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What Are the Requirements for a Hard Money Loan?

What Are the Requirements for a Hard Money Loan?

by | Apr 28, 2023 | Loan Programs

Obtaining a loan can sometimes prove to be quite challenging, especially for people that work in the real estate industry. If you are a real estate investor, then you already know that not every type of loan is the same. In the real estate business, when you are looking to make a quick profit by flipping a property, it needs to be done efficiently without wasting time. That being said, this line of work requires a lot of initial capital so that you can buy the property.

In most cases, investors do not have enough capital to buy the property outright. Because of that, they have turned towards potential lenders that can provide them with loans quickly. While most people would go to a financial institution, like a bank, to get a loan, real estate investors simply do not have that option. One of the main reasons behind this is that bank loans simply take too long to get approved. Additionally, the list of requirements is much more demanding if you want to take a loan from the bank compared to other forms of loan options.

Today, we will explore and talk about how to get a hard money loan. This is a go-to money loan for real estate investing, where investors are looking to complete a quick fix and flip project. Compared to a traditional loan, hard money loan requirements are not as strict. Due to this, these types of loans are approved a lot faster and they are often referred to as fix and flip loans.

If you are interested and want to learn more about hard money loans and how to get one, stick around and read on. We will go over everything that you need to know about the requirements for hard money loans. Now, without wasting any more time, let’s dive right into the article.

 

What exactly is a Hard Money Loan?

To put it in simple terms, a hard money loan is a type of loan that is based on assets or is used as bridge loans. These loans are quite popular and are used a lot more than one would initially think. When an investor is looking for a hard money loan, they will have to put up the property in question as collateral in order to get a hard money loan from the lender.

The main reason why these loans are sought after by so many investors is that they do not come from banks but rather from private investors or institutions. As we have already mentioned, these loans need to be approved as fast as possible due to the nature of the fix and flip property projects. These projects take anywhere from half a year and up to a year in most cases. So, in a situation where you would be denied a traditional bank loan, a hard money loan is the way to go.

 

How do Hard Money Loans Work?

A hard money loan is considered to be a type of short-term financing. These loans are in most cases given for 12 months and up to a maximum of 3 years. In contrast to the traditional forms of lending, private lenders will provide you with a loan mainly based on the property you are working with rather than your income or your credit score. That being said, it is always in your best interest to have the best credit score you can; however, even if your credit score is around 600, you can still get a hard money loan for your project with minimum credit.

When it comes to requirements, the process of money lending with hard money lenders is pretty simple. You will not have to present various documents to get a loan, but you will most definitely be asked to prepare a down payment. This is very common in these situations and should not come as a surprise. The lender uses a down payment as some sort of security if you fail to meet some of the loan payments or fail to repay the loan in its entirety. If that happens to be the case, the property will be used as collateral where the lender will sell the property as it is, or they will put in the effort to finish the renovations in order to create a profit from the project.

Because of these reasons, the thing that is most concerning for the lender is the value of the property in question. Considering that they are providing you with a loan, which poses a great risk for them, they need to make sure the property is worthwhile and that they can get back the investment by selling it.

 

Loan Amount Calculation

To determine the loan amount, lenders use something called loan-to-value ratio or LTV for short. LTV ratio is used to calculate just how much capital they can give you as a loan in comparison to the worth of the property.

In order to calculate the loan amount, you have to divide the total loan amount with the overall property value which serves as collateral. In general, you can expect to get a loan which amounts to between 65% and 75% of the total value of the property. For easier calculations, we recommend that you use loan calculators in order to make sure there are no mistakes. It should be mentioned that banks, when it comes to loan amounts, offer about 80% LTV ratio.

As a borrower, you also have to be prepared for the costs that come with hard money lending. These costs include loan application, origination fee, underwriting fee, processing fee, doc prep fee, broker fee, and lastly a funding fee. Given that his loan comes short-term, you can also expect higher loan interest rates. These loan rates can be between 10% and 15%, but even with high rates, these loans are still desired by house flippers.

 

How to Qualify for a Hard Money Loan

If you have never applied for a hard money loan, it might seem complicated at first. When you start looking at the requirements that you need to meet for a hard money loan, it can be somewhat unclear whether you qualify or not.

As we have already mentioned before, getting a hard money loan is not that difficult. Hard money lenders will require very little from you in comparison to traditional mortgages. As long as the property in question is capable of serving as collateral, you are good to go.

That being said, requirements for hard money loans are: that you have a collateral property, that you are financially stable to the point that you can cover the monthly payments with your cash reserves, that you can provide a down payment, and lastly that you have a well-laid plan.

