We receive a lot of phone calls from potential borrowers on a daily basis. Some are very familiar with hard money lending and have already financed several properties using hard money loans. Others are new investors with questions like “What are hard money lenders?” “How are they different from other sources of financing?” “How can hard money loans help me make money?” If you’ve never worked with hard money lenders before and have the same questions, read on.
We are all familiar with traditional lenders. They include your local bank, a national lender, your credit union or your neighborhood mortgage broker. The majority of their mortgage business comes from underwriting consumer mortgage loans or mortgages on primary residences.
Fannie Mae and Freddie Mac are the largest guarantors of consumer mortgage loans in this country. It means that traditional lenders have to follow their general guidelines when deciding whether a consumer can qualify for a mortgage. Consumer lending is a highly regulated industry and for good reasons. The recent housing crisis started with loose underwriting standards that lead to making high-risk loans to borrowers who couldn’t afford them. Since then traditional lenders got rid of many programs and tightened their loan qualification standards. To get a traditional mortgage, borrowers need to have more income, more savings, and better credit. Because of the government regulations, it also takes longer to get a loan. If you’ve recently purchased or refinanced your home, it probably took two months to close your loan and overwhelming amount of paperwork.
The easiest way to begin understanding who hard money lenders are is to know the key differences between them and traditional lenders. There are at least three.
Hard money lenders do not lend on primary residences.
Hard money loans are business loans issued to real estate investors looking to make a profit. As such they are not subject to many regulations that apply to consumer lending.
Hard money lenders do not sell their loans to Fannie Mae or Freddie Mac.
Typically, they lend their own money or money they raise from their capital investors. They decide which loans to fund based on their own risk tolerance and lending experience.
Hard money loans are typically short-term loans.
Unlike consumer loans, hard money loans are not designed to hold for fifteen or thirty years. Their typical term is between six to eighteen months before they need to be repaid either by flipping the property or refinancing it.
To summarize, hard money loans are not here to help borrowers purchase a primary residence. The purpose of hard money is to help real estate investors make profit by providing a unique source of funds to buy, rehab and sell a property. There are three major reasons why, without hard money lenders, real estate investing would be limited to those with deep pockets.
Many investors would simply not qualify for a loan.
Some folks don’t have a sufficiently high credit score, have dings on their credit, or do not show enough income to qualify for a traditional loan. Others would be turned down by their bank because they already have too many mortgages. Without hard money financing, these borrowers would have no choice but to sit on the sidelines and watch other people make money.
Many properties would not qualify for financing.
Traditional lenders typically base their loans on a current condition of the property. With few exceptions, they lend to consumers, not rehabbers, so they require a property to be “livable” right away. They don’t want to lend on properties that are damaged, trashed or don’t have a functioning kitchen or bathrooms. Hard money lenders focus on the property’s potential or what it can be once an investor finishes up its rehab. For example, at New Funding Resources we base our loans solely on the after-repair value of the property.
No ability to compete with cash offers.
A great investment opportunity often comes with a seller who is either under time pressure to sell or needs to close with a minimum hassle. An all-cash offer is hard to compete with – unless you are working with a hard money lender. No distressed seller would wait sixty days for a bank to approve a loan. In contrast, a good hard money lender should be able to fund a loan within a week or so. Because of their speed, hard money loans are widely considered equivalent to all-cash offers. In short, they level the playing field between the investors with significant liquid assets and those without.
Hard money loans are not for everyone and not everyone will qualify for them either. However, for many investors, they offer a fast and nimble source of capital not available from traditional lenders.
Kyle Sennott says
Thanks Ben. You are right: hard money loans serve a very particular niche. An investor relies on hard money lenders like us if they need to purchase fast, compete with cash offers and cannot qualify for a traditional loan because of a variety of factors (such as the current condition of the property, borrower’s credit, borrower’s income, etc.) I would not say that hard money loans are better per se (for example, they are more expensive than traditional financing from Fannie / Freddie), but they definitely offer types of financing that traditional lenders cannot touch with a ten-foot pole.
Thanks again for your comment and good luck with your investment strategy.