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.
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.