There are many ways to successfully invest in real estate. Hard money lending isn’t heard about as much these days but still has a valuable place in the investing world. Hard money lenders generally don’t value real estate in the same ways as most investors and other real estate professionals. Hard money loans can be easier to get, but they can be expensive. Despite the cost, they’re an essential tool for investors. Knowing when to use hard money and how to get it is critical.
As an investor, you should know your local market inside out. You should instinctively have a good idea of the property value after a brief inspection. What’s different for hard money lenders is they often lend money outside of their local market. It can be in a distant city or across the country. Hard money lenders can’t physically inspect the property themselves nor do they have a solid knowledge of local property values.
Hard Money Lenders Seldom Use Traditional Property Valuation Methods
Every private contract is written for the mutual benefit of both the investor and the lender but there are general rules that drive the hard money market. Hard money lenders don’t use the standard underwriting process that banks use. Banks focus on the borrower’s credit history and income. A bank loan is typically for 90% or more of the house value.
Hard money lenders focus on the value of the property instead of the borrower’s creditworthiness. While they will look at a professional appraisal but it’s not the only valuation tool that they rely on. Often, they want at least two and possibly three valuation models to make an educated decision. Hard money lenders will look over the tax assessment records but again this isn’t a reliable way of valuing real estate. Tax assessment districts calculate values on an annual basis at best and many only every other year. Also, the taxman only values property from the curbside. They don’t have access to the inside of the house.
The broker’s price opinion (BPO) is another tool hard money lenders use to value property. A BPO is a broker’s assessment of the property value. However, hard money lenders are skeptical of these valuations as well because brokers tend to overvalue properties in hopes of a higher listing commission and an optimistic view of the local real estate market.
The value a hard money lender puts on a property has nothing to do with the purchase price that you have negotiated. It will be based on what the market values the property at.
In the end, hard money lenders take all of the information available to make an educated determination. They ask themselves questions such as: “if the market bottoms out will I be able to recover the money loaned for the property? Will I profit from this property even if I have to take control in the event of a default?”
To fully protect themselves, hard money lenders typically only lend 50% to 70% of the value of the property. As an investor, you’ll either have to negotiate a purchase price in that range or have additional financing available. Also, keep in mind that a hard money lender knows the fix and flip business as well as any investor. They’ll want to know your exact plan for the property and have to approve that along with the value of the property.
Hard Money is Fast Money
Most hard money lenders make short-term loans averaging between six months and two years. Generally, the biggest advantage hard money provides is a fast closing. Because there is no credit check, the closing can happen a few short days after an application is approved. If you have established a relationship with a hard money lender, loans can be financed in a matter of hours. An investor interested in hard money needs to know what documentation will be required to approve the application.
If your ducks aren’t all in a row, funding can take a couple of weeks but as few as three to five days is possible. If you have a trusted relationship with a hard money lender, you might be able to have funds within 24 to 72 hours.
Hard money is not for everyone (or even most people). The only reason to take out this kind of loan is for a great investment that requires a speedy response. It may cost you 10% of the loan amount for interest and loan fees. But when you can make 30% on a deal in weeks or months, paying more for fast financing is probably worth it. When a good investment won’t wait, a hard money loan can still be the best answer.
What else do you think investors need to know about hard money loans? Please share your insights and experiences by leaving a comment.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to firstname.lastname@example.org.
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, near a national and the Pacific Ocean.
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