Investment in real estate can be very lucrative because of the continual rise in prices. There are some who purchase a property, develop it extensively, and sell it to individual buyers over a period of time while others who are able to spot a lucrative opportunity, buy a property with the express intention of renovating it and quickly disposing of it for handsome profits. The term hard money lending is very well known to those who are in the real estate business, however, outside that domain very few people have heard of it. It is a method of borrowing funds from lenders who are not generally included among the traditional mortgage lenders like banks. Rather, the funds come from high net worth individuals or investors seeking to deploy their funds in the short-term using the property as the collateral.
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Hard Money Explained
The way traditional lending works is that borrowers must prove that they have the ability to repay the lender the principal sum and the interest thereon within the contracted period. Typically, lenders make up their minds on the basis of the nature of the investment, the amount of the loan, the credit score, the income, and the cash flow of the borrower. Getting the requisite approvals from traditional lenders can take quite some time as there is a lot of paperwork involved and the approval process is bureaucratic even for borrowers with impeccable credentials. If borrowers have a less than satisfactory credit report or an unverifiable income stream, the approvals may not come at all.
The approach used by hard money lenders is quite different; they are relatively unconcerned about the borrower’s ability to repay but are more interested in the nature of the property and whether it can serve as adequate collateral for the loan with its current market value. Hard money lenders operate on the simple premise that in case of default by the borrower, they can sell off the property and get their money back. This method of business operation makes them more interested in the value of the property rather than the borrower’s financial position. Since hard money loans are typically for the short term, lenders are also confident that the market will not change dramatically.
Benefits of Using Hard Money Loans
Easier eligibility: Since the focus of the hard money lenders is on the value of the collateral property, they do not insist on borrowers having a very strong financial position or a good credit score. This makes them the ideal option for borrowers who do not have the credentials to get the loans approved by banks with their stricter approval process.
The speed of approval: Hard money lenders know the importance of being able to latch on to market opportunities and they are very quick to close deals. Since hard money lenders are also not fixated over a long and cumbersome application procedure, the need for the submission of detailed credentials, a good credit score, bank statements, balance sheets, profit and loss statements, cash flow statements, and a hundred other documents traditional banks like to fuss over, they are able to approve the loans far more quickly. The speed of loan processing goes up even more when you have a steady relationship with them, which means you can also close deals faster. Online private lenders like https://www.libertylending.com/ promise approvals in minutes.
The flexibility of approach: Hard money lenders are very popular because they don’t have a rigid approach like banks. They do not employ any standardized underwriting process but are willing to take on the exposure based on their evaluation of individual deals and their understanding of the local market forces. They are willing to look at making things work for you; hence, you can customize repayment schedules according to your convenience. Since these lenders are individuals with cash surpluses, not faceless corporate entities, it is easier to talk and discuss issues with the decision-maker who can often make up his mind on the spot.
Collateral: For hard money lenders, the most important factor for loan approval is the collateral that the borrower is willing to offer. Different lenders have different loan-to-value ratios that they would be willing to lend against. However, according to https://www.forbes.com, if a buyer has been lined up for the property to be acquired by the borrower, transactional lenders may be willing to fund the full amount of the deal. Typically, due to the very risky nature of the business, hard money lenders like to operate at a maximum loan-to-value ratio of 70% so if the borrower needs the full investment amount, he will need to offer multiple collateral assets. When the loan-to-value ratio is kept low, the lender knows that he has more leverage on the borrower and in case of default it will be easier to sell off the assets to recover the loan amount.
Why Hard Money Loans May or May Not Make Sense
Hard money loans make good sense for borrowers who don’t have the credentials to approach banks or need a very quick loan disbursal to take advantage of market opportunities. As a result, hard money lending is more favored by fix-and-flip investors who invest in properties with the express intent of improving them and selling them off in quick succession. It is not uncommon for the hard money loans to be taken for just a year or so after which the repayment is done with the property sale proceeds. The problem with hard money loans is that the rate of interest is significantly more than that charged by banks and the low loan-to-value ratio used by most lenders restricts the amount of money that can be raised. You could potentially have to also pay origination fees to get the loan processed.
Conclusion
Hard money loans are not the perfect solution to every need; however, they perform a very important function for borrowers unwilling or incapable of using traditional finance. Finding a reliable lender can often be an issue. You will need to ask people you trust who are in the property investment business for references. Typically, hard money lenders operate locally because they understand the dynamics of the local market better. If you are new to the game, be sure to discuss your requirements with a reputed lender and also ask for advice to get the best return on investment.
