Property investment is not as straightforward as it may look. To make a profit, you must have access to a large sum of capital to invest, without capital even the best investment idea cannot take place. Investors are constantly on the lookout for the best financial solution to help them invest in real estate projects. Traditional banks typically lend money to borrowers with excellent credit, documented income, which proves an issue for borrowers with subpar credit and those who write of all their expenses. They also do a lot of formalities, require an endless list of documents and take a long time to approve the loan application. Real estate investors and developers do not have that much time, particularly when they find a profitable investment that others may be interested in as well . They have to act quickly. They cannot wait for months as other investors are in line to work on the same project. They must be ready with the money.
Here comes the benefits of hard money loans. They are the best alternative for those who are in a quick search for large sums to develop a real estate project and investors who cannot provide all the necessary documentation to prove their credit worthiness. While there are many benefits of getting one, before you apply for a hard money loan, you will need to understand its pros and cons so that you can make the decision accordingly.
Pros of hard money loans
Hard money loans are often perceived as financing solutions for those borrowers who have a bad credit history. It is partially true in one way. A hard money loan can benefit you in several other ways too.
Fast turnaround and quick approval
Even if you are confident that your loan application will be approved by a traditional bank, it will take too much time as compared to a hard money loan – time that you may not have if you’re trying to become the winning party for a profitable investment. Conventional Banks do a thorough review of your bank statements, tax forms and credit reports and many other documents too. All these processes take a lot of time – usually 2-3 months, sometimes even longer.
Unlike traditional loans, there are fewer requirements to apply for hard money loans and get the loan approved. As a result, you can get a hard money loan funded within one week. Conventional banks have strict lending criteria, sometimes taking more than one month just to verify certain documents which ultimately lengthens the loan application, whereas hard money lenders do not require that much Information and documents; rather they are more concerned about the assets that serve as collateral. Furthermore, if you have already worked with a hard money lender and established a good relationship with them, in that case, you can grab other benefits such as faster closing, negotiation on loan terms and paying fewer origination points and many more.
Your credit score doesn’t matter
No need to mention that traditional banks will decline your loan application due to the low credit score. This means people with low credit scores or bad credit history can approach a hard money lender to finance their investment as long as their property has more than 20% equity. Hard money loans are asset-based financing. Hard money lenders are not concerned about your poor credit score, your financial position or your employment situation; rather, they are more concerned about the current value of the property that you are developing. If you do not want to use the property as collateral, talk to your lender and put the other available option in front of them, however the most powerful collateral to use is an investment property. Some may accept any other residential property or other assets that belong to you and are under your name. Investors who have a credit score of 620 or higher are typically approved for hard money loans so long as you have enough equity and/or the property is in a good location with recent growth. If the investor’s credit score is lower than that, they will have to explain the reasons to the lender but still, it might not be a deal-breaker.
Hard money lenders do not use a traditional underwriting process that mentions all the terms and conditions on which borrowers agree to take the loan. Instead, deals are evaluated on case-by-case basis. Remember you are negotiating with an individual or private company and not with a commercial bank with hard and fast underwriting policies. The borrower can negotiate on loan terms, revise repayment schedules and the loan’s duration. Rates typically start around 8% or higher. Second loans are even higher, starting around 10% or more.
Hard money lenders are not just a lender who fund your project, you can see them as a resource for contacts, advice and guidance on deals. They give you the right direction for stagers, agents, title companies and reputable contractors and how to get in touch with them. So if you want to make a career in the real estate sector as an investor or developer, hard money lenders can be proven to be the best option over traditional banks and other financial institutions.
No Prepayment Penalty
As a hard money loan is a short term loan that needs to be paid back within 1-3 years as per the repayment schedule agreement on which both the borrower and the lender had agreed upon, the borrowers who complete the project before time have the option to pay back their loan earlier than the agreed repayment loan term. Most lenders do not charge a penalty on prepayment. In contrast to hard money loans, traditional banks charge lower monthly interest and also charge a hefty prepayment penalty to cover their losses. Investors who complete their project earlier, can save money on interest payments and start their new project quickly.
Cons of hard money loans
Each entity has two aspects. So far we have talked about the advantages of hard money loans, now let us talk about its drawbacks. If you have decided to lend or borrow a hard money loan, consider its drawbacks that have been discussed below.
A high rate of interest makes the prospect of borrowing a hard money loan more difficult. Hard money lenders charge higher rates of interest that range between 8% to 12%. Lenders take more risk by giving you immediate access to a large amount of money for a distressed property. So if you develop and sell the property by borrowing a hard money loan, the interest rate might take a big chunk of your profit. On the other hand, conventional banks charge lower interest because they typically lend on low-risk properties such as owner-occupied primary residences with little or no construction needed.
Short term loan
Another drawback of a hard money loan is that it is a short term loan. Most lenders give 1 to 3 years in which the borrower has to close the deal, develop and sell the property, and payback to the lender with interest. So the investor gets very little time to pay back the loan with interest to the lender.
Hard money loan is typically a short term loan that has to be paid back to the money lender within one year or two. Sometimes borrowers have to extend the timeline of the project because of unexpected issues coming in the way of the development of the project. Thus causing the borrower to request a loan extension. Hard money lenders are generally flexible in granting the loan extension. However, borrowers should consider increased monthly interest payments and extension fees before asking for a loan extension.
The risk of foreclosure can be another drawback of a hard money loan. The borrower can face foreclosure due to failure in paying monthly interest payment, failure to maintain or repair the property, and an unpaid loan etc. Taking a property back in the middle of rehab or development becomes very costly for the lender, so they try to help the borrower in figuring out a game plan to complete the project as planned originally. So if you find that your project development is not working as you had expected or you are fearing foreclosure/default, it is best to communicate your issues with the lender. If You do not communicate, you are more likely to lose the property.
As you have read above, it is needless to say that a hard money loan is the best option for getting a quick fund to develop your real estate project. Though it is important to look at the pros and cons of a hard money loan before you go ahead with this. The essence of all of these discussions is that you get a large amount of some easily by taking a hard money loan but you have to repay the loan with a higher interest in a shorter period of time. With high profits made from a solid real investment, the higher cost of financing is outweighed by the profit.
Reach new heights in your career and reap all the benefits of a hard money loan by protecting yourself from the risks that we have discussed. Try to maintain a good and stable relationship with your lender by paying them on time and communicate with them early and often. Prepare a strong exit strategy if you feel it’s not working as you had planned.
The last but most important point to note is that if you prove to your lender that you are a safe investment by completing your project successfully, next time your lender might lend you at a lower rate of interest and lower origination charges, thereby improving your career prospects. Go ahead and put your new found knowledge to the test and invest in yourself.