Risks of Hard Money Loans
Hard money loans are a very useful financial tool when used correctly. But borrowers need to understand the potential risks of the loan to be sure it is their best option.
Hard money loans are an alternative loan which is asset based and not granted on the basis of the borrowers credit rating or credit history. As such, the loans can be easier to secure for a borrower with low credit or no credit history. But before opting for this type of loan, it is critical that the borrower understand the terms of the agreement.
Most of these alternative loans are offered for a very short period of time in comparison to a traditional mortgage or large loan. The average loan term is 6 months to a year, which is a very short time to pay off such a large amount. Many lenders will accept a payment of interest and only a small amount of principal while others will accept only interest payments. But in either case, the result is a large balloon payment due at the end of the loan term.
While this fast funding loan can be a life saver when you have found your dream property, it can also have a huge downfall if you are not able to meet the final payment requirements. Some lenders will extend the term of the loan but will charge a rather large penalty. Others will stick to the original timeline and foreclose as a result of your default on the loan terms. The result is that you will lose any money that you have paid on the loan as well as the property itself, which was the collateral.
Avoiding the Pitfall
While the speed of the funding for hard money loans is attractive, borrowers should have a well thought out plan prior to signing the loan agreement as to how they will repay the short term loan. In the case of a property flip, borrowers need to be certain that the property will be completed and resold before the loan term ends. If the flip pace slows, it is critical that the borrower begin to seek an alternative loan. In some cases the property will have increased in value and the borrower can then qualify for a long term traditional mortgage. In other cases, the borrower is forced to find a second short term alternative loan to pay off the first one. But not defaulting on the loan is paramount.
Use Hard Money Loans Wisely
Any loan should be carefully considered and the borrower should be certain to verify all of the terms prior to signing the loan documents. Even though the lender is a private person or group, the loan agreement is equally as binding as any loan with a bank or other lending institution. Using a short term loan as a bridge loan, as a means of securing cash fast for a purchase and then refinancing or for a fast flip are all good ideas as long as the project remains on the time table and you can meet the terms of the loan.
Staying on top of the current movements in both the financial world and in the real estate world is essential for ensuring that you, as a borrower, are able to make the most of your property investments. Commercial mortgages, just like any other economic indicator, have ebbs and flows.
After the real estate market crash in 2007, and the subsequent decline through 2012, real estate and property investments have surged back to reach pricing that was very unexpected in the days following the steep decline. However, as with any type of economic surge, there will come a time when that expansion begins to contract.
As a borrower and real estate investor, it is critical for you to stay on top of the tends in commercial mortgages so that you can be as prepared as possible to adapt your strategies to best take advantage of the market, whether it be expanding or contracting. With the market beginning to slow, it is important to examine what this might mean for what comes next.
It is no surprise that many investors turn to real estate as a lucrative investment option. It offers a great deal of stability, relative to the market, and it has consistently provided a source of income, as families always need places to live and businesses always need store front or offices spaces to effectively run. Commercial real estate has continued to grow at a slower rate in the past couple of years, but it is growth, nonetheless. However, the growth has become slower in both 2016 and 2017. For those in the business of commercial mortgages, this is usually understood to mean that a change in the market is soon coming.
While the recent election of Donald Trump to the presidency has had positive impact on the business, and therefore real estate, confidence, there has also been some concern over the potential for an increase in inflation with the rapid growth for which he has been advocating. This is especially worrisome for those dealing in commercial mortgages, due to the fact that threats to inflation often have the consequence of the Treasury raising interest rates in an effort to stabilize the impact. Obviously, rising interest rates from the Treasury department will have a restrictive effect on the real estate market, as fewer individuals and businesses will seek funding, creating a very competitive environment.
What are the potential market reactions to the economic impact on commercial mortgages?
Why Choose Hard Money Loans?
When borrowers think of private lenders, they often don’t understand the benefits of this lending option. But hard money loans can offer many benefits to the right borrower.
Hard money loans are a very different creature than the traditional bank loans that most people are familiar with. Unlike their stogy counterpart, the terms and conditions to qualify for a hard money loan are quite relaxed in many cases. The biggest factor in landing these types of loans is the value of the real property being used as collateral. Lenders use the loan to value ratio to determine the loan amount they are willing to offer. In most cases the highest a lender is willing to go on LTV is 50% to possibly 75% of the value of the collateral. This insures the lender that the collateral will always hold more value than the outstanding balance on the loan should the borrower default.
Knowing that your loan will only be around two thirds the value of your collateral might seem odd but there are many other factors which work in the borrowers favor to offset that one possible downside. Hard money loans are a viable solution for anyone who needs a loan but does not have the stellar credit that banks or mortgage lenders are going to require. Sure the interest rate is going to be higher than a bank would charge but higher interest is the price you pay to secure a loan with bad credit. It is also a good first step to take to rebuild your credit.
When Time Is Money
Hard money loans are also a very appealing option when time is critical for a business deal. Time really can be money in the business world. And if you have the chance to get in on a great deal but need to do it quickly, then a traditional bank might not be able to fund quickly enough to meet your needs. The solution is a non-traditional loan to land the deal and then the possibility of financing a traditional loan to pay off the first loan, leaving you with a lower interest rate for the long term.
