What is a Hard Money Lender?
The simplest way to define a Hard Money lender is an individual or investor who is providing money that is backed by collateral (typically a property). They play with their own set of rules and could range from a financial partner to a loan shark. However, when using the term Hard Money Loan the majority deals are done in the Real Estate investing and are short-term to help upgrade a property.
Why Use a Hard Money Lender
When it comes to Real Estate deals time is money. Especially in the world of flipping properties, the longer it takes before the property can be worked on, then the longer it takes before that property can hit the market and be sold and move onto the next project.
Most project homes wouldn’t pass the necessary inspection requirements needed for traditional lending. When the home needs some TLC to fix broken pipes, and holes in the walls or shattered windows the bank doesn’t want to sign off on the loan based on potential of the final condition of the home.
This remodel is a serious Project with a capital P. Consider this from the bank’s perspective, if you ran away with the bank’s money the day after you received it, they would be left with a home in horrible condition, that they would need to turn around and wait the long process to sell it at auction. They aren’t in the business of fixing up homes and selling them back to buyer, they want their money back.
Traditional Loan vs Hard Money
Let’s take a look at why there is even a market for Hard Money Loans and when it can make sense to go with one or to go through traditional lending.
The traditional bank will pull your credit compare all your current debts and incomes and check your Debt to Income ratio. Then after you submit all of your paperwork your loan will go to an underwriter for approval, that process comes with its own red tape.
It’s a lengthy process to gather all those documents, it takes a while for the bank to confirm everything and still they want the property in decent shape and you to follow through with their monthly payment (possibly balloon payment) and keep to the official schedule.
A Hard Money lender most likely isn’t going to do all those things. Instead, they would like to know your track record. Have you borrowed money from other hard money lenders before and paid them back? Have you done these types of projects before, and if so what was your timeline to get the job completed.
These investors are more focused and the project and its timeline than they are on your personal payments and condition of the property. However, because they know the property is not in the best condition they want to make sure that there is adequate equity and profit to be made should things fall apart and they take over property and its project.
Closing times with traditional banks typically can run weeks or even months but hard money lenders could provide you with the necessary capital in a matter of days. That can help speed up the closing process and begin work on the property.
Being able to dictate your own terms and able to negotiate altered terms can be an added benefit, especially when things don’t go exactly as planned. A simple quick turn around project can quickly become a longer term nightmare if there are more repairs and changes needed than anticipated. Making unexpected adjustments with the payback terms can be beneficial.
Contracts are written up with a hard money lender similar to a promissory note.
- Term – Typically 6 Months to 3 Years
- Rate – Simple Interest Rate – Higher Than a Bank, Most Likely Low Double Digits
- Repayment Terms – Installment Payments or Balloon Payment at End of Term
- Extension Options – Higher Rate at the End of the Term for Certain Amount of Exteneded Time
- Details of Subject Property How Money is Secured – To Provide Ownership to Investor in Case of Default
Typically the investor doesn’t want to own part of a property or take over the project either, but he’d be willing to renegotiate should a project be delayed. Being able to renegotiate new terms helps the project succeed, being flexible becomes priceless when all parties are willing to see things to completion.
Because the money needed to complete these projects is more along the lines of tens of thousands, it makes more sense to find a few investors to bring tens of thousands rather than finding a hundred investors bringing hundreds. The process can be done with multiple individuals but life is easier to work with only a handful of investors.
Consider for example if you need to renegotiate new terms, you could contact those few investors or you could contact those hundred different investors.
For this reason Hard Money Lenders can typically be found in real estate or investment clubs where they meet to discuss projects and meet up with those ready to put their money to work. The money can come from a variety of sources, some may have cash from a high paying job, others may have money from a recent sale (property, or business), or other may have cashed out retirement accounts or even received a lump sum from an inheritance. Whatever it may be, these investors know they have a lump sum of money and are ready to provide it for a decent return.
Partnerships vs Hard Money Lender
Partnerships are another way to invest in a project. Partnerships and LLCs help create an outline of more details for how the money is used and profits are split. Also included are the articles of organizational duties which lists specific duties of all parties involved.
Partnerships though typically have been associated with long term projects or multiple projects so the money doesn’t need to be immediately returned to the investor after a project is done, but they can receive a portion back after there are capital gains from the sale of the project.
Also, partnerships can benefit the investor more as they typically list out the % of the profits where with the hard money contract the rate typically is the same and doesn’t take into account the profit margins made on the property.
For example a hard money lender may demand 10% for up to a year. But if it was in a partnership it may be 8% plus 50% of the profits afterwards, so if the property sold for a high value the investor could receive a higher return than if they only demanded 10%. Though with the partnership the profits are shared, as well as the risks and downside can now be shared as well.
Want to become a Hard Money Lender
It may be easier than you think to be a Hard Money Lender. It is funny how after I sold my first home and provided some of the funds to a friend to fix up a home, I didn’t actually consider myself a Hard Money Lender, just someone who was funding a flip. But then when I had to explain to someone what I was doing with my money it dawned on me that, that’s exactly who a Hard Money Lender is. They are someone who is providing money to finish a project and get a return.
You can start by investing directly in projects, or in real estate trusts, or partnerships. Start small with multiple investors on projects and as you build up your finances you can become a direct hard money lender.
What have your experiences been working with real estate investors and hard money lenders?