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.
A number of real estate and construction companies need financing to complete certain projects. When looking to complete a particular project, these entities will need to get a construction loan. A new construction loan is a type of financing that allows a real estate developer or construction company get the funding they need in order to finance the purchase of materials, hire workers, and get the necessary permits. Whenever a developer or construction company look to get a loan, they will need to meet a certain qualification criteria as well as complete an application process. They will also need to understand certain aspects of the construction loan such as the down payment, the loan amount and the interest rates. By knowing these things, they will be able to benefit from this type of financing.
Like all other types of loans, new construction loans will have certain qualification criteria in order to secure one. New construction loans will often require that the borrower have a good credit rating, sufficient funds for a down payment, an income to make the monthly mortgage payments and also have a manageable amount of debt. The qualification criteria is quite easy to meet as long as a real estate developer and construction company are financially stable as well as not being overextended on their debt obligations.
Whenever a construction company or real estate developer gets a new construction loan, they will look to get and receive a certain loan amount. In most cases, the loan amount is usually going to be 80% of the costs associated with the project. For example, if a new apartment building is going to cost $1,000,000 to build, then the lender will provide $800,000 in funding. The loan amount will need to be paid back in both principal and interest payments during the lifetime of the loan. As a result, it is important for real estate companies to finance a loan amount that they can comfortably afford to pay.
The next part of a construction loan is the down payment. This is an amount of money that the borrower needs to provide in order to secure the loan. Down payments for construction projects will often vary depending on the total cost of the project. However, a lender will often require that the borrow provide between 20% and 30% of the total cost of the project. Back to the above example, if the project will cost $1,000,000, then the borrower will need to put between $200,000 and $300,000 down. A down payment is required to put down a certain amount in order to qualify for a new construction loan and to handle the monthly payments.
One of the key parts of any new construction loan is the interest rate. This is a percentage of the loan that the borrower will need to pay along with the principal balance. Every month, the borrower will need to pay this percentage on top of the principal balance amount. An interest rate serves as a cost to the borrower to have the loan as well as the profit margin for the lender. Today, new construction loan interest rates are quite competitive. They are often lowered at rates as low as 4.25% which allows many real estate developers and construction companies to get very affordable financing for their projects.
All new construction loans have an application process that borrowers must follow. The application process is required for any borrower to get funding for any new construction project. During the application process, the borrower will need to put down information such as the entity name, address, phone number, assets and liabilities. They will need to reveal this information for the lender to review. Once the lender receives the application, they will then evaluate it to verify all of the information given. The application will then be underwritten and funded. The borrower will then have the funds to pay for the project and begin paying the loan back within a couple of months.
Hard money loans are nothing new to experienced real estate investors. However, investors just starting out may not have an understanding of how they work. Some new real estate entrepreneurs often think hard money financing is borrowing money from shady companies who charge excessive fees and interest rates.
There was a time when unethical companies would intentionally charge outrageous fees and interest so they could foreclose on a real estate investment. Today, hard money lenders enjoy a better reputation since many new investors now recognize the role these loans play in the housing industry. To help new investors better understand how hard money loans work, this guide will cover the basics behind these loans and where to find this type of financing.
Explaining Hard Money Loans
Hard money loans are short-term financing with terms that are typically three years or less. The average term on these loans is 12 months. Instead of receiving funds directly from traditional banks, the funds come from private investors or companies that specialize in hard money financing. The real estate behind the investment is what lenders use as collateral for the loan.
Most banks lend borrowers money based on their ability to repay a mortgage. Hard money lenders offer loan amounts based on the value of the investment. In many cases, hard money loans are determined by the after-repair value of a home.
Borrowers must make monthly payments while there is an outstanding loan balance. However, most lenders only require borrowers to make monthly interest payments until the property is ready to sell. Once the borrower lists the property, hard money lenders require a balloon payment to pay off the principal balance of the loan.
Best Properties for Hard Money Loans
These loans are not for borrowers trying to buy a primary residence. Traditionally, hard money loans are for real estate investors who want to fix a property and sell it fast. The loans are popular among investors since banks typically do not lend money for investment purposes. If they do, it can take weeks or months for investors to receive the funds from the loan.
Investors use hard money financing to buy single-family homes, condos, multi-unit properties and townhomes. Sometimes people use these loans for land transactions such as buying a mobile home park in need of renovations. Investors also buy commercial and retail properties using these loans. A hard money lender will fund any real estate transaction as long as the deal makes sense, so there is no limit to what type of investment property someone can buy.
When to Use Hard Money Loans
When investors want to act fast on a real estate deal quickly, they often turn to hard money financing. Many times these loans fund within in a week or less, which gives an investor a chance to act quickly on a deal with several competing offers. When an investor receives an approval, they can present an all-cash offer that may stand out among sellers. If an investor relies on bank financing to act on a deal, they may have to wait 30-45 days before they receive the funds. By the time the funds arrive, a good deal with multiple offers is probably long gone.
When Not to Use a Hard Money Loan
A potential homebuyer with good credit, a big down payment and a solid income history should stick with a traditional mortgage. Hard money financing is not an ideal loan option for someone who wants to buy a primary residence. When compared to hard money loans, traditional mortgages offer far lower interest rates, fees and much longer loan terms.