Choosing a hard money lender is just the first step
by Dana Wasson, Lima One Capital
Do you need quick funding to finance your next real estate flip? Traditional lenders like big banks often engage in a slow, painstaking process. It requires you to submit credit scores and an extensive credit history, other financial details, and a specific debt to income ratio on your personal income. This type of conventional loan takes a lot of time, both in compiling documents and in the bank’s underwriting process.
That’s fine for some types of loans, especially if you’re getting a low, fixed interest rate on a 30-year note. But if you’re planning a fix and flip project with a bridge loan, or other short term loans, you often need a quicker and more efficient approach.
That’s why many real estate investors finance their investment properties with hard money loans or similar types of loans from private lenders or direct lenders like Lima One Capital. Here’s what you need to know about choosing a hard money lender.
Why Choose a Hard Money Loan?
Hard money loans are financed by private lenders rather than banks. Instead of basing the loan primarily on the borrower’s credit history and income level, a hard money lender will underwrite based on the asset, focusing on the value of the property as collateral. That means they can close the loan faster and provide more flexibility, which is especially important if you’re buying an investment property in a competitive market. Here are a few more reasons to choose a hard money loan over a traditional mortgage:
You can get approved faster: Because hard money lenders are more concerned with the property value than with your credit history, you can usually get approved for the loan faster. As long as there is enough equity in the property based on the after-repair value (ARV), you have a good chance of being approved.
You can bargain from a stronger position: A hard money lender is less likely to pull financing at the last minute. If you are making your offer based on a hard money loan, you may be able to use that as leverage in the deal. You may also be able to negotiate a lower purchase price since your escrow period is shorter and you can close more quickly.
You can reinvest equity into new properties: Private money lenders will often approve cash-out refinance requests more readily than banks will. Because they consider the property value as collateral, they view the loan as a positive move rather than a risk. As the investor, you can use that equity to purchase additional properties.
Hard money loans are best when you need to secure a loan quickly and you don’t anticipate the need for a long-term loan. That’s what makes them ideal for fix and flip properties. As with any loan, however, you should always perform due diligence before you choose a lender.
Which Hard Money Lender Is Right for You?
As with any loan, you should always perform due diligence before you choose a hard money lender. Here are six questions to ask before you move forward:
- Am I considering a direct lender or a broker?
Direct lenders, as the name implies, lend money directly to the borrower using their own capital. Brokers do not lend themselves, but they connect borrowers with lenders. This often works well, but brokers are reliant on their sources of funding and therefore can’t always guarantee that a loan will close. The best way to find a direct lender is to ask other real estate investors or professionals in the industry. If you are just starting out and don’t have many connections in the real estate industry yet, a broker can help you find a lender to finance your project. A great broker can help you find the best deal quickly. However, dealing directly with a private lender like Lima One Capital can often provide the best use of your time and money.
- Is the lender local?
Because lenders usually want to inspect the property before financing your loan, it is best to work with a local lender if you are using hard money. Otherwise, turn to a national direct lender (such as Lima One) that has established processes and a network of appraisers and inspectors around the country.
- Does the lender specialize in a specific type of property?
You can get a hard money loan on most types of property, but lenders usually specialize in one particular niche (for example, residential or commercial property). Some lenders will not lend on certain types of properties because of the specific regulations. (For example, due to federal regulations, Lima One Capital only lends on non-owner-occupied residential property, as do many other direct lenders and hard money lenders.) Even within the world of real estate investment, some lenders may focus on fix and flip loans or long-term loans for single-family rentals. Bottom line: it pays to do your research about lender specializations.
- How do the loan rates and terms compare with other lenders?
The structure of the loan can create significant variation in the overall costs you pay.
As you compare lenders, here are a few things to consider:
- Interest Rates – Interest rates for hard money loans are higher than those for conventional loans because the risk is greater. Still, there can be significant variation even among hard money lenders based on local competition and your unique circumstances such as experience or risk factors on your credit reports. Even your loan amount can impact the rate.
- Loan-to-Value Ratio – Loan-to-value ratio, or LTV, affects many of the costs associated with your loan. High LTV ratios carry more risk, and therefore will result in more costly loan terms. Some private investors prefer to maximize leverage with a higher LTV even though it means paying higher rates. Others are more rate sensitive. Your lender will determine LTV by dividing the loan amount by the property value. Be sure to ask whether the lender uses current property value or after-repair-value (ARV) to calculate LTV, since this will affect your costs.
- Added Fees – Make the sure the loan contract lists all fees associated with the loan. For example, most lenders use origination points to calculate the fee for processing the loan. One origination point usually corresponds to one percent of the loan. The loan terms may also include a down payment and prepayment penalty fees.
- How does the lender assess interest?
Hard money loans may have fixed or variable interest rates, depending on the type of loan. Most loans will also be structured with a balloon payment at the end of the term. Some lenders may allow you to avoid paying interest on undrawn construction funds, which can save you money. This kind of commitment funding strategy is attractive to many borrowers of private money.
- Is the lender licensed in your state?
Licensing requirements vary from state to state, and not all lenders may be required to have a license for all transactions. Still, the most reputable lenders will be licensed and registered with state and national organizations.
Hard money lending gives real estate investors the flexibility they need to secure loans quickly when a desirable property becomes available. As you consider which lender is best for your real estate investment situation, consider both the unique circumstances of your investment as well as the specifics of the loan agreement. It also pays to develop relationships with lenders before you need a loan so you can move more quickly when you are ready to begin your project.
Dana Wasson is the Director of National Sales at Lima One Capital, the nation’s premier lender for real estate investors.