The Package Deal Hard Money Loans
Traditional loans are typically a one size fits all deal and it is the borrower’s responsibility to find a way to make it work. But a non-traditional, or asset based loan is something that can be tailored to meet the individual needs of each borrower. Private lenders have much more flexibility because they are not forced to follow the state or federal laws which apply to banks and other commercial lenders. For this reason, borrowers are willing to pay a higher rate to enjoy the comfort of a customized loan that offers terms to meet their needs. In addition, there is far less paperwork and red tape to deal with when applying for a private loan. So your stress level and time invested in the process are both much lower. Just as when selecting your home, you pay more for custom features when getting a custom loan but the price can be worth it to enjoy the added benefits.
Which type of Hard money loan is right for you?
The “hard “asset being financed secures a typical hard money loan. But there are different types of asset-based loans, so how can you figure out which one is right for given your specific circumstances?
Asset- based lenders consider the value of the property which secures the loan rather than a borrowers credit score, so this type of loan can be more accessible for some borrowers.
The application process is easier than a traditional bank loan as borrowers don’t need to provide extensive financial documentation in most cases.
Typical types of asset-based loans include commercial, renovation and cash-out refinance loans. Businesses rather than individuals take out commercial loans.This type of loan is short term, and it is not typically used to purchase real estate or to make long-term investments. Instead commercial loans should be used to cover short-term costs like equipment or inventory.
Borrowers use renovation loans to improve a property and then resell it for a profit. Refinance loans allow borrowers to quickly purchase a property and then later refinance to a traditional mortgage.
So what are some specific situations and how do they relate to these particular types of asset-based loans?
Evaluate your situation to determine which type of hard money loan is right for you
An asset-based loan could be a good solution if your business has sufficient collateral and you cant secure financing from a regular bank. If you want to renovate a distressed property, an asset-based lender is your best bet. Few banks are willing to issue renovation loans because raising the required capital is made difficult by government regulations. Traditional lenders also deem such projects too risky because there is a high risk of default if the borrower’s project doesn’t go according to plan.
A cash-out refinance loan can be ideal if you want to purchase an investment property quickly. A traditional mortgage can take several months to close. A cash-out refinance loan allows you to make the initial purchase while giving you the option to refinance to a long-term mortgage at a later date.
Whatever circumstances asset-based loans provide you with flexibility, but any lender you approach should be transparent and willing to offer advice.
Beware of hard money lenders that can’t offer you specific advice about which loan is right for you
There are other types of asset-based loans of course, but a good lender will carefully consider your situation to find the option that can best meet your needs. You should look elsewhere if a lender isn’t transparent or is unable to give you insight into your specific situation.
A commercial loan can be great for businesses owners with a lot of collateral, but who are ineligible for regular financing. A renovation loan can allows you to improve and resell a distressed property, and a cash out-refinance loan allows you to complete time-sensitive transactions. In short, asset-based loans are easier to qualify for, can be used to make speculative investments and can close quickly to complete time-sensitive purchases. Carefully consider your specific situation to find the type of loan to meet your financing needs.
The Difference in Hard Money Loans
Many people, before they delve into the world of real estate investments, think of hard money loans as those you obtain only if you have poor credit and are desperate. Those that have been in the business for a while understand that they are an important lender to have in your lending portfolio and that many have different requirements and protocol.
Hard money loans are often obtained from private individuals that specialize in various types of real estate loans. The rates they offer vary dramatically and can range anywhere from 10 percent and 1- or 2-point origination fees, depending on your terms, to 18 percent interest on a short term loan with a 5- percent origination fee. An origination fee is designed to cover the cost of entering into and processing the loan agreement. Some lenders will roll your origination fee into the loan balance while others require payment upfront. Compare loan APRs along with fees in order to determine who is offering you the best loan.
You’ll find underwriting processes, or loan determinations, very different among lenders of hard money loans. For many, creditworthiness and credit scores are not even considered in the approval process. For others, it is an important consideration. When evaluating what you bring to the table, which includes your down payment as well as your collateral, some will only consider the LTV or loan-to-value ratio while others consider the ARV or after-repair-value. If you’re looking for a loan amount based on the after-value, you will need to come to the table with a solid background in your chosen real estate investment as well as budget and expenses that includes contractor fees.
Some hard money lenders specialize in specific types of properties. For instance, you will find hard money loans specifically for fix-and-flip models while others are solely investing in manufactured homes with land. Obviously, it’s important to find out what types of investments they are willing to loan on before wasting any time with a lender that does not specialize in the type of loan that you need. Generally speaking, most will not lend on an owner-occupied residential property thanks to Dodd-Frank regulations.
The Main Reason Real Estate Investors Choose Hard Money Loans
One of the main reasons real estate investors choose hard money loans is because they are often quick to fund. Many of these types of lenders will fund in as little as a week or less, in comparison to the month or two that traditional lenders take due to underwriting processes and extended time to funding. If an investor finds themselves in a bidding war, having cash on hand can often mean the difference between starting their next renovation or still searching for that ideal property.
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We offer loans with no prepayment penalties and with terms that can be extended. Our popular construction loans start at 9.5 percent APR with 24-month terms and convenient monthly draws. Call us for a no-obligation quote.