Post written by
Michael Polk
People buy real estate for many reasons — generating cash flow, a tax write-off, appreciation value. Some of the greatest profits are made when buying real estate in a down market. Seasoned investors and fortunate newcomers who purchased coastal residential property from 2012-2017 are sitting on healthy equity appreciation as well as competitive interest rates in the 3.5-5% range.
The traditional path to buy a property is to obtain financing through banks, credit unions or a mortgage company. Following the 2008 housing crisis, traditional lenders implemented more strict guidelines: Stellar credit scores from 740 and above, stable employment, a low debt-to-income ratio, six months or more of liquid reserves.
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For hopeful investors unable to meet these demands, alternatives are to pay all cash or to finance the purchase using hard money financing or a private lender. By utilizing one of these two methods, buyers also do not have to be concerned with the mounds of paperwork lenders requested. There are some advantages and disadvantages by using either type of alternative financing.
I have been asked so often about alternative lending for commercial real estate clients that I realized I needed to be able to point folks toward a source for this. I have seen some bad situations arise for borrowers who didn’t know enough about the hard money lender they were getting involved with, so our firm took the time to develop our trusted network of hard money lenders. With interest rates trending upward, this area will only see more traction. The consumer should beware of all aspects of this lending.
Hard money lenders are professional lenders who seek out borrowers. They typically place more importance on the collateral or equity in the property than your credit. Over the years, it has transformed into a more common option — but unlike traditional lenders, hard money loans may have high-risk characteristics such as low credit scores and marginal credit. And with a higher risk loan comes high interest rates.
The term “hard money” doesn’t mean it is hard to get financing. The financing part is pretty easy if you have 30-50% equity or down payment. The term simply describes the asset, real estate, which is considered a hard asset. Some experienced investors joke that the term implies they charge such high interest that it is hard for someone to pay back.
Private lenders, in most cases, are private individuals who periodically have money to lend, be they family, friends, professional acquaintances or accredited investors.
Advantages Of Hard Money And Private Money
These type of lenders can often turn around a loan application in seven to 10 days, opposed to the typical 30-45 days of a traditional bank. There is a lot less red tape. The underwriter is not reviewing conditions to satisfy the investor, since the lender is the investor. Many hard money loans are based on the property’s after-repair value (ARV) in contrast to the current property value used by a conventional lender.
Rates
Many savvy investors choose hard money financing to rehab and flip a property. A high interest rate for a short period is often a minor expense compared to the return the investor stands to make.
Types Of Lenders To Avoid
Once TILA-RESPA Integrated Disclosure (TRID) rules took effect back in October 2015, hard money lenders modified the way they lend by reviewing income documentation of the borrower’s ability to repay the loan. Prior to that, a large percentage of hard money lenders primarily focused on the equity in the borrower’s home. Once a borrower signed their loan documents and ended up not being able to make the payments, the borrower was likely to lose their home through foreclosure. Loans granted without such due diligence may be classified as predatory.
Further examples of predatory practices involve bait-and-switch schemes, where the lender promises the borrower a fixed rate loan or specific interest rate but without any explanation switches them to a completely different loan.
In some cases, borrowers really aren’t aware of the difference until, months later after closing, they see their next payment due is significantly higher. Upon further examination, they discover it is due to an interest rate adjustment that was never disclosed.
Don’t be a victim to predatory lending. While it’s true you may be getting money a lot quicker than with a traditional loan, look for a hard money lender who is transparent. The documents at closing should always be consistent with what you were told throughout the loan process.
Changes In Hard Money Lending
It seems every year or two since the housing crisis, the mortgage industry goes through a change. This is due collectively to advances in technology, an expanding customer base and other external elements.
The peer-to-peer lending sector emerged when LendingClub became a publicly traded company in 2014. Its objective was to sidestep the traditional lender with a lending marketplace that connects borrowers and lenders through an online platform.
Another key change over the last decade has been the observable uptick in private money lending perhaps originating from the popularity of home-flipping reality TV shows. These many programs all but promise the common person a path to potentially lucrative income and a new career either actively or passively.
In a more traditional investment, you could expect a return on investment in the range of 1-5%. With a hard or private money loan or note, investors can see up to a 7-20% return. Small private capital investors are no longer the only source for an investor to obtain hard money lending.
If you’re interested in borrowing from a hard money or private money lender for your next real estate investment, now you have a pretty good idea of what to expect.