If you are new to property investing, you may be familiar with the term “hard money loan,” but you may not be aware of how it works. In general terms, hard money loans come from a private individual (or group of individuals) for the purpose of a real estate transaction. Hard money loans work well in certain situations. Before you decide if a hard money loan is right for you, educate yourself on the key terms associated with this type of financing.
Loan to Value (LTV) Ratio
LTV is calculated by taking the loan amount and dividing it by the property’s value. For example, a loan of $200,000 on a property worth $250,000 has an LTV of 80%. Ideally, hard money lenders like to see LTV in the 65-75% range.
After Repair Value (ARV)
Because hard money loans are not coming from banks, the criteria by which the investors judge the likely success of the deal are different. Some hard money lenders will look at the ARV, which is the estimated value once the rehab work has been completed. ARV-based loans have more risk for the lender, and therefore may carry a higher interest rate than if the terms of the deal are based on LTV.
Just with traditional lending, the interest rate impacts your bottom line. The difference, however, is in how much interest the typical hard money lender charges. Where a bank may charge interest around 4.5%, with hard money you are looking at around 10-16%. That is clearly a substantial difference. However, you must factor in how much faster you can close on a hard money loan as compared to the typical bank closing time frame. Also, since the goal is to flip the property quickly, ideally you will be paying back that hard money loan quickly enough that it will not cost you a lot in interest.
Points are the fees you must pay to the lender for borrowing the money. A point is 1% of the loan amount. Typical hard money lenders charge between 2 and 6 points per loan. Often, lenders add this fee to the loan amount. On a $200,000 loan, 4 points comes out to an additional $8,000 added to that loan.
Hard money lenders want to get in and out of their deals quickly. This is why they generally only lend to property rehabbers and flippers. Terms on hard money loans are usually between 3 months and 1 year. Each day you don’t repay that loan, you are accruing interest. You must factor this into your budget. Also, realistic about how long it will take you to complete the work, list the property, and close a deal. If you fail to repay your loan on time, you may be forced to pay additional penalties.
Again, because hard money lenders are individuals and groups, rather than banks, you will find a range of loan minimums and maximums. Do your research. Some may stipulate a minimum, others a maximum. They all have their own business strategies and frameworks within which they operate. You will need to find a lender that can work within your target loan amount.
Hard money lending has become more popular in recent years, which means it is easy to find a lender. A quick Google search, or a conversation with your real estate agent contacts, should get you pointed in the right direction. Real estate investor clubs and conventional mortgage brokers can also be great resources. You can decide if this option is right for you once you understand the terms and talk to lenders.