Now, let us go into more detail regarding these requirements and everything you should know about them.

 

Down Payment and the Overall Equity

When you start looking for a hard money real estate loan, you need to be prepared beforehand. One of the first things that you will be asked to provide is the necessary down payment. Every lender will require a down payment as a form of security. However, if you have equity in the said property, that can also serve as a down payment which in turn serves as collateral for the loan you will get.

In the case of the down payment amount, you should expect something between 25% and 30% when it comes to residential properties. On the other hand, if you are working with a commercial property, the down payment amount will be between 30% and 40%. Keep in mind that this is the minimum amount, and depending on the lender they might ask for a bigger down payment.

Additionally, you can also use cross-collateralizing in order to secure a loan. Basically, cross-collateralizing is when a borrower uses several properties as a down payment in order to acquire a single loan.

Depending on how big of a down payment you can provide, you will have a much higher chance of getting the loan. If your down payment barely meets the minimum requirements, a lender might be hesitant to provide you with a loan as they will see you as too big of a risk for them. This is all to be expected, as the investor will always look for the least amount of risk possible. So if you provide a large down payment, a lender will be more content to give a loan as the reward far outweighs the risk.

 

Financial Capabilities and Cash Reserves

After the down payment, the next requirement that you need to have is financial stability. You need to have enough cash reserved so that you can convince the lender that you will be able to meet the monthly payments for your loan. Additionally, you can assure them that you will be able to cover holding costs as well. These costs can include the following: taxes, HOA payments, insurance, and every other type of payment that needs to be covered while you are the owner of the property. Due to this, if you are able to present a sizable cash reserve, the lender will be much more willing to provide you with a loan, as they will not have to worry about these expenses or you failing to meet the monthly payments.

If you do not have the necessary amount of cash in your reserve, then getting a hard money loan will be a lot more difficult. That being said, it may be possible for a lender to increase the loan amount. This can be done in order to preserve your cash reserves so that the lender can be sure that you can meet the payments for the loan as well as other costs that come with the property. With this, you will still be able to acquire a loan while the lender can have peace of mind that you will meet the payments for the loan.

Taking everything we just covered, it is clear that there is a higher chance that a hard money lender will work with you if you are a strong borrower. If you present a high likelihood that you will default on the loan, the hard money lender will be hesitant to work with you.

 

Real Estate Experience and a Solid Plan

Last but not least, your experience in dealing with real estate properties is crucial. Every lender will be interested in your overall experience and if you are a capable real estate investor. You can probably guess, if you have a lot of experience you will probably get a loan much easier compared to if you were a rookie. For example, someone that has worked as a real estate investor for two decades will have incomparably greater chances of acquiring a loan than someone who is just starting out with the first project.

That being said, even if you are a beginner it does not mean you do not have any chances of acquiring a loan. The best thing you can do in this situation is create a plan. If you present a solid plan that covers everything that a lender might be interested in, you will certainly increase your chances of getting a loan. Work through everything and create a foolproof plan with an exit strategy. This way, even if it is your first real estate fix and flip project, your chances of getting a loan will be very high.

 

Who is Right for a Hard Money Loan?

Investors that have not been able to acquire a loan from traditional lenders tend to divert their efforts towards hard money lenders. This is mainly due to income history, short sales, credit difficulties, and foreclosures which directly influence your chances of getting a traditional loan. For example, it does not matter if you are currently classified as a high-salary earner, if you do not have a solid history regarding your earnings, it will not increase your chances of getting a loan from a bank.

On the other hand, this simply does not matter when you are looking for a hard money loan. Any hard money lender will be content as long as you have enough home equity and resources for a down payment. They do not care about your earning history as long as you provide these things.

One of the main reasons why investors opt to use a hard money loan is because these loans get approved much faster compared to other loans. You can expect your loan to be approved within one week, while a loan from the bank can take anywhere from a month and up to two months.

With that out of the way, hard money loans are best suited for quick fix and flip projects, mortgages for land, if you have credit problems, when you simply have to go with a rapid decision, and lastly for construction financing. So, if you are in need of quick funds, going for a hard money loan is a much better alternative compared to a standard bank loan.

 

What Are Hard Money Loan Interest Rates?

Interest rates that come with a hard money loan are not always the same. They can vary quite a bit depending on several factors. However, one thing is for sure that they will always be relatively high. That being said, you can expect your loan rates to be anywhere from 8% up to 15%, which again will depend on the deal you are agreeing with. As we already know by now, the probability of defaulting on the loan is much greater with hard money loans, so due to that, a hard money lender will in compensation always charge you with more interest.

