The Pros and Cons of Working with a Hard Money Lender

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With interest rates climbing, lenders less flexible, and cash flow models being tossed into turmoil, many investors are considering hard money loans as a way to keep growing their inventory.

I could be wrong, but when we first started our real estate investing in 2000, there were no organized, official Hard Money Lending Companies out there. Instead, I can only remember one Hard Money Guy in Central Indiana that loaned money to investors who needed quick cash.

Today, there are a bunch of these Hard Money Lending Companies, and we recently interviewed Shere Clark with Longhorn Investments in our monthly podcast to discuss her company, and its role in today’s lending environment. Longhorn, by the way, has a national presence.

In this blog, we’ll review the pros and cons of working with a hard money lender, because hard money loans are clearly not for everyone. And, if you choose to secure a hard money loan, you certainly need to understand exactly what’s in store.

Before we list out the pros and cons of hard money loans, let’s first provide a full synopsis of exactly what a hard money loan is.

What is a Hard Money Loan?

At its very basic definition, a hard money loan is a non-conforming loan for investment properties that is not offered by your “normal” lenders. For example, you will NOT secure a hard money loan from Chase Bank, Wells Fargo, or from your local bank or Credit Union.

It may be a bit confusing, but the “hard” in the hard money loan has nothing to do with the difficulty level in obtaining the loan. Instead, the “hard” part is actually the asset that is required, in every case, to secure the loan.

So, here’s an example…

You are an investor and find a rental property that you want to flip. The process involved in engaging traditional financing could prove to be too timely and “involved.” There’s a motivated seller on the other end, and you need to act quickly.

Hard money loans generally provide a very quick turn-around time (think days, not weeks) and less overall hassle and having to jump through hoops.

Hard money lenders will still assess your creditworthiness and will assess the viability of the asset they are securing (appraisal) but, again, these lenders can and do move quickly.

Let’s get into the pros and cons of a hard money loan.

Pros of Hard Money Loans

Speed

As we’ve already noted, hard money loans are generally super fast.

Where a traditional loan can take weeks to obtain, hard money lenders can provide funding in a matter of days.

Credit checks and some minimal review of your personal financial situation are almost always required. Appraisals, too, are almost always required. However, once those two obstacles are cleared and the cash is ready to go, you can close your deal and get to work.

This speed to close can put you in a favorable position if you’re competing against offers that may need 30 or more days to arrive at the closing table. Sellers like, sometimes love, quick closings, so using a hard money loan could help you land the property.

No Loan Maximums

When we were buying homes at a steady rate and using traditional financing to buy those homes, we continually ran into loan maximums by either Fannie Mae or Freddie Mac.

It seemed like the lending landscape changed weekly: one week, we could have seven loans in our name, the next, it was 10. Back and forth it went.

This was an incredibly frustrating experience. We would identify a “perfect” rental property, only to get shot down because we’d hit our maximum number of loans we could secure in a personal name. Once we began moving to commercial loan products, the numbers game was no longer an issue, but it did hurt us when we first began real estate investing.

Since all hard money loans are private and non-conforming loans, the individual Hard Money Lending Companies set their own rules, and many of them will continue lending to you as long as you and the deal continue to make sense.

Again, as someone who suffered from loan maximums in the past, this is a big deal and shouldn’t be discounted.

Flexibility in the Condition of Property

As we all know, traditional lenders can be fickle.

Flipping is a fun, exciting, and, if you do it right, a highly profitable vehicle to navigate your way on the investment roadway.

The very nature of flipping, in a large number of cases, requires significant investment into the property for construction. In simple terms, a lot of flippers buy distressed properties, invest, in some cases, a significant amount of money in the rehab, and then “flip it” (sell it) to an owner occupant.

The trouble comes when that traditional loan or lender balks at lending on that boarded-up potential beauty that you want to flip. They may consider the distressed property “unlendable” (is that a word?) and deny the loan.

We often see even homes in perfectly livable condition get dinged by traditional lenders. For example, if an appraiser for a traditional lender has an issue with the way a gutter is hanging, the seller may be required to fix the gutter before the loan is approved.

Hard money lenders, on the other hand, EXPECT that some of the properties they finance will be distressed. So, while appraisals, again, are almost always required, the overall condition of the home will likely not kill the deal.

And, speaking of construction…

Money for Construction

This is another biggie.

Remember my scenario where the flipper buys the home and then makes a significant investment into the construction of the property? Well, unlike traditional loans, hard money loans provide money for that construction.

Again, this is HUGE.

While all hard money lenders are different, construction funding basically works like this.

As an investor, you will work with your hard money lender to create the scope of the project. You’ll basically put together a budget of what’s needed to get the home in move-in ready condition… whether that’s a move-in for a new buyer, or a move-in for a new tenant.

Each project will naturally have milestones that are established.

For example, one milestone could be to complete all exterior work, which could include roof, gutters and exterior paint.

Once that milestone is met, the hard money lender will send a representative to confirm that the work is completed and then provide a draw to pay the contractor or contractors involved in that work.

Let me repeat that… the hard money lender will send a representative to confirm that the work is completed. Wow! For those out-of-state investors, this is an invaluable service.

We’ve all heard horror stories of contractors that submit an invoice, advise that the work is done, and, unfortunately, it’s not. This type of value-add, in my opinion, is priceless.

While hard money lending offers some tremendous benefits, there are a couple of distinct drawbacks. Let’s examine a couple of them.

Cons of Hard Money Loans

Cost

Hard money loans, as I’m sure you know, are more expensive than traditional loans.

Let’s use today’s timeframe of April 2023, as a comparison point.

Today, a traditional lender will provide real estate investors with an interest rate of around 7%. That could include points, too.

According to Shere with Longhorn, her company is currently charging 12.99% interest only, along with 3 points. So while you’ll make interest payments each month, you won’t have the extra principal paydown costs of a traditional loan.

The interest rate difference will impact your profit, no doubt, so it’s critical to figure in this difference when running your numbers on an investment property.

Terms of Hard Money Loans

Unlike traditional loans, where you could lock in a rate for 20 or even 30 years, hard money loans have a different set of rules.

Generally, hard money lenders require full payback (balloon payment) within six months. Certain lenders, for an additional point or two, may extend the loan for an additional few months.

Bottom line: You need to move quickly when you close on a hard money loan.

Additional Considerations When Assessing a Hard Money Loan

Again, the details of your hard money loan will likely vary from lender to lender. Shere provided some additional details that you may find helpful when assessing a hard money loan.

  • Credit scores will generally need to be 650 or higher to secure a hard money loan. So, your credit history does matter.

  • Most hard money lenders, in spite of popular opinion, want cash in the bank. Shere mentioned that Longhorn likes to see liquid assets (cash reserves) of $15,000 or more. So, be prepared to share bank statements.

  • To add to that point, hard money lenders will only loan 70%-75% of the After Repair Value, or ARV. So, you will have skin in the game.

Conclusion

As an investor, it’s literally impossible to have too many proverbial tools in your toolbox. So, while hard money loans may not be for everyone, they certainly provide real estate investors with additional sources of capital if the need arises.

About the Author

Jeremy Tallman

Jeremy is the Chief Executive Officer and Managing Broker for T&H Realty Services. He has been active in the Central Indiana real estate market since 2000 and leads one of the most successful single-family property management companies in the state.

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