SS258: What is a Hard Money Loan?

SS258: What is a Hard Money Loan?

If you are flipping a house and looking for a loan, you will likely encounter a loan product called a hard money loan. In this episode, Charles discusses hard money loans, what they are, how they work and when investors should use them.

Watch The Episode Here:

Listen To The Podcast Here:

Talking Points:

  • A hard money loan is a short-term loan product that is typically used to finance residential real estate flips. Unlike typical real estate loans, which require good credit and income, etc. Hard money loans are mainly underwritten by reviewing the property and the borrower’s available funds. Since these are short-term loans, ranging from 6 to 12 months, lenders are primarily concerned with the investor’s ability to renovate and resell the property at a profit. To do so, they spend more time reviewing the deal and less time reviewing the borrower.
  • What is a Hard Money Loan:
    • 1. Asset-Based Loan. The underwriting for hard money loans primarily focuses on the deep discount the investor has negotiated on the deal, their experience, and the funds they can bring to the deal. Some hard money lenders won’t even pull credit or request tax returns. I remember a seasoned hard money lender once telling me that he would gauge his aggressiveness on underwriting by reviewing his portfolio. If less than 10% of his loans were in default, he needed to get more aggressive; if more than 10% of his loans were in default, he needed to become more conservative. 
    • 2. Private Lenders. Yes, there is a lot of institutional capital that lends on flip properties, but true hard money loans are typically made by private lenders, who lend their own money or that of their investors. As an investor, when you are speaking to the 1 person who is making the decision on whether you get the loan or not, that is very powerful. Compare this with institutional capital that is consistently changing its lending terms, is lending one day and then not lending the next day, and firms that work with institutional lenders have much smaller margins, larger firms, and more capital deployed, which might mean they are less interested in developing a long-term relationship with a new flipper that does 2 deals per year. Furthermore, when the market goes south and deals appear, institutional capital often disappears, even though it is the safest time to lend.
    • 3. Fast Loan Approvals. Fast loan approvals are most likely the biggest benefit of obtaining a hard money loan. Simple, straightforward underwriting allows lenders to approve loans and disburse funds in days, not weeks or months.
    • 4. Short-Term Loans. Most hard money loans typically have loan terms of 6-12 months. Typically, you will see a 12-month term with no prepayment penalty, as lenders want their money back as soon as possible. If investors require an extension, they will usually be required to pay additional fees to the lender.
    • 5. High Down Payments. Most private lenders will require borrowers to bring 20%-35% of the purchase price to the closing table.
    • 6. High Interest Rates. It is not uncommon to see rates of 10%-15% and 2-3 points at closing for hard money loans.
    • 7. Higher-Risk. Short-term investing and borrowing, especially in real estate, is riskier than buying an apartment complex with a 10-year loan. You need to ensure that you purchased at a deep enough discount, have sufficient funds to cover all the renovations, and are able to sell the property before the hard money loan matures. 
  • Hard money loans are a fast and flexible way of financing a property in the short term, and are designed for investors purchasing a deeply discounted property with a clear exit strategy, in most cases, selling the property. If you told a hard money lender you want to refinance them out, they are now going to fully underwrite the borrower, since if the borrower is unable to be approved for a loan to refinance them out, the hard money lender is going to have their money stuck in the deal.
  • A good hard money lender is most interested in the deal, the purchase price, your rehab budget, your available cash, the after-repair value, and the investor’s team and experience. 
  • Before we wrap up, I should mention that on this show, we talk a lot about commercial multifamily properties, properties with 5 or more units, and in the commercial multifamily realm, bridge loans are the hard money equivalent, and if you want to learn more about bridge loans, check out episode SS122.

Transcript:

Charles:
What if you could fund your next real estate deal without showing your credit score, tax returns, or pay stubs? Welcome to Strategy Saturday. I’m Charles Carillo, and today we’re breaking down what is a hard money loan. These short-term loans are popular with house flippers and they work very differently from typical bank mortgages. So let’s get started. A hard money loan is a short-term loan product that is typically used to finance residential real estate flips. And unlike typical real estate loans, which require good credit and income, hard money loans are mainly underwriting by reviewing the property and the borrower’s available funds. Now, since these are short-term loans ranging from six to 12 months, lenders are primarily concerned with the investor’s ability to renovate and resell the property at a profit. And to do so, they spend more time reviewing the deal and less time reviewing the borrower.

