If you’re thinking of asking for a loan from a hard money lender, it’s important to understand the services they offer, how much interest they charge, and what you can expect. To help you as a potential borrower decide if a hard money loan is right for your needs, the Rules of Thumb blog from MoneyThumb has listed below the most important questions and relevant responses that will help you decide if a hard money loan is right for you, (The majority of hard money loans deal with real estate, so many of the answers below are relevant to that niche) :
WHAT ARE THE BENEFITS OF USING A HARD MONEY LENDER INSTEAD OF A TRADITIONAL LOAN?
Traditional loans from banks and institutional lenders can be an option if you plan well ahead. However, it can take several weeks to get a traditional loan approved. Hard money lenders offer several significant advantages:
- Speed: Loans can be approved quickly.
- Simplicity: The process of applying for a hard money loan is often much simpler and easier than for a traditional loan.
- Flexibility: A loan officer from a private lender will work with you to find the best loan product for your project, often customizing it to fit your individual needs.
- Scrutiny: A hard money lender won’t scrutinize your personal finances as closely as a traditional lender. Instead, they are most interested in your assets and the value of your completed project.
HOW MUCH COLLATERAL DO YOU NEED TO PROVIDE?
Hard money lenders lend money that’s secured against your collateral, which often is a real estate project. The value of your construction or development is the “collateral” you provide in return for funding. Private lenders take into account the total cost of the project and what the finished development will be worth when it’s sold. A lender will be able to provide an estimated value, typically based on an appraisal or BPO, for the collateral you need to provide, depending on how much you want to borrow.
HOW MUCH MONEY CAN YOU BORROW?
Every lender will set the amount you can borrow around several different factors. These might include:
- The “Loan to Value” (LTV) of the property: The amount you’re borrowing, compared to the overall value of the finished project. For example, if a project will be worth $300,000, and the lender offers up to 70% LTV, they might consider lending up to $210,000. Streamline can typically offer up to 70% LTV for renovations and new construction projects.
- The “Loan to Cost” (LTC) of the property: This is similar to LTV, except instead of comparing the amount you’re borrowing to the finished value, the lender looks at the total cost of your project and makes a determination on how much to lend. For example, at Streamline Funding, we can typically offer up to 95% LTC for residential new construction.
- The “After Repair Value” (ARV) of the project: The value of the real estate after it’s been improved, renovated, or fixed up.
- Minimum and maximum loan sizes: Some lenders put lower and upper limits on how much they’re prepared to fund.
- History of borrowing: If you’re applying for follow-up loans and have successfully borrowed in the past, a lender may be more likely to approve your request.
HOW MUCH OF A DOWN PAYMENT IS NEEDED?
A lender will not provide all of the money needed to pay for a project. Ask the lender what their LTC is, as that’s the maximum they will fund towards the project, and you’ll need to come up with the rest. For example, if they provide 80% LTC, and the project will cost $150,000, they could fund up to $120,000, meaning you’d need a down payment of $30,000.
WHAT INTEREST RATES DOES THE PRIVATE LENDER CHARGE?
Hard money lenders do charge higher interest rates than a traditional bank loan due to the additional risk. However, your monthly payments will typically be interest-only and you’ll be responsible for paying off the principal balance at the end of the loan term. The interest rate is the single biggest influence on how much you’ll repay. Most private lenders charge interest rates between 9% and 14% a year, depending on the purpose of the loan. You’ll also want to ask how the interest is calculated. For example, is it applied on a daily basis, or over some other time period?
WHAT ARE THE REPAYMENT TERMS?
The frequency of repayments and the length of time it takes you to repay will have a significant impact on your capital and interest payments and your cash flow. Ask the lender about the loan repayments you’ll need to make on a regular basis and how long your loan term will be.
DOES THE LENDER CHECK PERSONAL CREDIT SCORES?
Most private money lenders are more interested in the details of your project and the collateral you provide than your personal credit history. Although they may review some of your finances in a loan decision, credit scores don’t play as big a role as they might for banks or other traditional lenders. It’s important to note that issues like bankruptcies within the last two years, tax liens, open judgments, fraud, and other white-collar crimes may mean you won’t be eligible for a loan.