Real estate investors often choose hard money loans over traditional loans to fund their projects. They do so because conventional banks have more stringent guidelines that take a long time to approve and transfer the funds to the borrower. Real estate investors do not have that much time as they have to act quickly, particularly when there is fierce competition in the mrket. To avoid any delay in getting funds, they approach hard money lenders to finance their projects, who use the equity of the property to qualify the borrower. The demand for hard money lenders has increased overtime within the real estate sector because of ease in paperwork and the speed of the funding. If becoming a hard money lender if a goal of yours, this post will highlight everything you need to know.
Here, in this post, we have discussed in detail ‘how to become a hard money lender‘. So let’s get started.
Hard money lenders can be an individual, groups of people or a corporation who lend their capital to other investors. They secure their investment by using the equity of property that serves as collateral. Since a hard money lender is an individual or group of investors and not a bank, the borrower can better negotiate the loan terms, rate of interest and loan’s duration.
If you have idle money or a surplus amount of income and you are willing to lend your money to get a higher return in a minimum amount of time, then private money lending is the best option for you.
You may consider yourself to become a hard money lender if any of the following applies to you –
- You are a real estate investor looking to expand your portfolio
- You are a doctor, engineer, businessman and other professionals with a surplus amount income
- You are a retired person and want to earn a passive income on your saving
The main point is to say if you have a large amount of capital and you are interested in investing in the real estate sector to get a higher return on your investment, you can become a hard money lender and guarantee your rate of return based backed by real estate.
There are two types of hard money lenders-
- One who directly lend to a borrower
- And the second one works with the brokers to find potential borrowers
Let’s discuss each one of them in detail.
Hard money lender who directly lend to the borrower
Some hard money lenders start with finding the borrower through their own efforts or when the borrower directly comes into contact with them. In this way, there is no role for a third party such as a broker between both of them. In this scenario, the hard money lender works directly with the borrower. If you are a novice in hard money lending, you are suggested to start working with someone you know and familiar with their professional history.
Hard money lenders who work with brokers
The mortgage broker community is the greatest lead source for hard money lenders. These brokers work in the real estate sector and are connected to a large number of borrowers, real estate agents and professionals.
Instead of spending precious time searching for the borrower, some hard money lenders work with brokers who find potential borrowers for them. In this case, the lender does not directly communicate to the borrower, but the broker does. The lender will have an agreement with the broker and then the broker will have a direct agreement with the borrower. However, the agreement’s paper and the document is always in the name of the lender.
Borrowers have to pay the fees for loan applications and approval. Generally, the hard money lender and broker split the fees equally charged to the client. However, the monthly interest charged on the loan amount is owned by the lender. They also make money by charging points. Generally, the charging point ranges between 2-5% of the total loan amount, however in some instances may go as low as 1%. A hard money lender should always work with a licensed broker. The broker must have a license with the state in which they are doing business. Brokers are required to have a broker license and NMLS license.
How to become a hard money lender
If we talk about making a career as a hard money lender, this requires basically these six steps that we are going to discuss.
1. Be ready with capital or fund – No need to mention that the hard money lending profession requires a large amount of sum or capital. If you are just getting started as a hard money lender, first the capital or cash must be readily available to you. This is the very first requirement to get into the business of hard money lending. If you are ready with the cash, now is the time to determine how much money you are willing to lend at one time? Never lend your entire money altogether. Try to diversify your fund across different investment opportunities to lessen the risk.
2. Find potential borrowers – Once you are ready with the cash and determine the amount of sum you are willing to lend, look for the investment opportunities. An effective way to find potential borrowers is through attending the meeting of the real estate professional’s community where you get the chance to meet the real estates’ professionals such as investors, developers, agents and brokers. Talk to these professionals, your colleagues, friends and family members who are active in the real estate sector and let them know that you are offering private financing. It is ideal to start working with the person you know and trust or someone who has a private placement memorandum (PPM).
3. Conduct your due diligence – As a hard money lender, it is crucial for you to know how to analyze and review real estate investments. The lender must do due diligence on the property they are considering lending on such as determining its value and loan to value ratio. Lenders typically do not lend above 80% LTV. The lender must also perform due diligence on the borrower to lessen risks. Due diligence is when a party puts effort into confirming the financial background of the borrower and verifying the condition and value of the property the money is potentially being lent on. Make sure that the investor has a decent track record with no bankruptcies or any other red flags such as recent foreclosure, no income issues, etc. Prior to lending, even if comparables have been made to the subject property, hard money lenders should verify the current condition of the property, gross rental amounts, and others. Confirm the information that the broker and borrower has provided to you regarding the real estate project and collateral.
4. Determine the loan terms – The next step is to determine the loan terms such as a fixed-rate mortgage, adjustable-rate mortgage, prepayment penalties, fees, cost etc., Lender can offer the same term for each loan or they can set terms and conditions by looking at the investment opportunities and negotiation on which both the parties have agreed upon. Some lenders have prepayment penalties that requires the borrower to pay a minimum amount of interest, while other offer rates that adjust.
- Interest rate.
- Interest type (adjustable or fixed).
- Length of loan (time for repayment).
- Closing costs or fees (like points).
- Whether there is a balloon.
5. Finalize the paperwork – This is not required but it is the best practice to have a legal attorney draft. Make sure that the proper legal terms are included in the draft in case of default. The lender and borrower should have the proper paperwork such as legal contracts, disclosure and mortgage statements etc., The lender should always keep the original draft and mortgage or security instrument in their possession and provide a copy of all drafts and documents to the borrower. Depending upon the situation, if the borrower defaults and the foreclosure action needs to be taken, the original note and mortgage are required in the court to foreclose.
6. Start collecting – Once the lender transfers the fund to the borrower, now the lender can start collecting. Make sure you are keeping a good record of all the payments that the borrower has made. Keep and review the records of the checks and bank statements made by the borrower to confirm the payment with principal and interest. Do bookkeeping on payments and always keep the account clear.
Hard money lenders establish relations with various real estate professionals including real estate agents, contractors, developers, and real estate investors to get the clients. When one of these parties refer them to the business, the hard money lender split the fees with them. Hard money loans are riskier that is why the lender charges 3 to 4% higher interest rate than a conventional bank.
Some additional information about Hard money lenders
Hard money lenders do not only lend on commercial or investment properties but they can sometimes lend on primary residences as well. However, the rules governing each one of them are different. Hard money lenders who lend on primary residence must abide by the Dodd Frank Act. This Act oversees primary residence homes and sets a cap on fees, interest rates and terms while loans to investment properties do not have to abide by the Dodd Frank Act. Hard money lenders who lend on investment properties set their terms and conditions and also set their charges.
Becoming a hard money lender is not the best invetment option, unless the lender has experience doing property evaluations and doing background checks on borrowers they lend money to. It can however be a good option for those who have idle money and want to earn a passive income by investing it in the real estate sector, but it must be done properly. You should always keep yourself updated on real estate investing strategies, the market and lending practices. On top of everything, the most important point is that your risk tolerance must align with this form of investment. Hard money lending is riskier but it can grow your wealth enormously if done properly.