The asset-based lending market in the United States is worth more than $465 billion. Asset-based hard money loans, also known as bridge loans, give borrowers more flexibility by using their assets (properties) as collateral. Asset-based bridge loans allow an investor to buy a new property without having to sell any of their existing assets or properties.
Real estate investments can be a profitable way to build wealth and an excellent way to expand your portfolio. You can invest passively through real estate crowdfunding and real estate investment trusts (REITs), but some investors would like to own property directly.
If you don’t want to put down a large sum of money upfront to buy property, a hard money loan for multifamily, (or any type of property) may be the way to go. While this type of loan has some benefits over traditional financing, it also has some drawbacks. In any case, there is still a need for a capital buffer.
What Are Hard Money Loans and How Do They Work?
Hard money loans, also known as bridge loans, are short-term loaning instruments used by real estate investors to fund investment projects. House flippers and real estate developers who want to remodel or develop a property and then sell it for a profit frequently use this kind of loan. Private lenders, in contrast to traditional financial institutions such as banks, issue hard money loans.
The ability to access hard money financing is not determined on the borrower’s creditworthiness, as it is with conventional loans which are issued by banks. Hard money lenders, on the other hand, decide whether or not to make a loan based on the property’s value. These lenders pay particular attention to the After Repair Value (ARV), which is an estimate of the real estate property’s value after the remodeling or development phase has been completed.
When considering utilizing Hard Money as a funding resource, there a three (3) basic principles that an investor should be aware of:
1. Have a firm grasp on when the property will turn a profit.
- 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. Be sure to hire a trustworty contractor because 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 ensure that you will be able to pay it back on time and prevent any additional costs incurred as a result of incorrect completion judgments.
Hard money loans come with their own set of advantages and disadvantages.
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.
***The advantage in this case is that these loans are usually for a shorter time period, because it gives the investor the ability to get a property ready to sell as soon as possible. As a result, the borrower, in most cases has the ability to repay the loan quickly which can significantly reduce the amount of interest paid.***
2. Thoroughly familiarize yourself with the contract’s terms.
- 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.
- If this is your first time applying for a loan to make investments, you may have a tougher time getting accepted and may be required to provide additional information that a seasoned investor would not be required to provide.
- When considering a hard money loan, 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.
- Always educate yourself on the agreement’s terms, as well as the risks and benefits involved. Don’t be afraid to ask any questions that come up during your time working with the lender.
This brings us to our final point!!!
3. Do not be afraid to ask any questions that you may have.
- You’ll have questions, regardless to whether you’ve worked with the lender before or are completely unfamiliar with his methods. When it comes to determining the terms and conditions of the contract, each lender takes a different approach and adheres to different standards. Even the lender with whom you have previously dealt may have different “standards” for different types of projects they might choose to lend on.
Note: Small hard money lenders, may not always have the resources to service their loans “inhouse.” This could indicate that they’ll either sell the loan or hire a third-party servicer. Since you are no longer working with the original developer, this can be difficult for you as a customer. It’s always a good idea to ask about this ahead of time.
Another important question that many borrowers have is whether or not the hard money lender they’ve chosen regularly underwrites clients.
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, if you look closely, you may notice a few issues.
They may be taking on additional risks if they lend to just about anyone. 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.
Because of all of these factors, it’s always a good idea to ask all of your questions before signing the contract or even later on as you go through the process.
Overall, if you know about using hard money effectively, it can be the vehicle that propels your investment to another level. And, while these pointers are intended to increase comprehension of the industry and the ability to identify the most appropriate types of lenders for and investor to use, there’s a lot more you should know before taking out a loan of this type. Before you go all in, learn about the latest industry trends, current price rates, and speak with people who have previously taken this path.