Keep in mind that even if you are paying higher interest, the period that you have to repay the loan is much shorter compared to a traditional mortgage. This means that you will pay way less interest for a hard money loan than you would pay for a long-term mortgage.

 

Advantages and Disadvantages of Hard Money Loans

Now that we have covered the majority of the topic, let’s go over some pros and cons of hard money loans.

 

Pros of Hard Money Loans

The first advantage of hard money loans is the lax requirements to get one. You are not required to have a high credit score or any specific income to qualify. That being said, requirements do depend on the lender and can differ depending on the person.

The second advantage is how fast these loans get approved. Hard money loans get approved within a week while traditional loans can take a month or two before they are approved.

The third advantage is that the terms for a loan are considerably more flexible for hard money loans. Traditional lenders such as banks need to conduct their business according to strict rules and regulations. This means that their terms are predetermined and are not subject to change. On the other hand, hard money loans can be considered something like a personal loan. Hard money lenders have much more room to adjust the loan according to both their and your needs.

Last but not least, the amount of the loan is directly based on the value of the property that serves as collateral. What this means is that your credit score or income will not influence the amount you can get in a loan. As long as the value of the property is high enough that is the only thing that matters when it comes to the amount you can get in a loan.

 

Cons of Hard Money Loans

Even though hard money loans are quite popular and provide many advantages to real estate investors, there are some disadvantages that you need to know about before you decide to get one.

The first disadvantage that we will cover is the high-interest rates. As we have already mentioned before, hard money loans bring with them interest rates that are much higher compared to the interest rates of traditional loans. Considering that hard money loans offer quick funding at lower requirements, high-interest rates are to be expected.

The second disadvantage we need to talk about is something called the interest-only period. This period means that every payment is a 100% profit for the lender while you still have to pay the complete balance before the end of the term. This is why you need to carefully read the contracts so that you do not sign something that will not be in your favor.

The third disadvantage is the down payment. If you want to get a hard money loan, you will have to show the lender that you can make the down payment. When it comes to hard money loans, down payments are much higher and are usually about 20% to 30% of the property value.

The last disadvantage is the lack of long-term options. We have already established that hard money loans are always short-term. The reason behind this is that long-term hard money loans are simply too risky for lenders. This is why hard money loans are short-term and are always within a period of one to three years.

 

Final Thoughts

Hard money loans are definitely an amazing option if you are looking to acquire some quick capital in order to finance your real estate projects. That being said, before you decide to get one, you need to inform yourself about everything regarding hard money loans. They are certainly not recommended if you are a beginner who just started working in the real estate industry. However, if you do know what you are doing, hard money loans will certainly help you with your fix-and-flip projects.

No matter what, we hope that we have managed to provide you with the necessary answers to all of your questions regarding “How to get hard money loans?” Again, as long as you have a plan for your project, and you are sure you can make a solid return from the project, then a hard money loan is a perfect opportunity to get the necessary funds in order to do so.

Construction Loan vs Bridge Loan – What Is the Difference?

Construction Loan vs Bridge Loan – What Is the Difference?

by | May 6, 2022 | Loan Programs, Loan Resources

Real estate lending can be complex as there are multiple loan options available. However, the variety allows investors and property developers to choose an appropriate loan depending on the costs of a specific project and available funds. A good understanding of the intrinsic differences and characteristics of available options can help you make a good decision.

Bridge and construction loans are common hard money loans that you can tap into when undertaking a real estate project. Therefore, it’s prudent to understand the differences.

What is a Construction Loan?

Construction loans are often issued against real estate value when funding new projects. Typically, these loans provide the money for purchasing shovel-ready land. It covers the costs of buying the land and building a new property. New construction projects tend to be more expensive than purchasing an existing property.

Most lenders design the loan structure based on construction reserve accounts depending on the property value and potential loan risks. Approximately 10% of the total loan cost is used to cover the costs associated with potential risks.

The defining factor is that construction bridge loans are not disbursed in full when closing the borrowing process. Instead, the funds are released in stages depending on the construction budget. Also, the loan has a pre-funded interest reserve account to issue payments when construction is ongoing. After the construction phase, the loan is paid back with a refinance.

The term and total loan amounts depend on construction cost, but it’s usually between 12 and 24 months. The loan only attracts interest during the construction phase, but it includes a non-material execution risk.

What Is a Bridge Loan?

Bridge loans serve a vital need in the real estate industry for people selling a home to purchase a new one. It is a short-term loan that provides the funds for buying a home before selling your current home. Bridge loans for new construction reduce the hassles of looking for a house when your home is on sale. Since the loans are short-term solutions for home buyers, the loan term is about six months. Also, bridge loans have higher interests than traditional loan options.

