Private money (‘hard money”) is a financing option available to investors where lending requirements are based more on the asset rather than the borrower. Sure, credit history and financial stability matter, but if you have an investment property with a high upside or at least a reasonable loan to value, that asset can be used to qualify for a private loan. While a hard money loan is a good option, it is not without cost. You should borrow only what you need to make the purchase and rehab the property, and use the money no longer than is necessary. A typical hard money loan can offer a term from anywhere between 6 to 12 months, but if you pay it to offer sooner, you will save yourself considerable interest.
What is Hard Money Lending?
Hard money lenders use investor capital (or their own) to fund the loan. So, since they make the rules, their terms are usually entirely different than from traditional lenders. First, expect to pay about double the interest rate you would see from a mainstream bank. Interest rates from between 12 to 16 percent are to be expected, including points. Up-front fees and points are usually charged by the lender to pay the loan officer, as well as protect the lender for early termination (payoff). Since hard money loans are typically used for short-term finance, the lender expects to get their funds repaid sooner rather than later. This uncertainty about the term of scheduled interest payments is calculated into the closing costs in the form of points, as a percentage of the total loan amount. These points can add up quickly depending on the property type and qualification of the borrower and can be in the range of from three to six points total.
Why Use Hard Money?
Hard money loans are a good option for fix and flip properties because of the easier qualification criteria. These loans can usually be closed within a week’s time, provided you have all your paperwork in order. This short funding schedule allows investors to make quick decisions on the purchase of an investment property. Even if it is a property that you plan on renting, a hard money loan can enable you to close the deal and work on refinancing options later, once you have a tenant. You may also be able to get more purchase money than you would typically see from a bank loan. If the property is a fixer, most private lenders will base the loan amount on the after repair value (ARV), or the amount the house will be worth once it is renovated. So, you may be able to qualify for a loan that is say 75% of AVR, and not based on the purchase price. This technique gives an investor more options and more opportunity when seeking out an investment property that will offer the best profit potential.
How Hard Money Loans are Structured?
There are a couple of different scenarios that can happen with a hard money loan. You can decide to pay a down payment, obtain a hard money loan for the difference, and pay for all repairs out of pocket. Alternatively, a second option would be to obtain a loan amount greater than the purchase price, based on a significantly higher ARV, and use the extra cash to pay for the remodel. In the second option, the loan would work more like a construction loan, paying contractors directly for repairs or paying invoices for major purchases such as appliances. The lender may be able to structure the loan to pay 25% of the renovation cost to the borrower at closing and allocate the rest in 25% increments as the rehab progresses. Depending on the lender, you may also have the option to pay all the points and fees after you sell the property, similar to a balloon loan. Finding the right private lending partner will allow you to explore all the different financing options they are willing to offer. And building a relationship with a quality private lender is key to obtaining financing when you need it, and with the most favorable terms.
Other Financing Options
Other financing options could include borrowing money from friends or family, or possibly even using money that you have sitting in a retirement or IRA account. An IRA account typically offers a set annual interest rate based on the type of investments empowered to your financial advisor or accountant. Using the funds from an IRA account to purchase investment property can be a good plan for both flip houses and prospective rental properties. By the numbers, using IRA funds for investment property buying can be much more profitable for your retirement plan than collecting simple interest. You are essentially borrowing money from yourself and paying it back at a much higher interest rate than you would earn from a traditional IRA account. Even if you decide to sell the renovated property and carry the loan for the new buyer, you can pay yourself back over a 30-year term at triple or quadruple the interest rate you were previously earning.
While every real estate market is different, becoming an investor could provide much better returns than you could ever get from traditional investment accounts. With current CD rates hovering around 1%, investment properties can be a sound way to diversify and build a stable retirement faster than you would ever be able to do otherwise.
Keep in mind that real estate investing is not for everyone. Knowing your market, researching the costs associated with renovation, and understanding the costs and fees related to financing the properties are the first step for any person considering this type of investment. However, rest assured, if you find that real estate investing is for you, there are many innovative and opportunistic financing options available to help make your dream a reality.
Geraci Law Firm is one of the few law firms with true expertise representing hard money lenders across the country for loans secured by properties throughout the country.