Hard Money is a type of loan that is generally used by real estate investors to purchase and repair a piece of real estate. Lenders are mostly small companies or private individuals with funds to invest. These companies and individuals operate differently from traditional mortgage lenders who write government backed loans such as FHA or VA. Because of this they can determine their own rules for making loans, and they can be as flexible as they wish to be.
Hard money loans are based on the "After Repair Value" or ARV, instead of the current appraised value. Depending on the lender, the property may be residential or commercial, so this loan type can be used with a wide variety of properties.
Let's say you've located a single family home in a nice area. The home is in need of paint, carpet and some general updating of the kitchen and bath. You've checked on the repair costs, and found that the repairs will be about $15,000. You plan to fix up the property and rent it out to a tenant for cash flow.
You've done some checking on the recent sales in the immediate area, and have determined that the value of the property after the repairs are completed will be $100,000. This is the After Repair Value. (ARV)
Generally a hard money lender may loan about 50% to 68% of the ARV for a property. This would be roughly $68,000. Let's also say that you have the property under contract for $51,000. Your total cost for purchase, plus repairs of $15,000, would be $66,000. You could potentially borrow the entire amount needed to buy and fix the property.
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. 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. These loans are intended for the specific purpose of buying and fixing, so they are 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.
You've borrowed $66,000 to buy and fix a house that will appraise for $100,000 after the repairs are completed. Then you refinanced into a 30 year traditional mortgage at an 80% Loan To Value. The "refi" would provide $80,000. You'd have $66,000 to pay off the hard money loan, plus $10,000 for points, interest and closing costs, and you would still put $4,000 of loan proceeds into your pocket. This is called a "cash out refi". And it's still possible to do where the LTV is low enough to meet the mortgage guidelines.
Important: 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.
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.
Owner-occupant buyers may also use hard money to purchase and fix a property they wish to live in. This strategy is not limited to investor buyers. But most owner occupants are not as aware of this financing strategy, since it is promoted primarily to the investor community.
When the housing market crashed, many lenders stopped lending or went out of business. Now that prices are a lot lower, and there are millions of foreclosed properties in need of repairs, hard money lending is beginning to make a comeback.
Be sure to check your loan costs carefully when shopping for a hard money lender. Know your total cost before you buy a property. Be sure your loan amount will cover your needs, and stay within your budget. Keep your repairs managable and in line with your abilities. Don't get into a project that is too big for you to handle.
The most common mistake investors make with hard money loans is getting behind on their repairs, and/or going over budget on repairs. If this happens you'll end up owing more in interest and late fees.
Professional hard money lenders advertise and are pretty easy to find online by searching for "hard money lender in ___________ city". It's best to get some references from local investors or investment clubs. There are loan scams out there, so be sure to check your loan contract carefully or have your attorney review it before you sign. Family or friends may also be interested in acting as a private lender for you, for the chance to earn a high rate of interest.
The key to making hard money loans workable is to buy the property for the lowest price possible and do a cost effective job on the repairs. The final appraised value will reflect this and you'll have a very profitable outcome, whether you are an investor or an owner occupant who wants a great deal on a home to live in.
Donna Robinson is a staff writer for Realty Biz News, and has over 16 years experience in the real estate industry. An active investor and former agent, she develops and teaches real estate investing courses as well as doing private coaching for real estate investors and investment companies. To request a free PDF copy of Donna's latest book, you may email her at [email protected]