3 Tips for Hard Money Loans for Real Estate
If you don't want to put down a large sum of money upfront to buy an apartment building, a hard money loan can be a good option — though it does have drawbacks.
- Three Tips for Using Hard Money Loans
- 1. Understand When Your Property Will Turn a Profit
- 2. Clearly Understand the Loan Terms
- 3. Ask Many Questions
- Hard Money Loans: Pros and Cons
- Advantages of Hard Money Loans
- They're Quick
- They're Flexible
- They're Short Term
- Disadvantages of Hard Money Loans
- They're More Expensive
- They're Short Term
- Conclusion
- Related Questions
- Get Financing
Hard money loans can be an attractive option for investors looking to finance their multifamily real estate projects. These loans are typically used for short-term investments and are based on the value of the property rather than the borrower's credit score.
However, as with any form of financing, it's important to understand the advantages and disadvantages of hard money loans, as well as the key factors to consider when using them for your multifamily real estate investments.
We'll review three key tips for using a hard money loan for a multifamily purchase, followed by an examination of the pros and cons of using this type of financing. Not sure if a hard money loan is right for you? We'll walk you through your options — fill in the form below.
Three Tips for Using Hard Money Loans
1. Understand When Your Property Will Turn a Profit
One of the biggest advantages of hard money loans is that they can provide quick financing for real estate investments. However, this also means that the loan terms are much shorter than traditional bank or agency loans. It's important to have a clear understanding of when your property will turn a profit — if your property is still in the red when it's time to refinance, this could be trouble.
Let's illustrate with an example.
John is looking to acquire a property. He knows the community in is in a desirable location, and he's confident that it will attract high-paying tenants. He also knows that the area is growing, so there is higher demand for luxury rental properties. However, he wants to be certain that his investment will be profitable before taking a two-year, $4 million hard money loan.
To do this, John performs a thorough analysis of the property's effective gross income and expenses. He takes into consideration the estimated rent he can charge for each unit, the property's operating expenses, and any potential capital expenditures. Based on his analysis, John determines that the property will turn a profit after 12 to 18 months.
With this information, John can confidently proceed with the hard money loan, knowing he should be able to easily refinance the loan before the balloon payment is due.
2. Clearly Understand the Loan Terms
Hard money loans typically have higher interest rates and fees compared to traditional mortgages. What's more, the loan terms can vary widely depending on the lender, as it's not a standardized loan product. To avoid any surprises down the line, it's important to clearly understand the loan terms. Look at the interest rate and repayment period, and also take note if the loan is interest-only — many are.
Also keep an eye out for any prepayment penalties. Typically, hard money and other bridge loans do not have penalties for paying off the loan early, but it pays to be prepared.
3. Ask Many Questions
Don't hesitate to ask questions and resolve any doubts you may have about the loan terms and conditions. Even if you're working with a reputable lender, don't completely rely on them having your best interests at heart.
And your lender may even change. Small hard money lenders often don't have the resources to service their loans in-house. This could indicate that they'll either sell the loan or hire a third-party servicer. Since you would no longer be working with the original lender, this could potentially create some challenges down the road.
Because there are so many varieties of hard money loans, we would strongly encourage you to seek expert advice from a broker or loan advisor who understands your property, the market, and the current state of financing. We can help with that.
Hard Money Loans: Pros and Cons
There are great reasons to get hard money financing, but they are absolutely not for every investor or scenario.
Advantages of Hard Money Loans
They're Quick
Few loan products can compete with a hard money loan's speed of execution. When a fast close is necessary, these may be the only option in town. Yes, you will pay more for the speed, but it's a small price to pay if your deal hinges on a fast close.
They're Flexible
Flexible underwriting can be a huge advantage, particularly if your personal credit score isn't anything to write home about. Hard money loans are based on the value and income of the property itself, not your credit history, so this can make it significantly easier to secure a competitive loan.
