Like many financial instruments, hard money loans are often misjudged by investors. The concept of “hard money ” is a direct reference to a loan collateralized (or backed) by a “hard” asset, which typically includes real estate or any other tangible asset.
Fortunately, savvy investors have slowly dismantled hard money loan myths, who understand that these types of loans were not developed to compete with the conventional loan or government-backed mortgage market. Private investors design them to meet a very real unmet financial-market need.
Real estate wholesalers, wholetailers, and fix’n’flippers (and even traditional investors) have learned how to utilize funds provided by hard money lenders in Los Angeles (and beyond) as a tool that helps meet their investment objectives. Hard money is more costly when compared to a conventional mortgage. However, for those who use hard money loans, the higher interest rate or additional closing cost is simply seen as a business expense and included as a component when calculating the anticipated (or actual) investment ROI (Return on Investment) when evaluating investment quality.
Hard money lenders in Los Angeles finance lending scenarios that would otherwise be considered non-fundable (also known as un-bankable) in the world of traditional lending.
Myth – Hard Money Loans Require No Documentation
The Truth – Hard money loans offer more lenient lending guidelines than their traditional mortgage counterparts. However, this does not mean that hard money loans are offered without any loan criteria. A borrower’s situation will be evaluated by the hard money underwriter to –
- Appropriately evaluate the risk of the transaction in question.
- Determine the loan terms to meet the application’s risk profile.
The more well-prepared the borrower applicant is, the faster one arrives at the approval stage.
Myth – Those Choosing to Borrow Hard Money Are Desperate
The Truth – Generally speaking, hard money lenders have a certain amount of leeway in overlooking a borrower’s financial shortcomings, which can help those who are in the process of rebuilding their credit profiles. However, some borrowers are NOT choosing hard money loans as a last resort but as a viable financial instrument that helps leverage certain investments with remarkable flexibility regarding lending decisions.
Myth – Hard Money Lenders Are Loan Sharks
The Truth – This myth is simply a dated depiction of the hard money lender market. By 2019, there were more than 8,000 private money lenders in the nation. Most hard money lenders, even those with just a small market share, are reputable and well-established. However, like other economic sectors, less reputable players will find a way to infiltrate the market, so it is critical for you to do your due diligence before committing to a mortgage offered by a new lender.
Myth – Hard Money Loans Are Too Risky for Borrowers
The Truth – Most hard money lenders are private corporations or lending entities that lend their own money to mortgage applicants. As such, a hard money lender is unlikely to want to take on too much risk to avoid making a bad investment that may lead to a loss.
In addition, many hard money lenders lend in defined geographic locations, which gives them an edge into hard-to-see market insights. This only makes their ability to evaluate a quality mortgage applicant or deal even stronger.
Myth – You Don’t Need an Exit Strategy
The Truth – In reality, hard money lenders are very interested in hearing how a borrower plans to exit the short-term hard money loan. A strong exit strategy is an essential aspect of the mortgage approval process. Typical strategies may include –
- Refinancing to a more traditional, long-term loan to hold the property or ownership or rental income.
- Selling the property before the hard money loan is due.
The investor’s exit strategy should align with the investor’s abilities as well as the asset collateralizing the transaction.
How Hard Money Lenders Determine An Approved Loan Amount
Hard money loans are underwritten, and ultimately the approved loan amount will be based on the collateral or subject property’s value. Of course, other credit factors – like credit score, work history, and income requirements also come into play, although it varies from lender to lender.
Each hard money lender establishes its set of underwriting guides. These range from basic income requirements to the manner in which one calculates the maximum loan (or Loan-to-Value) for each specific hard money loan program.
For example – a hard money loan program offers up to 70% of the property’s value. A borrower purchasing a property for $300,000 (who meets all other underwriting requirements) would be eligible for maximum financing for $210,000 = $300,000 * 70%.
Hard money lenders are known in the mortgage business as niche lenders – a professional company primarily focused on a subset of the greater lending population. In this case, the market subcategory of the lending marketplace is that of borrowers who need flexibility in terms of underwriting guidelines or a quick turnaround to close.
Hard money lenders approve a borrower primarily based on the value of the property being purchased or refinanced. While the hard money lender will review a borrower’s credit profile, work history, assets, and other personal finances, the underwriting guidelines for hard money lenders are significantly less rigorous and restrictive compared with a conventional or government-backed mortgage loan.
This abbreviated process of hard money loans allows the deal to close faster, so it is possible for borrowers to receive their funds in a matter of days/weeks rather than months.
The downside of the abridged approval process is that the lender knowingly takes on additional risk. The lender compensates for this added risk by seeking a higher return for itself – usually in an elevated interest rate or other fees.
Hard money loans are great alternative financing vehicles for specific borrowers. But a hard money loan is not always the best choice for all borrowers. There are many reasons to consider a hard money loan; however, for all financial decisions, it is essential to speak with your financial advisor or a mortgage professional prior to committing to any loan program that is likely to reach hundreds of thousands of dollars on each deal.