When you get a hard money loan, instead of making a down payment or evidencing good credit, you’ll be using a piece of real estate as collateral. It is this real estate that will be used to calculate the amount of money that can be loaned to you. You may know how much money you need, but do you know how much a lender is willing to extend you?
Determining the Amount of Your Loan
Loan amounts will vary from lender to lender, but you can follow these four steps to determine a rough estimate of your loan amount:
1. Decide which property you will use to secure the loan.
Because hard money loans are typically obtained by someone who needs money fast, who experiences poor credit, or who has undergone a short sale or foreclosure, they can be risky for the lender. That’s why you’ll need a piece of property to put up as collateral for your loan. Your property should have a sufficient amount of equity, as your loan amount will be calculated based on the equity in your property.
There are variety of real estate types that may be used to secure a hard money loan. Single-family homes, multi-family homes, land, commercial property, and industrial property are all potential collateral, but you will have to check with your lender to verify which types of property they consider.
2. Determine the value of your property.
Once you have selected a property to use to secure your hard money loan, you’ll have to determine the value of that real estate. The lender will do this for you, but if you want to make a rough estimation, consider your purchase price and the appraised value of the property. Lenders typically use the lower of these two figures when deciding how much money to loan you.
For instance, if you bought your single-family home for $250,000, and it appraises for $300,000, the lender will use the $250,000 value to figure your loan. This may not seem fair on the surface, but keep in mind that hard money loans are risky for the lender. If you still owe any money on the property, subtract that from its value.
3. Find out what LTV your lender uses.
Hard money lenders employ a loan to value (LTV) ratio to calculate how much money they will loan a borrower. The simple formula for the LTV is as follows:
LTV = [Amount of Loan / Value of Property]
Ask your lender what his or her LTV ratio is. Most hard money loan lenders will extend you a loan amount equal to 50% to 75% of the value of the property.
4. Calculate the amount of your loan.
Now that you know the value of your property and the LTV ratio employed by your lender, you can determine the amount of your hard money loan. Just plug the LTV and property value into the formula provided in step 3.
For example, if your lender uses a 65% LTV and the lower of the purchase price and appraised value of your parcel of land is $250,000 (and you have 100% equity in the property), you can calculate your loan value as follows:
LTV = [Amount of Loan / Value of Property]
0.65 = [Amount of Loan / $250,000]
Amount of Loan = $250,000 X 0.65
Amount of Loan = $162,500
Determining the Total Cost of Your Loan
Now that you’ve determined your loan amount, you’ll probably want to consider the total cost of your loan. To do so, you’ll need to know the interest rate of the loan and the points charged by the lender. These tend to be higher than with conventional loans because of the risky nature of hard money loans. To determine the full cost of your loan:
1. Multiply the points by the amount of your loan. So, for example, if your lender charges 3% in points and your loan amount is $162,5000 as in the example above, your points will be 0.03 X $162,500 or $4,875.
2. Determine the total cost of your interest over time. To do this, it is often helpful to use an online loan calculator or compound interest calculator. Enter the amount of your loan and the interest rate provided by your lender.
3. Add together any other loan fees.
4. Add 1 through 3 above. This is the total cost of your loan. You will have to repay the full amount of your loan plus these loan-related expenses.
Now that you know how to determine your loan amount and cost, you’ll have a better idea of whether you can make that purchase you’ve been eyeing.
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