Commercial mortgage brokers have many choices when searching for the right loan fit. The default choice may be to seek conventional financing.
Hard money is another option, but navigating this world sometimes scares even the most experienced mortgage brokers and investors. Although exploring options within the hard money realm may seem daunting, hard money loans hold clear advantages over conventional financing, under certain scenarios.
Closing loans quickly
Speed is the greatest advantage of hard money. It can take months to get a conventional loan approved. Even when the investor has a prior relationship with the lender, a conventional lender will tend to start the approval process from the beginning each time the property requires a loan.
Hard money lenders move much more quickly. The borrower can receive funding within a time frame of 24 hours to four weeks. This speed varies by each hard money lender, and it depends on how they evaluate the property and the borrower. An asset-based lender will primarily approve a loan based on the property’s resale value, and often does little investigation into the borrower’s history.
A borrower, for example, may need $100,000 to fix a property that has an after-repair value of $500,000. An asset-based lender can close quickly on that loan, knowing that the property will likely sell for more than $100,000 regardless of what the borrower does with the property.
Other hard money lenders, however, will evaluate the borrower’s credit history and experience, and will follow similar processes as conventional loans. In most cases, however, these lenders are not as strict in their evaluations as conventional lenders, and the loan can typically be completed within four weeks.
Room for flexibility
Hard money lenders also tend to have room to be creative, and can design loans to fit specific properties more easily than conventional lenders. The use of cross-collateral is one example. Cross-collateral allows the borrower to use equity from a property they already own for a downpayment on the purchase of another property.
Many hard money lenders will not finance the entire property purchase and will require a downpayment to ensure that the borrower holds some skin in the game. Typically, the downpayment will be at least 20 percent of the purchase price. This presents a considerable hurdle for an investor, particularly as the loan size rises.
To help investors clear the hurdle of a downpayment, hard money lenders will often place a lien on the borrower’s second property and will accept that equity as cash toward a downpayment. If there is enough equity in the property used as cross-collateral, a commercial hard money loan can be structured so the monthly payments are rolled into the combined loan balance. The borrower can conceivably withhold any payments until the investment property is sold.
The hard money lender also tends to be more invested in the property itself and will often work with their borrowers to gather information on the local property market. A conventional lender’s primary goal, conversely, is to ensure that the borrower will pay back the money regardless of what happens to the property.
An asset-based lender’s primary goal is to determine if the money will be paid back regardless of what happens to the borrower. This protects the borrower from entering into a financial disaster. The lender simply won’t provide the funds if the borrower is asking for more money than the lender is comfortable lending for that specific property.
Hard money costs
Hard money loans cost significantly more than conventional loans. Although hard money loan prices will vary from state to state and lender to lender, on average, the interest rate on a hard money loan ranges from 10 percent to 18 percent, whereas the interest rate on a conventional loan is about 5 percent to 9 percent.
Hard money financing also can be structured as a so-called “balloon loan,” which can reduce the monthly payment. Balloon loans are typically interest-only loans in which the principal is paid in a lump sum by the end of the loan term. Balloon loans are common in commercial real estate, where property owners often are not trying to pay off the loan balance. Interest-only loans are useful for home flippers, who typically purchase homes, renovate them and then resell them within a calendar year.
Let’s assume, for example, a fix-and-flip borrower received a 12 percent interest-only loan for $100,000 and a 12-month term. This means the borrower would pay 1 percent per month for 12 months, or $1,000 per month for 12 months.
If the borrower stays in the loan for 12 months, they would pay the full 12 percent of $12,000. If the borrower is able to fix, flip and sell the house within six months — the average time it takes to complete a home flip — then the payback is only 6 percent, or $6,000. An interest-only loan, in this case, reduces the borrowing costs and encourages home flippers to be faster and more efficient with their projects.
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Commercial banks and conventional lenders tend to not have an appetite for deals that need to close quickly. Similarly, conventional lenders also tend to shy away from short-term loans and loans for investment properties, where the borrower could sell or refinance the property within a few months. Conventional lenders also are wary of offering certain loan products, such as construction-only loans. In these cases, savvy investors and commercial mortgage brokers should consider mining the territory of hard money.