Charles:
So what is a hard money loan? Number one is it’s an asset based loan. Okay, so the underwriting for hard money loans primarily focuses on the deep discount the investor has negotiated on the deal and their experience and the funds they can bring to the table. Now, some hard money lenders won’t even pull credit or request tax returns. Now, I remember a seasoned hard money lender once telling me that he would gauge his aggressiveness on underwriting by reviewing his portfolio if less than 10% of his loans were in default. He needed to become more aggressive if more than 10% of his deals were in default, he needed to become more conservative. Number two are private lenders. So yes, there are a lot of institutional capital that lends on flip properties, but true hard money loans are typically made by private lenders who lend their own money or that of their investors.

Charles:
Now, as an investor, when you are speaking to that one person who is making decision on whether you get the loan or you don’t, that is very powerful. And compare this with institutional capital where it’s consistently changing the lending terms and lending one day and they’re not lending the next day. And the firms that work with institutional lenders have much smaller margins, larger firms, and more capital deployed, and which means that they’re maybe not interested in really developing a long-term relationship with a new flipper that’s only doing two deals per year. And furthermore, when the market goes south and deals start to appear, institutional capital often disappears, even though it’s the safest time to lend. Number three is fast loan approvals. So fast loan approvals are most likely the biggest benefit of obtaining a hard money loan. Simple, straightforward underwriting allows lenders to approve loans and disperse funds in days, not weeks or month.

Charles:
Number four are short term loans. So most hard money loans typically have loan terms of six to 12 months. And usually you’ll see a 12 month term with no prepayment penalty as lenders want their money back as soon as possible. And if investors require an extension, they will usually be required to pay additional fees to the lender. Usually they’ll pay be required to pay their points over again. Number five is high down payments. So most private lenders will require borrowers to bring 20% to 35% of the purchase price to the closing table. Number six, high interest loans. So it’s not uncommon to see rates of 10% to 15% and two to three points at the closing for hard money loans. Number seven is higher risk. So short term investing in borrowing, especially in real estate, is riskier than buying an apartment complex. With a 10 year fixed loan, you need to ensure that you purchase that deep enough discount, have sufficient funds to cover all the renovations, and are able to sell the property before hard money loan matures.

Charles:
Now, hard money loans are a fast and flexible way of financing a property in the short term and are designed for investors purchasing a deeply discounted property with a clear exit strategy. In most cases, selling the property. Now, if you told a hard money lender, you want to refinance them out, keep the property, they’re now going to fully underwrite the borrower. Since the borrower is, if they’re unable to be approved for a loan to refinance them out, that hard money lender is gonna have their money stuck in that deal from possibly years because there’s no exit strategy. Maybe at that point they’ll force ’em to sell, but really they want to keep the relationship going. So they would want you to refinance them out. But in most situations, there has to be a very strong borrower when some, a borrower that really purchase a deal with a really deep discount.

Charles:
So a good hard money lender is most interested in the deal and the purchase price, your rehab budget, your available cash, the after repair value, and the investor’s team and experience. But before we wrap up, I should mention that on this show, we talk a lot about commercial multifamily properties, properties with five or more units. And in the commercial multifamily realm, bridge loans are the hard money equivalent. And if you wanna learn more about bridge loans, you can check out episode SS122. That’s SS122. So I hope you enjoyed. Please remember to rate reviews, subscribe, submit comments, and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndicationsuperstars.com. Look forward to two more episodes next week. See you then.

 

Links Mentioned In The Episode:

Are You a Fan? Subscribe, Rate, Review & Share – Click Here To Learn How

What question do you always wish I would ask but I never do?

Connect with the Global Investors Show, Charles Carillo and Harborside Partners:

Scroll to top