Hard money loans have always played a very important role in the financing of real estate transactions, particularly that of commercial property. While amateur investors tend to stay away from this strategy due to their perception of it being risky, hard money loans are especially used by shrewd commercial real estate investors as a specialized financing tool to flip properties and earn a lucrative return on investment. According to experts, home flippers earned a whopping 48.8% ROI in 2017 largely on the back of easy availability of funds from private money lenders, especially in the fast-growing online environment. The pros and cons of hard money lending examined:
Advantages of Using Hard Money Loans to Invest in Commercial Real Estate
Quick disbursement of the loan: The real estate market is extremely dynamic and you need to move very fast to seal a lucrative deal. When you want quick access to the funds, the last thing you want is to get bogged down in the bureaucracy of conventional lenders like banks and credit unions. Instead of asking for endless documentation and asset titles as collateral, most private money lenders are prepared to move fast with a consideration of just a few issues like the valuation of the property, the down payment, the amount of the investor’s equity, and a contingency plan to address possible investor defaults.
Typically, the approval procedure gets completed within 3-5 days, a fact that will surprise investors who have never dealt with private money lenders and are more accustomed to the several weeks of processing by the banks for traditional loans. This is the prime reason why investors who are in a hurry to access the funds or have been refused by banks turn to private money lenders for hard loans.
Hard money loans are possible even for investments that no bank will consider: Banks and credit unions or other institutional lenders have very strict parameters governing the investments for which, they are ready to fund. When you are planning to invest in a real estate transaction that falls outside the lending policy of conventional lenders, it is still possible to get a loan from the private money lenders who are far more flexible in their approach.
For example, banks do not entertain what is known in the real estate parlance as ‘Fix and Flip Projects’. These are short-term investments of typically less than a year in which, a property is acquired, renovated, and then sold off for a profit. Commercial hard money lenders like libertylending are experts in spotting the potential of these investments and do not shy away from lending money to the investors. Banks are typically geared toward making investments for the longer term that will bring them an assured interest income while private money lenders welcome the churning of the money for better profits. Hard money lenders are the best people to approach when you want a real estate loan for the short-term.
Fewer requirements for loan eligibility: One more reason why experienced real-estate investors prefer to take loans from hard money lenders even though they charge higher rates of interest is that they have fewer requirements for the loan eligibility. Typically, hard money lenders are interested in details like the valuation of the property, how much equity the investor has in the deal, the cash flow of the investor, and the exit policy that will allow the investor to repay the loan. On the contrary, conventional lenders like banks rely on the investor complying with all the requirements of which normally there is a long list. The process of compliance for the lender can be quite long and on top of that, the bank is also usually in no hurry to process the application. Hard money lenders appreciate that they are in a very dynamic and competitive market and thus process loan applications in a matter of days to enable the investor to snap up a lucrative deal. Hard money lenders have no use for the credit score of the applicant preferring instead to assess the profitability potential of the investment.
Drawbacks of Hard Money Loans for Real Estate Investments
The higher rate of interest: The rates of interest that hard money lenders typically charge are much higher than that charged by banks. The reason why this is so is that the profiles of the investments are riskier and a premium is taken for the quick loan processing that allows investors to land more profitable deals. The rates quoted are also higher simply because the investor has normally no other way of getting the money for the investment. Also, in addition to the interest, borrowers also have to pay an extra charge, typically referred to as ‘points’ that amount to a certain percentage of the loan amount as an upfront payment before the first monthly installment becomes due.
Hefty down payment: Hard money lenders require investors to pay a down payment of 20-25% of the value to the property from their own resources. This acts as a measure of the confidence that the investor has in the transaction’s potential. With a substantial stake in the property deal, the investor will only go ahead with transactions that are truly profitable. While the banks are more insistent on a good credit score, hard money lenders require the investor to have a significant equity in the property as a reassurance of the investor’s intent.
Available only for the short-term: The maximum tenor of the loans extended by hard money lenders are one to two years because the lenders do not want long-term exposure to risky assets in an environment that is subject to change any time. Investors who are looking at a longer term to hold the property to make an adequate profit should look at sources of funding other than hard money lenders.
Hard money loans are perfect for experienced investors who want to capitalize on a market opportunity quickly without going through a cumbersome application process and make a quick exit to realize a handsome profit. These loans are not for conservative investors wanting a long-term loan on a low rate of interest.