Have you ever stopped to consider how house flippers fund their projects? Some people assume that flippers have deep pockets and pay for the sales price of the home and all renovations out of their own personal funds. While this is true in some cases, many flippers use hard money loans to fund their activities. While this is a common use of hard money loans that can yield tremendous profits for investors, there are also other profitable uses that you can consider. After learning more about hard money loans, you may be ready to expand your investment activities so that you can take advantage of this type of financing.
Learning About Hard Money Loan Requirements
A hard money loan is a short-term real estate loan, but it is not your typical real estate loan. The traditional real estate loan from a bank that is used for both residential and commercial properties has a 15 to 30-year term. It is fully-amortized, so there is not a balloon payment. The interest rate and loan fees are usually very competitive. This is a loan that must conform to a bank’s very specific underwriting requirements. These requirements may include a minimum credit score requirement and a maximum debt-to-income threshold for the applicant. If the loan is on an investment property, the lender requirement may also include a minimum level of cash flow. The unfortunate reality is that many loan requests do not meet all of a bank’s lengthy list of requirements. Each hard money lender reviews loan requests differently, but you will typically find that hard money lenders do not analyze current cash flow of an investment property, and they also are not concerned with an applicant’s financial qualifications. Typically, the primary focal point is the property’s value.
Analyzing Hard Money Loan Terms
As you can see, a hard money loan generally has much more lenient requirements, and this means that hard money lenders are able to provide financing for many scenarios that banks simply cannot touch. However, this flexibility with regards to underwriting generates entirely different loan terms than what you may expect from a bank’s real estate loan. For example, you may be hard-pressed to find a hard money loan with loan-to-value higher than 70 percent. Hard money loans also typically have a high interest rate with an interest-only payment. The loan term may vary substantially from six months to two years depending on the loan scenario and the lender. With this structure, a balloon payment is required within a short period of time.
Deciding How to Use Hard Money Loans
As you can see, hard money loan terms make this an undesirable financing option for a typical real estate transaction. The short-term structure of the loan with a large balloon payment required within a few months to a couple of years after closing makes this financing ideal for real estate projects where the property is repositioned in some way. This may include leasing up a property that is vacant or that has low occupancy. It may include stabilizing net income for a few months or longer so that the property will comply with bank lending guidelines. A property that requires renovation work may also be a great fit for a hard money loan. Another common loan scenario that hard money loans are used with is a quick closing situation. This may be when a seller is pressuring you to close the loan or lose the deal or in other similar situations.
A hard money loan is an excellent financing solution that you can use for house flipping projects as well as many other loan requests that do not work well with bank lending requirements. If you are looking at a real estate project that requires a more creative approach to financing than what a bank offers, using hard money may be an excellent strategy to pursue.