When most people first hear about hard money loans, they hear about rather high fees and interest rates in comparison to other loan programs available. They may also hear about very short terms that may last for a couple of years at best. When you consider the possibility of qualifying for a loan with a better interest rate, lower fees and a longer term through a traditional bank loan, it seems like the obvious preference is to apply for the bank loan.
However, there are specific situations when a hard money loan makes sense. Not every borrower who needs real estate financing can qualify for a traditional bank loan. After all, banks and credit unions have very specific criteria that needs to be met, and not all loan requests comply with their requirements. When a traditional loan is not available as an option, a hard money loan makes sense. These are some of the more common scenarios that hard money lenders may consider when banks cannot.
Construction and Development
Construction and development loans for both residential and commercial properties can be difficult to come by when specific market conditions are present. They may also be more difficult to obtain in select markets, when a preferred contractor has not been engaged and when other factors are present. In addition, depending on the circumstances, a traditional bank may take two months or longer to close on a construction and development loan request.
Hard money lenders generally are more open to reviewing and approving development and construction loan requests. They may have less stringent requirements related to property location and property type, and they may also not have a preference regarding the contractor. More than that, a hard money loan may close in a week or less. This means that the construction and development efforts can begin very quickly when hard money financing is used.
Many properties have unfortunately not been properly maintained or updated over the years. Some may require substantial aesthetic improvements to make them desirable and functional for the intended use. Others may require significant and expensive physical improvements, such as a new roof and electrical rewiring. When a property is properly rehabbed, its value may skyrocket. These properties can therefore be very lucrative, but most banks will not consider them.
A hard money lender looks at all aspects of a loan request, including the current need for cash to buy and update the property. It also looks at the anticipated future value or cash flow. When the upside is substantial, a hard money lender may be eager to provide funding for this type of real estate project. A hard money loan may be used for a residential rehab, such as flipping a home for a quick profit. It also may be used for a commercial property rehab, such as renovating an old building and transforming it into luxury condos.
Improving Management Efforts
Hard money loans can also be used to fund properties that have been severely mismanaged. This typically relates to commercial properties rather than residential properties. A property manager is tasked with finding qualified tenants and charging them a market rental rate. The manager is also tasked with maintaining a property properly and ensuring that occupancy rates are in line with local market conditions. Poor property management could result in a property with substantial deferred maintenance and much lower net income numbers than it should have. When deferred maintenance is an issue, the problem of occupancy can become more significant. For example, because the property is in less desirable condition, it may have to offer reduced rent to tenants.
Hard money loans can be used to improve management efforts on the property. With this type of loan request, the borrower typically will have already identified a qualified new management company to take over. Market rental rates will be researched, and a plan to improve property condition as necessary will be created. A short-term hard money loan is used to fund the property’s renovations and to cover expenses through the lease-up effort.
In each of these special situations, a traditional loan from a bank is simply not an option. However, each of these types of real estate projects may make financial sense and can be very lucrative. While a hard money loan has a higher interest rate and fees than other options, the bottom line is that the other options are not applicable in these situations. In addition, the upside potential for these projects is so significant that the financing costs are worthwhile. Each of these situations may be addressed within a short period of time, so the short term of a hard money loan is not an issue. After the properties have been properly addressed in various ways, they can be sold to another party or refinanced with a traditional bank loan.