Sam Kohn, CEO & Founder
Sam answers some of the most commonly asked questions
regarding hard money and real estate financing.
WHAT IS A HARD MONEY LENDER?
- A hard money lender is an investor who makes loans secured by real estate.
- Hard money or private money lenders typically charge higher rates then traditional banks, but can process and fund loans more quickly.
- Generally speaking, hard money or private money lenders will approve loans that fall outside the narrow scope of institutional banks.
WHAT DIFFERENTIATES HARD MONEY LENDERS FROM BANK LENDERS?
Hard money lenders differ from bank lenders in that they often fund more quickly, with fewer requirements. Hard money lenders are sometimes called “asset-based lenders” because they focus mostly on the collateral for the loan, whereas banks require both strong collateral and usually excellent credit and cash flow from the borrower.
Hard money lenders are willing to foreclose on and “take back” the underlying property if necessary, to satisfy the loan. Bank lenders typically look at the borrower to be able to pay back the underlying loan from the borrower’s income, whereas hard money lenders are comfortable looking to a sale or refinance of the property as the method of repayment.
WHY DO HARD MONEY LENDERS EXIST?
Hard money lenders exist because many real estate investors need a quick response and quick funding to secure a deal when looking for a real estate loan. Banks and other institutional lenders that offer the lowest interest rates don’t provide the same combination of speed and transparency in their decision making process, along with quick access to capital.
WHEN DOES IT MAKE SENSE FOR A BORROWER TO USE A HARD MONEY LOAN?
In our experience, even investors/developers with strong financial statements and access to bank credit frequently choose to use private money loans (also called “hard money loans”). Situations where private money loans make the most sense include those where the borrower:
- Requires a quick closing and banks cannot meet the deadline;
- Wants to avoid spending too much time raising equity or debt from many different smaller investors, but prefers to instead focus on finding new opportunities;
- Lacks the patience or time to deal with the bureaucracy of securing a loan from a bank;
- Has an excellent investment opportunity, but does not have sufficient financial strength to get a bank loan, and/or;
- Has a bank line of credit but needs a larger loan than is allowed under the existing bank line.
The common theme is that there is an opportunity for the borrower to generate substantial profit (or savings) quickly, and the cost of interest and origination fees is small relative to the anticipated profit, even given the higher interest rates charged by private lenders versus banks.
WHAT ARE OTHER TERMS FOR HARD MONEY LOANS?
Hard money loans are also sometimes referred to by the following terms: (1) private money loans; (2) bridge loans; (3) short-term loans; (4) transitional loans; (5) asset-based loans; (6) rescue loans.
ARE HARD MONEY LOANS USED MAINLY WHEN THE BORROWER IS IN DISTRESS?
Some hard money lenders do focus on distressed situations such as when the borrower has another loan in default and needs to refinance. This is particularly true for commercial bridge loans.
In the single family residential arena, most hard money lenders shy away from distressed borrowers who are owner-occupants. Lenders are not eager to foreclose on a borrower living in his or her own house. Furthermore, regulations make this type of foreclosure much more time consuming and difficult as compared to an investor-owned property.
WHAT ARE ADVANTAGES OF HARD MONEY LENDERS?
Hard money loans can have a number of advantages over traditional bank financing including:
- A simpler application process and quicker approval/disapproval decision;
- Less scrutiny of the borrower’s personal financial situation, including income and historical tax returns, compared to bank loans;
- Borrowers can allocate less time to seeking financing and instead concentrate on other business;
- Borrowers can avoid the humiliation of being rejected by a bank;
- Most hard money lenders do not expect perfect credit and substantial amounts of disposable income from borrowers, but instead focus on the merits of the specific deal under consideration;
- Self-employment is acceptable to private lenders, whereas many banks view self-employment negatively and strongly prefer lending to professionals with very steady income.
WHAT ARE SOME DISADVANTAGES OF HARD MONEY LENDERS?
Disadvantages of seeking a hard money loan may include:
- Hard money loans are more expensive than bank loans, with higher interest rates and origination fees;
- The quality of hard money lenders varies substantially from one lender to another; some are unscrupulous and may be seeking to have the borrower default in order to foreclose on underlying real estate as a business strategy;
- Some lenders may collect non-refundable deposits without having the capital required to make the loan; they may either hope to find the capital once the loan is “tied up” or in rare cases, they may simply aim to collect the deposit with no intention of funding the loan.
WHAT KINDS OF PROPERTY DO HARD MONEY LENDERS LEND ON?
Hard money lenders will lend on commercial, shopping centers, office buildings, multi-family, industrial, raw land and residential properties, although many will not lend on owner-occupied residences due to higher thresholds of scrutiny required by law. Commercial properties can include industrial, shopping centers, and office buildings.
WHEN SHOULD YOU USE A HARD MONEY LENDER?
A borrower might consider using a hard money / private money loan in situations where he or she is willing to pay a higher interest rate and/or higher up-front fees in the interest of gaining access to capital more quickly, dealing with less bureaucracy and more transparency during the application process, and finding capital to pursue an opportunity that banks will not finance, either because they are unwilling or unable to do so.
WHAT DOES THE TERM “HARD” MEAN IN “HARD MONEY LENDER”?
The “hard” in hard money lending refers to the higher price which is charged to borrowers both in terms of interest rates (typically high single digits or low double digits) and higher loan origination fees (often around 2 percent of the loan amount, versus 1 percent or less for a typical bank loan).
WHO FUNDS HARD MONEY LOANS?