They're Short Term
If your investment strategy is for a short-term hold, a hard money loan may be what you need. This type of financing can be very beneficial for fix-and-flip investments.
Even for longer-term investments, hard money loans' short terms can be a key advantage. We'll use an example: Shawna plans to buy a multifamily property that she believes has great potential. The property is in need of some renovations, but she's confident that she can make it profitable with the right upgrades. Shawna has two options for financing her purchase and renovation: a traditional long-term loan or a hard money loan.
Shawna decides to go with the hard money loan because she knows that she can use it to quickly acquire the property and make the necessary renovations. She also knows that if she goes for a long-term loan first, she'll be locked into an expensive loan for several years, thanks to prepayment penalties.
With the hard money loan, Shawna can renovate the property, reposition it as a high-end multifamily asset, and then get better, long-term financing once the property is stabilized.
Disadvantages of Hard Money Loans
They're More Expensive
Undoubtedly, one of hard money loans' largest disadvantages is the extra cost you take on. Interest rates are much higher than standard, long-term financing, and significant fees are also not uncommon. Of course, these extra costs may be worth it, depending on your investment strategy and how you plan to utilize the loan.
They're Short Term
Yes — hard money loans' short-term nature can also be a disadvantage, depending on your situation. Let's look at the previous example with Shawna to illustrate. We know that Shawna wants to buy the community and reposition it.
That's all well and good…but what if the demand for luxury units in that area doesn't materialize? Shawna may be left holding the bag on a property that lenders and buyers will shy away from if the asset is plagued by vacancy issues. It would be very difficult for her to get a competitive refinance with the community in that state, and likely no buyers would be interested if they don't see a way to get it filled with residents.
Conclusion
To wrap things up, pay close attention to the three tips previous illustrated — they could make the difference between a successful experience and disaster. Beyond that, pay close attention to the upsides and downsides of these loans.
Simply put, hard money lending for real estate assets is not for everyone. If you have very little experience flipping or stabilizing a property, you may want to think twice. For these reasons, it's critical to understand the key elements, ask questions, and engage professional support for any multifamily loan you take.
Related Questions
What are the benefits of hard money loans for real estate?
The two biggest advantages of hard money financing for real estate are greater flexibility and speed. Hard money loans are generally offered by private lenders, which makes it much easier for investors to negotiate on loan terms. There is usually very little room for investors to negotiate terms of conventional financing vehicles, but with hard money financing, an investor may be able to tailor certain aspects of the loan to better suit their needs. Hard money lenders are much more willing to restructure the repayment schedule or reduce or eliminate certain expenses like the origination fee. Additionally, hard money loans are typically funded much faster than conventional loans, which can be a major benefit for investors who need to close quickly on a property.
For more information, please see The Pros and Cons of Hard Money Loans for Commercial Real Estate Investments.
What are the risks associated with hard money loans?
Hard money loans come with their own set of advantages and disadvantages. As a result, while they rank highly in terms of convenience, the average rate can be nearly 10% higher than a traditional loan. A hard money loan's loan-servicing fees, origination fees, and closing costs are more likely to cost investors more. Such a loan aims to assist an investor in getting a property ready to sell as soon as possible. As a result, once compared to conventional mortgage loans, such loans have very short repayment periods.
When flippers and landlords start working on their renovations, they frequently run into a snag or two. There's a good chance you'll find problems in house systems like electrical, plumbing, or even structural discrepancies that aren't easily and quickly visible on the surface. It's also possible that there's a mold hiding somewhere. If a contractor decides to leave and you're left with a partially finished project, you'll have to wait until you can find another contractor or agency to take over.
At any point in time, unpredicted issues can arise. When they do, ensure the hard money lender you pick allows you to extend your loan and does not call or foreclose on your note. Furthermore, if they really do offer sustained growth, find out how long they can stretch it for and whether there will be any changes to the originally agreed-upon terms. There's a chance that the hard money lender will try to take advantage of the situation by raising or even doubling the interest rate, charging an additional origination fee, or looking for other ways to profit from your bad luck.