The real estate market can be competitive, and buyers need to act quickly once they find a suitable house. To secure a good property, home buyers use a bridge loan in the short term before refinancing with a long-term loan. The typical interest rates depend on the value of the real estate property and the creditworthiness of a borrower, but it’s about 1% higher than conventional loans. A peculiar characteristic of bridge loans is that the borrower uses their current home’s equity when purchasing a new house.

Bridge Loan vs Construction Loan

It can be challenging to distinguish between types of loans that sound similar, like a bridge loan vs construction loan. While they can be categorized as hard money loans and look like they are used for similar needs, the loans have distinct characteristics.

Construction Loans vs Bridge Loans Uses

Typically, retail apartment construction bridge loans are used to purchase a property where new construction will start or an existing building that will be demolished to pave the way for new construction. On the other hand, bridge financing can be used to purchase a construction-ready property, but it can also be used to acquire a property that needs slight home improvements before flipping at a higher amount.

Moreover, bridge loans are a temporary financial solution for individuals who want to buy a property quickly before securing long-term financing or a line of credit.

Construction Loan vs Bridge Loan Repayment

In bridge loans, the amount is paid back using a long-term financing option taken later. On the contrary, borrowers pay back a personal construction loan after completing the construction and selling the property. As such, bridge loans have a shorter repayment time compared to construction loans.

And while the two funding options may seem to overlap, the terms determine how borrowers can use the money. Ideally, bridge financing doesn’t cater to construction costs since its primary use is property acquisition. On the contrary, construction loans are a better option for developers who need money to build a real estate investment property.

When Should You Use a Bridge Loan?

Bridge financing is suitable when you need financing for the short term before you find long-term funding options. The loan comes in handy when you want to acquire a property quickly, especially when dealing with a competitive market. Since mortgage bridge loans are more flexible, an investor can refinance with a long-term home equity loan when all permits and documentation are ready.

Additionally, developers targeting construction-heavy projects for commercial use can leverage a bridge loan to acquire the property. This is because a hard money loan has a 12-month term, making bridge money an appropriate option before getting all the necessary zoning and approvals. After acquiring the property and getting everything in place, it becomes easy to refinance with a less-costly financing option.

A bridge loan is often used to cater to various costs, including:

  • The costs of urgent closing costs and deadlines
  • Property rezoning
  • Soft costs before residential flipping

When Should You Use a Construction Loan?

A construction loan is appropriate when a real estate investor wants to buy a shovel-ready property. The funding takes care of the costs of acquiring the property and starting construction work. In addition, this type of funding can be suitable for a developer who wants to buy a distressed property to tear down and rebuild a new property. Whether it’s a dilapidated property or a mold-laden house, an investor can use a construction loan to buy and remodel the property before selling it at a profit.

A construction loan can be a good option if you already have a property and the necessary permits to begin building new structures. Typically, getting the permits for new construction can be an uphill climb, but if you have the documentation ready, construction financing can provide the money needed to kick start the project. This type of financing can be used to cover various costs, including:

  • Cost of buying land
  • Building materials
  • Contractor expenses
  • Construction permits

Bottom Line

The real estate landscape can be complicated if you don’t have sufficient funds to finance your project. But there are several hard money options you can leverage when you want to venture into real estate investment. Bridge loan vs construction loan are among the great funding options for real estate investors and developers.

Developer Land Loans

Developer Land Loans

by | May 6, 2022 | Loan Programs, Loan Resources

When developing your next residential or commercial property, lots of processes and on-site activities need to be done. One of the most challenging steps in the development process is securing the right financing, called developer land loans, to fund the project from start to finish.

These loans can be used to acquire and improve the land or/and construct structures and buildings on the land. We have covered more about developer land loans in the subsequent sections below.

What are Land Developer Loans?

Development loans are funds obtained from a bank, private lender, or other financing sources to improve a piece of land. These loans can be used to acquire, subdivide, construct or renovate a parcel of land/property. Real estate development loans are available for both residential and commercial property developers.

There are different types of development loans, and you can pick one depending on your unique needs. For instance, acquisition and development loans will see you buy and improve the value of the land. On the other hand, construction loans will cover all expenses that involve the setup of structures and buildings. Below are the main types of developer land loans.

4 Types of Development Loans

Acquisition Loans

These are loans used to finance the purchase of an undeveloped parcel of land. Acquisition loans do not offer much except buying a piece of land; hence, they are less popular among investors. Serious property developers who want a quick return on their investment will choose to buy the parcel of land using their own money before securing a substantial development loan.

