Op-Ed: Decreasing the risk associated with hard money loans

by Ernesto Rostoker12 Nov 2020

As many readers may know, a hard money loan is one someone can get through private money lending companies or individual hard money lenders instead of going through a bank. This typically means that there’s a shorter approval time (usually two to four weeks) and fewer requirements to meet; even those with a bad credit score may get a chance to finance non-owner-occupied real estate.

But is becoming a hard money lender risky, and what should your clients be aware of if they want to go into hard money loans? What kinds of clients should they look to acquire? These are critical questions that responsible lenders – and their mortgage advisors – should attempt to answer before taking the plunge into hard money. What follows is a primer that I hope will be of value for any mortgage professionals whose clients or associates are thinking of diversifying their investment portfolios.

Key considerations

How do hard money loans work? Though they may sound scary, the whole process is much simpler than it seems.

In short, a lender is approached by a potential borrower who needs the money for real estate and/or renovations that should incur a profit once the property is sold. At that point, they can evaluate the plan, how the borrower will pay back the money, and how feasible the whole project is. If they determine there’s little to no risk at all, they can lend the money under certain conditions.

The whole appeal of these loans is that, although they are more expensive, the approval is easier than in banks. More importantly, the whole process is more flexible and faster, allowing for quicker project development and return on investment.

In general, there’s little risk involved if the lender covers all bases beforehand and doesn’t invest more than they can handle. Still, when deciding on a particular project, the lender should consider the following factors:

  • How high they want (and can go) with the loan. Lenders are mostly concerned with the property’s value and aren’t usually seeking out perfect credit scores. Still, they aren’t in this business to lose money. A smart lender will try to stay in the 65% to 75% range when it comes to the loan amount; they want to make sure they don’t suffer a loss in the end. 

However, if other factors point to more risk, the interest rates and the points are likely to go pretty high. The numbers will be determined after a complete appraisal.

  • How Flexible They’re Ready to Be. Since the standardized underwriting process is not a necessity, hard money loan agreements are rather flexible. Yet, the payment schedule and all the conditions do depend on the lender and if they can go the extra mile for the borrower. Something that would help them decide on this is the fact that both parties have the same goal — profit. Therefore, it’s always a good idea to make a flexible agreement that favors both of them.
  • How Fast They Can Fund the Loan. The whole appeal of hard money loans lies in the fact that the borrower doesn’t have to wait for ages to get approved. When it comes to banks, they’re looking at weeks of waiting, and there’s always a chance they’ll get rejected. With hard money lenders, however, the criteria are less severe, and the turnaround is fast. If a lender isn’t able to deliver the funds quickly, they’re likely to have a hard time finding a good project to invest in.
  • If They Want to Evaluate the Borrowers Like Banks Do. A great thing about hard money loans is that there’s no need to sift through bank statements, review the borrower’s income and try to find anything in their credit history that could incur a higher interest rate. Hard money loan requirements are pretty simple to meet overall. The biggest factors in the game are the value of the property and the potential profit.

Still, if one wants to conduct a more thorough check, they can, though that may make the whole process a bit slow. Most of the time, it’s enough to do simple checks and then focus on making sure both parties are on the same page regarding what they expect from the project, the timeline, the feasibility, etc.

  • Relying on a Few Sources When Appraising the Property. Since the property value will make or break a hard money deal, it’s necessary to evaluate it properly. Because of that, lenders ought to use several sources in order to determine the correct value. By not relying on one source, they may mitigate more risk before delving a step further toward the agreement. 

Types of clients to strive for

These loans are non-traditional financing solutions, so non-traditional clients are a given. The lenders will not be so impressed with perfect credit scores, no recent foreclosures, or a generally fantastic financial background. Of course, such clients are an incredible option, but those factors aren’t necessarily going to determine the loan approval outcome.

The feasibility of the project and the plan concern the lenders the most. Thus, their perfect clients are developers or other individuals who:

  • Have been in the business for a while. Thus, they know what they’re doing in terms of buying, renovating, and selling property.
  • Are ready to ensure the value goes up in the end by not cutting corners and relying on their own skills only.
  • Have planned out how they will use the loan and make the payments on time.
  • Are willing to include the lender in that plan and partner up for a profitable deal.

The borrower has to keep in mind that unlike banks, which only expect the payments on time, the lender has a direct interest in the project’s success. Thus, forming a good interpersonal relationship is a solid idea. In fact, it may up the chances of success, as neither party will feel as if their time is wasted. Better still, the lender won’t feel like they’ve thrown money to the wind.

Final Thoughts

If some of your clients are looking into becoming private lenders, it’s vital for them to learn more about what that entails, the risks, and which clients they should be on the lookout for. It’s not enough to want to invest money that way — hard money loans are risky business when done without proper research and planning.

About the Author: "Ernesto Rostoker is the founder of RBI Mortgages, which funds competitive private loans to real estate investors. Launched in 2016, the company quickly gained a reputation for its short closing times and flexible loan terms. Rostoker received a Bachelor’s Degree in Industrial Engineering from the University of Miami and a Master’s Degree in Accounting from Nova University.