Hard money loans are typically funded by individuals or by funds that aggregate capital from multiple wealthy investors. Individuals who invest directly into a single loan are known as trust deed investors. Many trust deed investors are real estate investors/owners who invest in “bridge loans” to keep available capital working to generate a higher rate of return, rather than leaving the capital in banks earning minimal interest rates. Investors who prefer to invest passively in a fund are typically not as experienced in real estate investment and choose to pay the fund manager a fee to oversee the process of sourcing, selecting and originating a series of bridge loans.
HOW DO I GET A HARD MONEY LOAN?
The best way to secure a hard money loan is to know or be referred to a reputable hard money lender. The prospective borrower can simply call and describe the nature of the project for which capital is desired. When presenting a project to a lender, the borrower should be prepared to provide the following information:
Deadlines and dates which are critical to the transaction (for example, the closing date for a purchase if the borrower is seeking a purchase money loan); The specific property address; Whether the loan is for a property acquisition or refinancing of an existing loan; The purchase price of the property; The intended renovation budget; The intended asking price for the property (assuming the project is going to be resold after renovation).
WHAT DOCUMENTS ARE INVOLVED IN A HARD MONEY LOAN?
Typical loan documents required for a hard money loan include a Note and a Deed of Trust; other documentation requirements do vary but may include a personal guarantee from borrower (sometimes non-recourse loans are issued without a personal guarantee); personal financial statements such as past tax returns and proof of income; and assurance that the borrower has access to sufficient cash to perform any and all proposed property renovations.
WHAT IS THE PURPOSE OF A LETTER OF INTENT?
The purpose of a Letter of Intent (LOI) for a hard money loan is to provide a quick means to be sure that both the prospective borrower and lender are on the same page. Although this document is not legally binding on either party, it serves to put the prospective deal “in writing” and helps to avoid any miscommunication or misunderstandings.
WHY DOES THE LENDER NEED TITLE INSURANCE?
Title insurance helps protect someone who has purchased real estate against another party making a claim challenging the ownership of the property and the seller’s right to enter into a transaction. Well known title insurance companies include Fidelity National, First American Title, and Chicago Title. The title insurance company will handle any issues that arise during the property sale, and if a competing claim of ownership is deemed legitimate, the title insurance company is responsible for payment of any fees to the claimant. The reason why hard money lenders insist on being covered under title insurance is to enjoy the same protection as the borrower.
IS A HARD MONEY LOAN PERSONALLY GUARANTEED?
Some lenders may require that a hard money loan be personally guaranteed by the borrower, although there are instances where lenders are willing to offer no-recourse loans based on the borrower’s history and the appeal of the specific opportunity.
WHAT ARE TYPICAL HARD MONEY LENDERS TERMS?
The typical term for a hard money loan is 6 months to 3 years. Loans requiring greater than a 3-year maturity are usually outside the scope of this form of financing but may be done on an exception basis.
Hard money loans often require a personal guarantee and require first positioning as the lender of record, although some lenders are willing to make subordinate junior loans where another lender holds the primary mortgage.
HOW ARE HARD MONEY LENDERS REGULATED?
Hard money lenders are typically regulated at the state level via the Department of Real Estate, as at least one person associated with hard money lending must have a valid Real Estate Broker License. Additional licensing requirements may be required on a state-by-state basis.
Cross-state transactions fall under the jurisdiction of both states involved and are subject to each state’s respective requirements.¬† Securities licenses are usually not required for hard money lending unless a loan is classified as a securities offering due to the loan being syndicated to multiple investors.
HOW DO HARD MONEY LENDERS COMPARE WITH BANKS
Hard money lenders are licensed differently with less regulatory scrutiny than traditional banks and can look at the merits of a loan more so than a bank, which must meet certain non-negotiable criteria to issue a loan.
HOW CAN YOU TELL IF HARD MONEY LENDERS ARE REPUTABLE?
It is essential for borrowers to ascertain whether a lender is reputable, to avoid disappointments, wasted time, and lost opportunities. A borrower can research a prospective lender using the following techniques:
Ask for references from clients/borrowers and mortgage brokers; talk to the references. Consider working with a local mortgage broker who has done transactions with that lender; Confirm that the lender has a valid Real Estate Broker License; Determine whether any complaints have been filed against the Real Estate Broker License; Consider checking with the Better Business Bureau (BBB); Find out what industry events the lender attends and ask people at the event about the lender’s reputation.
HOW LONG DOES IT TAKE HARD MONEY LENDERS TO FUND A LOAN?
It generally will take a hard money lender 30 days or less to fund a loan, although some are equipped to do this in a matter of days.
WHY ARE BANK LOAN INTEREST RATES SO MUCH LOWER THAN HARD MONEY LENDERS INTEREST RATES?
Banks can offer lower interest rates than hard money lenders because banks can fund loans via retail deposits on which they pay minimal interest rates. Hard money lenders fund loans via private capital which has higher expectations.
CAN BORROWERS WHO START WITH HARD MONEY LENDERS MOVE ON TO WORKING WITH BANKS INSTEAD?
It is possible for borrowers who start with a hard money lender to transition to working with a bank later in the process. This may happen if the borrower has a recent credit issue (such as a past foreclosure or bankruptcy) and the hard money lender is used to “age out” that credit issue
until the borrower qualifies with the bank. A borrower may also choose to enter into a hard money loan prior to seeking a traditional bank loan in order to demonstrate performance and credit worthiness.
Borrowing from a hard money lender can act as a bridge to receiving future credit in that it builds a track record and can also enhance the borrower’s financial strength, assuming the underlying investment for which the loan is used proves successful.
DO LEGITIMATE BUSINESSES USE HARD MONEY LOANS?
Yes, many legitimate businesses use hard money loans responsibly to meet their funding needs, and to capture opportunities that require quicker funding than is available from traditional lenders.