For all of these reasons, it is critical to conduct a property market assessment and clearly understand when the unit will be profitable before applying for a hard money loan. This will make sure that you will be able to pay it back on time and prevent any additional costs incurred as a result of incorrect completion judgments.
The risks associated with hard money loans include higher interest rates, loan-servicing fees, origination fees, and closing costs, shorter repayment periods, and the potential for the lender to take advantage of the situation by raising or doubling the interest rate, charging an additional origination fee, or looking for other ways to profit from your bad luck. Source and Source
What are the qualifications for a hard money loan?
The qualifications for a hard money loan vary depending on the lender, but typically include an evaluation of the asset's real estate values, an evaluation of the borrower's financial history, and a requirement of 30-40% closing costs to secure the loan. According to Multifamily.loans, hard money loans for fix and flip properties offer terms of between 12-36 months, LTV allowances up to 90%, and interest rates between 7% and 12%. Additionally, Multifamily.loans suggests that borrowers should thoroughly familiarize themselves with the contract's terms and acquire the ability to read between the lines.
What are the typical interest rates for hard money loans?
The typical interest rates for hard money loans are between 7% and 12%.
Source: www.multifamily.loans/fix-and-flip-hard-money-loans and www.multifamily.loans/fix-and-flip-loans
What are the typical loan terms for hard money loans?
Typical terms for hard money loans are between 12 and 36 months, and they usually have interest rates of between 7 and 12%. Plus, hard money loans can offer generous LTVs of up to 90%, and usually don't have any prepayment penalties. Sample terms for hard money fix and flip loans in 2023 include:
- Size: Varies
- Term: 12- 36 months
- LTV/Leverage: Up to 90% LTV/Up to 80% ARV (after repair value)
- Interest Rate: Rates vary, but generally between 7.00 - 12.00%
- Closing Costs: 2.00 - 5.00%
- Credit Requirement: 550+ (can vary significantly based on lender)
- Lender Fees: Typically between 1.50 - 10.00%
- Timing: These loans can typically close in as little as 10-15 days
- Advantages: Typically no prepayment penalties
- Disadvantages: High interest rates, high fees, usually requires that the borrower has past experience with 2-3 successful fix and flip projects, less experienced borrowers may be required to work with a licensed contractor throughout the entire process
For more information, please visit our page on Fix and Flip Hard Money Loans.
What are the best strategies for securing a hard money loan?
The best strategies for securing a hard money loan include thoroughly familiarizing yourself with the contract's terms, acquiring the ability to read between the lines, and asking any questions that you may have. It is also important to learn about the latest industry trends, current price rates, and speak with people who have previously taken this path.
Due to the fact that private businesses and individuals typically provide hard money loans, the loan prerequisites can differ significantly between lenders. However, because the borrower deals with the lender often, there is more room for negotiating terms. It is also important to note that most lenders confirm the asset's real estate values, evaluate the borrower's financial history, and, in most cases, require 30 percent to 40% closing costs to secure the loan.
When considering a hard money loan, it is also important to be aware that the majority of hard money lenders today advertise that they do not perform any underwriting on borrowers. They may also claim that no borrower screening takes place. This appears to be a great deal on the surface because you can get a hard money loan quickly based solely on the property, and there aren't many hoops to jump through. However, it is important to be aware that they are taking on additional risks if they lend to just about anyone.
It is also important to be aware that if a loan fails to perform and the borrower cannot make timely payments, the house will be foreclosed, and the borrower will lose all of the materials, time, and money invested in the project. This has the potential to be disastrous. Moreover, the foreclosure process is both intimidating and costly. You'll have to pay legal fees, court fees, and a slew of other expenses.
Sources: 3 Crucial Tips on Using Hard Money Loans for Real Estate Investments