Hard money loans are an invaluable resource to real estate investors, especially for those who need to close on that deal quickly or who don’t qualify for a traditional bank loan. Still, it’s important for investors to know how to spot unscrupulous lenders.
When real estate investors need financing, hard money loans are a common source. Hard money loans are typically funded by private individuals or groups of private individuals. They typically are easier to obtain compared to traditional loans, but come with higher interest rates.
They are ideal for short-term financing — fix-and-flip investors love them, as do investors who need quick closings to snatch up good deals before the competition. Hard money loans are also attractive options for people with poor credit, because they place greater emphasis on the value of the property being purchased than the credit history of the borrower.
Because hard money loans are not regulated in the same way as conventional loan products — the bank loans people use to purchase their primary residences — there are more opportunities for fraudulent activity on the part of lenders. Here are some things to keep an eye on to help you weed out the scammers from the legitimate lenders.
1. Offers are too good to be true
Be on the lookout for loan offers that seem too good to be true — they often are. Hard money loans can close quickly and be a viable alternative for borrowers with poor credit, but that means they also come with higher interest rates — expect to pay between 10 percent and 15 percent.
If a lender offers you a rate much lower than that, consider it a warning that they may not be legitimate. Also be on the lookout for lenders that guarantee they can fund any loan. Hard money lenders typically fund loans with low loan-to-value (LTV) ratios. The maximum LTV most hard money lenders accept is 70 percent, which means you’ll need a down payment of at least 30 percent. This helps ensure lenders that if you fail to repay the loan, they can sell the property and recoup their investment.
2. You need to pay a lot upfront
It’s normal for hard money lenders to charge fees — that’s one of the ways they make money. But one warning sign of a scam is a lender that charges excessive fees that you have to pay upfront. Some hard money lenders charge these high fees and then find an excuse to not fund the loan, and you don’t get a refund. Many legitimate lenders will refund all or part of such fees if the borrower doesn’t qualify for a loan.
3. Who is this lender? No one knows
Look into a lender’s reputation before getting into a business relationship. Shady lenders may change names frequently to make it harder for borrowers to identify them as scammers. If you have difficulty pinning down a lender’s history, either good or bad, proceed with caution. Look for the name of the company, as well as the top managers.
Start with a general search to ensure the company has a verified telephone number and a physical address (as opposed to only listing a post office box). Look them up on the Better Business Bureau website, and the consumer protection office in the state where the company operates. It’s also a good idea to check court records for civil cases against the lender.
4. Fine print that is not fine
Carefully look over the loan agreement before signing onto a hard money loan. Not doing so can get you into trouble. For example, in 2014 a hard money lender in University Place, Washington, was arrested after he issued loans that allowed him to seize a home if the borrower missed even a single payment. He also funded loans that disguised inflated commission payments to himself. The lesson: Always read over the fine print carefully, and have a real estate attorney review the documents if you feel like you don’t fully understand them.
Hard money lenders play an important role in the world of real estate investment, but some unsavory lenders will take advantage of you if you let them. By taking the time to fully vet hard money lenders, you can reward legitimate lenders with your business while avoiding scammers.