Understanding Hard Money Loans for Real Estate Investing

Report: Understanding Hard Money Loans for Real Estate Investing

Executive Summary

Hard money loans are short-term, private loans used primarily by real estate investors. They are characterized by higher interest rates and fees but offer significant advantages over traditional financing, including speed, flexibility, and a focus on the property’s potential value rather than the borrower’s creditworthiness. They are a crucial tool for strategies like fix-and-flip or bridge financing.

What is a Hard Money Loan?

Definition: A short-term, private loan from an individual or private company, not a traditional bank or government agency.
Primary Use: To finance the purchase and rehabilitation of an investment property for a quick resale (fix-and-flip) or to hold until long-term financing can be secured.
Term Length: Typically 1 to 2 years.
Key Feature: Loans are based on the property’s After Repaired Value (ARV), not its current value.

Key Players: Lenders and Brokers

Hard Money Lenders: Private individuals or companies that provide the capital for the loans.
Hard Money Mortgage Brokers: Specialists who connect real estate investors with private lenders. They are the most common point of contact for obtaining this financing.

Key Terms, Costs, and Payment Structure

Interest Rates: Typically range from 12% to 18%. While high, the payment structure mitigates the impact.
Points: An upfront fee charged by some brokers/lenders, where one point equals 1% of the loan amount. Typically 5-10 points, though many charge none.
Prepayment Penalty: A fee for paying off the loan early, often around 3 months’ worth of interest. Not all lenders charge this.
Payment Structure: Interest-Only Payments.

- Monthly payments cover only the interest, not the principal.
- This keeps monthly overhead low for the investor.
- Example: 18% interest on a $50,000 loan results in a $750/month interest-only payment.

Lending Guidelines & Qualification

Basis for Approval: The loan is secured by the property’s value, not the borrower’s personal credit or job history.
Loan-to-Value (LTV): Lenders typically loan between 50% to 65% of the After Repaired Value (ARV).
Credit Requirements: A significant advantage. Many lenders do not check credit, while some may require a minimum score (e.g., 600-650). Qualification is generally easy.

What Can Hard Money Finance?

Hard money loans are flexible and can cover:

100% of the property purchase price.
100% of the necessary repair costs (held in an escrow account).
In some cases, more than the total cost of purchase and repairs, which can help cover mortgage payments during the project.

Key Benefits and Strategic Advantages

Accessibility: Easy to qualify for, making it possible to buy properties without strong credit or a large down payment.
Speed & Flexibility: Avoids the “red tape” of traditional bank loans.
Strategic Cost: The high interest cost is often justified because:

- It is short-term, minimizing the overall financial impact.
- The availability of funds (allowing you to do the deal) is more important than the cost.
- It is often cheaper than giving away a large share of profits to a partner.

Deal Facilitation: Investors can refer their wholesale buyers to hard money brokers to speed up the sale process.

Required Documents & Closing Considerations

Key documents required for closing include:

“Subject To” Appraisal: Based on the ARV and a provided list of planned repairs.
Hazard Insurance: With the lender named as “additionally insured.”
Title Insurance: A lender’s policy is required; an owner’s policy is highly recommended.
Note and Mortgage: The core loan agreement.
Assignment of Rents: Allows the lender to collect rent if the borrower defaults.
Repair Escrow Agreement: Details the repair schedule, fund draw process, and inspection fees. Repair funds are always held by the closing agent.

Important Considerations & Warnings

Referral Responsibility: Be cautious about who you refer to your hard money sources. If referred investors default, it may damage your relationship with the lender.
Protecting Your Sources: When referring wholesale buyers, only do so after they have signed a sales agreement and provided a deposit. Consider requesting a non-circumvention agreement from the broker.
Term Length: Ensure the loan term is long enough for your strategy (e.g., a 12-month term is insufficient if you need a 12-month “seasoning” period before refinancing).