This reduces the number of active loans that could hurt your credit score. Plus, you’ll only need to deal with a few lenders instead of several lenders with varying loan rates and terms.

Development Loans

Unlike an acquisition loan, land developer loans are designed to fund improvements on the land. These would include site clearance, leveling, building roads, connecting sewers, water lines, etc. Most developers refer to these improvements as horizontal improvements. And since development loans improve the value of the land, they are more common than acquisition loans. However, they aren’t as popular as construction loans.

Acquisition & Development Loans

As the name suggests, A&D loans are meant to acquire a piece of land and develop/ improve it. An acquisition and development loan is one of the most versatile loans since it serves two purposes at once. The loan amount will include the cost of the undeveloped land and other expenses such as horizontal improvements, interest reserve, sales commissions, and contingency reserve. Most private lenders will require investors to make at least a 30% down payment in cash to qualify for the remaining 70% of the loan. However, this isn’t guaranteed as some lenders will not exceed the 50% loan-to-value range.

Construction Loans

These loans are meant to finance the building or renovation of a real estate project. It’s one of the most popular development loans among property developers. Construction loans differ from the other development loans in that you’ll receive the money not as one lump sum but in monthly draws. Most lenders will fund up to 70% of the construction project only if it’s well-conceived. This is especially true if the developer has a proven track record in the real estate space.

How to Get a Real Estate Development Loan

Before we look at how to get started with a real estate development loan, it’s important first to understand the financing options available. In other words, where can you secure your construction or acquisition and development loans? Ideally, there are several ways to fund your real estate project, from land acquisition and improvement to development. However, the most popular financing options are:

Traditional Financing

Here, the lender is a bank that assesses the risks of funding the project based on several factors. These factors include the likelihood of the project’s success and the developer’s credit history and real estate experience. Most banks will finance 60% to 80% of the project’s cost. That means the developer must seek alternative means to fund the project fully.

Private Money Lenders

These are private companies that lend money to real estate investors at a fee, typically 6% to 15%. Most private lenders have a repayment period of 12 to 36 months. But with the option to extend the repayment period up to three or even five years. A private lender will often fund 25% to 50% of the total cost of developing the real estate project. The benefit of this financing option is the quick processing speed, flexibility, and convenience.

Private lenders don’t focus much on credit history, which is a huge plus for some investors. Instead, they may use the property under development as collateral. This comes with some risk, so this option is best for investors developing projects for quick sale. Or those with other ways of repaying the huge debt within the stipulated time.

Crowdfunding

This is a way of pulling resources from investors who are willing to participate in a real estate project. Thanks to the current legislation, these investors don’t need to be people in the developer’s close circle. Nowadays, developers can crowdfund through social media and get investors willing to invest in their projects. This is also a great opportunity for the less capitalized investors to venture into projects historically reserved for the wealthy.

Sponsor Equity

A real estate sponsor is the individual or team that takes an active lead on a real estate development project. These sponsors must outlay their capital during the initial project feasibility and other site evaluation activities. The best type of sponsor equity in commercial real estate is the one that brings hard cash equity. However, most sponsors don’t have 20 to 40% of the project’s cost in cash. So many sponsors will eventually turn to other equity financing options.

Getting Started with Real Estate Developer Land Loans

Securing a real estate development loan can be hectic, but it doesn’t have to be. The options we have highlighted above aren’t exhaustive but are the most popular in the market. Here are some critical factors to consider when choosing a real estate development financing option.

  • Conduct proper research and feasibility study. Preliminary due diligence against potential challenges and associated financial costs are key to successful real estate development. Always consider the micro and macroeconomic factors that may impact the project’s profitability.
  • Have an accurate budget and list of expectations. A high degree of accuracy is crucial when building development budgets. Whether you are applying for a construction or subdivision development loan, poor budgeting can jeopardize the whole project. Similarly, you should have realistic expectations when applying for land developer loans. Having contingency plans and embracing a flexible mindset is also important.
  • Balance debt and equity. Leverage is great until the banks or private lenders aren’t comfortable funding your projects. Instead of going all-in with debt, consider building your equity as well. This will positively impact your ability to finance future projects.
  • The overall cost of the loan. The real estate investing landscape is complex and requires the right mix of skills and experience. Not all the financing options will work for your development project. One factor to keenly consider is the cost of the loan. If the loan is too expensive to bear, you should rethink your investment options.

Make a Leap in the Right Direction

Developing a real estate project from scratch is time and resource-intensive. Having the right financing options is key to the success of the entire real estate project. To boost your odds of success, consider the financing options we’ve identified above. Similarly, take your time to do proper research, streamline your budgeting, and balance your debt and equity.