates are also higher than traditional mortgages, typically between 8-15%.
When searching for a Hard Money Lender there are many questions you should be asking them when vetting to see who the best fit is for you. Sometimes the best terms aren’t always the best lenders to work with. Below I’ll outline some questions to ask:
I’m writing this as if you are a new investor and haven’t done many deals. More experienced investors who have built a relationship with a hard money lender will be able to negotiate better terms than outlined below:
- What is your max loan amount?
Most Hard Money lenders will lend on 100% of the rehab and 70-90% of the purchase price to not exceed 65-75% LTV (65-75% of the ARV of the subject property). It is important to ask this upfront because it will impact how much additional cash you will need to close referred to as gap funding. As you build a relationship with Hard Money Lenders the % of the purchase price they will lend will increase.
- How many points do you charge?
All Hard Money Lenders will charge a “Loan Origination Fee” referred to as points. 2 points would be 2% of the total loan amount. This will be charged to you at closing which will increase your closing costs. As you build a relationship with Hard Money Lenders you may eventually not be charged any points.
- What interest rate do you charge?
Hard Money Lenders usually charge between 8-15% and this will have a large effect on your monthly holding costs. Be sure to ask the lender what rate they will charge. As you build a relationship with Hard Money Lenders you will be able to negotiate better interest rates.
- Do you require an appraisal?
Some Hard Money Lenders require an appraisal to verify the ARV of the subject property which cost you around $800 at closing. However, some smaller Hard Money Lenders do not require an appraisal. Appraisals can hold up closing and prevent you from closing as quickly as you may advertise.
- What are your Processing and Legal fees and Draw Fees?
It is important to ask for the full breakdown of processing and legal fees from each lender. Many lenders may charge a low interest rate but charge a lot for some form of Legal document fee, processing fee, or attorney fees. Also, most Hard Money Lenders will charge a draw fee every time money from the construction reserve is drawn. This fee can range from $50-$350.
- How are funds held back for construction disbursed?
In my opinion this is the most important question. While your total cost of financing is important, it is even more important to get this question answered. Do you require a 3rd Party Inspection to confirm draw funds to be released? Most Hard Money Lenders will schedule a 3rd Party to inspect your project when you ask for a draw for the work completed on your project. This will most likely result you in not receiving those funds for at least 1 week from the time you requested the funds. Some Hard Money Lenders will release the funds within 1 day and don’t require a 3rd party inspection, just pictures from you.
- Is interest paid on the borrowed balance or on the total loan amount?
Lastly, ask if interest is paid on the total loan from the origination date including the construction reserve, or if interest is paid on the outstanding balance as the construction reserve is dispersed throughout the project.
I believe it is the most important to find the Hard Money Lender that is the most convenient to work with. We use a local lender, Pimlico Capital, because they don’t require an appraisal and don’t require 3rd Party inspections to release draws. This does come with a cost, they typically charge 1-2% higher than the lowest rate we could find. They also charge that interest on the total loan amount from the origination date. However, they disburse draw funds usually the same day I submit pictures. This is very important to keep your contractor on schedule. If you have to wait for a 3rd party inspector you will be forced to front contractor payments to keep them on schedule. Also, we do save on appraisal fees since Pimlico does not require one to close. This increases the terms of our offers because we are not contingent on any appraisals and can close fast.
If you’re working on a project that will require a long time frame or at a super high price point then the terms of the loan become even more important. In this business speed is everything! We don’t mind paying 11% on a hard money loan if we know the total duration of the loan will be no more than 4-5 months. But if you are working on a project that will take 8 months and the total loan amount is hundreds of thousands.. Then the terms of the loan can save you 10s of thousands in financing costs. Maybe it would be more beneficial in those cases to raise more private capital if needed to front contractor payments while you wait for draw funds to be disbursed.
Once you find a Hard Money Lender you work well and be sure to stick with them. Building that relationship will allow you to negotiate better terms with you because you will be building trust with them as you complete each deal. They’re in a risky lending business and greatly appreciate efficient, profitable, and successful real estate investors.