Hard Money Lenders: What Makes a Good Lending Partner

Every small business owner or a real estate investor (REI) in the United States dreams of growth. This may be through rental property, a multifamily deal, or a commercial real estate project. However, business owners do need substantial funds to invest in such projects. But securing financing from traditional banks and traditional lenders can often feel like pushing through red tape. This is because banks have lengthy loan applications, strict underwriting, and excellent credit history.

So, what is the alternative to this? Hard money lenders are private lenders or private investors who offer hard money loans. These private money loans help bridge the gap when business owners need cash fast. Instead of focusing heavily on credit scores or income history, hard money lending prioritizes the value of the property being used as collateral. Hence, business owners may be able to secure funding in days rather than waiting for weeks.

This article explains when you may want to skip the bank and go with hard money lenders instead. It also explains how hard money lending works, and how private lenders can benefit real estate investment strategy.

What Is a Hard Money Lender

Hard money lenders are private money lenders, individuals or firms who provide asset-based loans. These provide business owners with hard money loans that are secured by real estate property. Unlike mortgage loans from traditional banks, these loans majorly focus on the value of the property, and not just the credit score or income.

Hard money loans are usually short-term loans that can be used as a bridge loan. They are usually offered by private money lenders, private investors, or bridge lenders. Also, the underwriting is flexible for these loans. Lenders often evaluate the loan-to-value (LTV) ratio, where the loan amount is divided by the value of the property.

In short, hard money lending isn't for everyone. It is especially for real estate investors and borrowers who need quick access to funds. However, it is important to understand the risks of this loan as it's a powerful financing solution.

Situations When You May Want to Choose Hard Money Lenders

Real estate investors and business owners can seek hard money loans as it offers a practical solution than a traditional loan. These loans can be used in the following situations:

1. Time-sensitive property deals: When real estate investors spot a hot deal on a flip loan or a distressed warehouse, hard money loans can help close this deal in a few days.

2. Poor or limited credit history: Business owners who have a limited credit history or a bad credit score, traditional lenders may reject their mortgage loan applications. Hence, in this situation, hard money lenders can offer quick access to funds.

3. Short-term financing needs: Hard money loans can be used for short-term expenses such as renovations or as construction loans before selling or refinancing.

4. Rental property investments: When business owners acquire or renovate a single family, multifamily, or investment property to rent out, hard money loans give quick access to capital.

5. Owner-occupied projects: Private lenders also provide hard money loans for commercial real estate or mixed-use building when you're owner-occupying a property.

6. High-risk value plays: If the purchase price of a property value is uncertain during flips or rehab, a hard money line of credit can give business owners a flexible financing option if the value increases later.

7. Need to refinance quickly: A hard money lender may offer shorter-term bridge for a high-rate loan before you refinance with a better long-term lender.

Benefits of Choosing Hard Money Lenders

Hard money lending offers several advantages over conventional business financing. These include:

• Speedy loan decisions: Hard money lenders typically turn around loan applications in days. This helps avoid long loan approval processes associated with traditional banks.

• Flexible underwriting: Hard money lenders look at asset-based value and not just the credit score. This makes it easy for flippers and real estate investors with imperfect credit to get access to funds.

• Short-term bridge financing: Hard money loans often work as bridge loans. This helps close a deal cheaply and refinance later.

• Leverage for renovations and construction: Business owners can secure construction loans or funds to renovate and then convert via refinancing or resale.

• Custom repayment structures: Some hard money lenders also offer hard money lines of credit, interest-only payments, or short-term repayment.

• Access to capital when traditional funding fails: For business owners who struggle to get a traditional mortgage or traditional loan, private money loans can be a lifeline.

Risks and Considerations

Despite having several benefits, hard money lending comes with substantial risks:

1. Higher interest rates: These loans often carry higher interest rates than traditional mortgages because of the risk.

2. Shorter loan term: Hard money loans have shorter loan term. This means business owners need a clear repayment or refinancing plan.

3. Prepayment penalties: Some private money lenders may impose prepayment penalties. This reduces flexibility if business owners want to refinance early.

4. Default risk and foreclosure: Since hard money loans are secured by the property, failing to repay can trigger foreclosure. This can lead to losing the very asset that business owners pledged.

5. Origination and exit fees: Private lenders may charge points and other fees, making the overall cost quite high.

6. Loan-to-value risk: Business owners having an aggressive LTV score can be declined in value of the property, leaving them underwater.

7. Unclear underwriting standards: Because underwriting is more subjective, you must trust the lender's valuation and terms.

8. Cash flow risks: If you're depending on rental income or resale, any delay or vacancy can strain your cash flow and jeopardize repayment.

How to Find Reliable Hard Money Lenders

Finding the right hard money lender takes research, discipline, and networking. Here's how to find them:

• Look for licensed lenders: Check if the lender is registered with relevant authorities. For example, in the U.S., NMLS (Nationwide Mortgage Licensing System).

• Ask for references: Speak with other real estate investors, flippers, or homeowners who have used hard money lending. Their deep insights can help on loan approval, loan terms, and repayment terms.

• Compare loan options: Before considering hard money loans, compare interest rates, origination fees, loan terms, prepayment penalties, LTV score from different lenders.

• Review underwriting rigor: Ask the private lenders how they underwrite. Do they use appraisals or rely on internal valuations.

• Verify transparency: Make sure your lender is transparent about fees, repayment schedules, and exit terms. Also, avoid lenders who hide costs in the fine print.

• Understand exit strategies: Make sure you have a plan. Will you do a cash-out refinance, sell the property, or convert to a traditional mortgage? A lender should evaluate your exit plan.

• Use a mortgage or alternative credit broker: Brokers familiar with private lending and hard money lending can connect you to trustworthy hard money lenders with better terms.

Hard Money Lenders vs. Banks: Quick Comparison Table

Here's a side-by-side look at how hard money lenders stack up against traditional banks or traditional mortgage lenders: