As many of you aware, there are conventional loan mortgages which are commonly used to buy a home. It needs 20-25% down payment and the home should meet certain terms and condition. One important criteria for the mortgage to be approved is home has to be in livable condition. That means A/c, Heat and Plumbing should be all in working conditions. Otherwise there is no way to get the conventional loans.
That’s not the case with many properties when you are trying to get cheap/low priced homes for investing purpose. Many times, you need to rehab the house before putting in market for rent or sale and it won’t be qualified for conventional loans. Apart from that situation, you might not have all the money to put for down payment and as well fix the property. There is 203k financing available for home owners via FHA loans but they are not for investors. Finally many investors don’t have good credit to get approved for conventional loans. In order to fill this void and help investors, Hard Money lenders came as saviors. With that background,lets look at more details.
What are Hard Money loans?
Hard money came to existence in 1950 when the US credit industry went in drastic changes. I usually say, it is the money which is put to work hard for investors. It is the private lenders who make every penny work hard through real estate investors by charging high interest rates. Hard money loans are real estate investors goldmine to purchase a cheap properties which are in need of lot of work and investors don’t have money to do it.
The lenders are usually small companies which pool money from private investors/money sharks as they call in the industry. These private investors like to invest their funds in expectation to get high Return on Investment/interest for their investment. These small mom and pop lending companies operate differently from traditional mortgage lenders and follow their own rules and make their own fee schedule for making loans for anyone with or without credit.
How it works?
Basically, it is a collateral loan towards a home. Loans are handed out based on the “After Repair Value” or ARV, instead of the current appraised value. Every lender has their own product which works differently depending on the property. There are products were investors in put down payment and closing cost, whereas others with no down payment and just closing and some others with no down payment and some closing cost rolled over to the loan. It all depends on which lender you are working with and what type of loan works for you current financial situation. In almost all cases, there will be 2 closing. One closing for the rehab loan with high interest to get money to buy and fix the property. The second closing is to refinance the rehab loan to conventional loan to lower or market interest rate.
How the Numbers work?
For example, let’s assume you found a nice little single family home in a nice area which you think would be suitable for investment. The home might need some paint job, carpet replacement, condenser unit change and updating of the bathrooms. With help of contractor, you’ve figured the repair costs to be around $10,000. You plan to fix up the property and rent it out to a tenant for cash flow. After checking some comps with help of Realtor, you have determined that the value of the property after the repairs are completed will be $100,000. This is the After Repair Value(ARV) not appraised value.
Generally a hard money lender may loan about 60% to 68% of the ARV for a property. They try to loan very low LTV as possible. This would be roughly $68,000. Let’s also say that you have the property under contract for $50,000. Your total cost for purchase, plus repairs of $10,000, would be $60,000. You could potentially borrow the entire amount needed to buy and fix the property as your total cost purchase and repair cost of $60k is well below the maximum loan amount $68k.
You’ve borrowed $60,000 to buy and fix a house. Many lenders would require you to fix the propery as soon as possible and put it back on the market. You don’t have to make any payment during fixing the property. The property will appraise for $100,000 after the repairs are completed. Then you refinance into a 30 year traditional mortgage at an 80% Loan To Value. The “refi” would provide $80,000. You’d have $60,000 to pay off the hard money loan, plus fees, closing cost and points, interest and you might still have leftover to pocket which is usually rare case.
Why many people don’t use Hard Money Lenders?
Many stay away from Hard Money lenders due to their bad reputation. They are known for huge upfront costs, expecting 30-40% upfront either in equity or as a down payment and another 4 or more points paid up front (a point is 1% of the loan value). The loan costs are somewhat higher than traditional mortgages, and this reflects the added risk of loaning money for properties that may not even be in livable condition. The annual interest rate is usually 12% or more, and the balloon payment is usually due in only a year or two. If all this isn’t enough, there is the fact that hard money loans are designed so that there is little risk for the lender. Between the upfront costs and the collateral, the lender can foreclose and still make money. This is also why hard money loans are perfect for real estate investors. With High risk comes high return with no money down. Some hard money lenders will even defer payments on the loan until the property is refinanced. That could mean very little money out of your pocket up front.
Tips & Tricks
Hard Money loans are not for everyone and not for every property. The property has to have enough equity to take the hard money cost so you don’t have to put lot of money out of pocket. Below tips might help you to make a decision whether you want to take this route or not.
- First, check with various lenders to compare their costs, but a typical hard money requires about 3 to 5 points, carries a 12 to 15% interest rate. As these loans are intended for the specific purpose of buying and fixing, they are expect to be more expensive. The objective is to use them for only a short time, and pay them off as quickly as possible by getting the property refinanced once the repairs are completed and a more traditional, lower cost loan can then be used.
- Get your permanent refinance loan prequalified before you close on a hard money loan. Getting the hard money loan paid off quickly is essential for total success.
- Know your total cost before you buy a property. Be sure your loan amount will cover your needs, and stay within your budget.
In conclusion, You don’t have to use Hard Money Loans to be a successful investor. Hard Money loans are just one of many routes to buy investment property. But the important point in making hard money loans work for you is finding and buying properties with high equity/lowest price possible and do a cost effective job on the repairs. If you want referral to good hard money lender in Houston, let me know. Few of my clients used Hard Money loans but I always bought my investment property either cash or conventional loan.
About Vijaianand Thirnageswaram
I am a Proud Realtor of Texas, trying to guide and help clients to find their dream home and educate them to buy them for right price. I am also a Candidate for CFP who has more financial knowledge which allows me share and educate clients in any financial decision making process.
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