Applying for a loan from a hard money lender can be an off-putting experience, particularly if you’re new to commercial real estate investing.
But before you sign on the dotted line, it’s essential you understand the lender’s loan terms, and that you feel confident they can deliver everything they say they can.
No one wants to put a deal under contract, only to discover that they can’t get the loan without a co-sponsor, or that you need to put together a reserve that you don’t have the money for.
That’s why understanding how the lender evaluates you as an investor, and the risk you present can help you decide whether or not you should work with a particular lender.
In order to understand your lender’s underwriting criteria, make sure you network with potential mortgage brokers or lenders long BEFORE you start making offers on deals.
Why Choose a Hard Money Lender?
Many investors prefer hard money lenders to traditional banks or credit unions. They can often turnaround a loan in a week, which means if timing is critical, then hard money lenders offer your best chance of closing a deal before another investor grabs the property.
Another reason is that hard money lenders are more interested in the profit potential of the property rather than your own credit history.
Since the property serves as collateral for the loan, they make sure that there is sufficient cash flow for you to meet your monthly debt obligations. This means that investors who wouldn’t otherwise be able to get financing from a conventional lender can get one from a hard money lender.
There are two kinds of hard money lenders: direct lenders, and brokers. The former use their own money to fund the loan, while brokers match investors with private lenders.
Because brokers take a commission and act as the middleman, you will generally get a better rates if you’re able to work directly with a private lender. If you’re just getting started, however, brokers can be a good way of funding your purchase without having to meet with and ‘sell” the loan to numerous people.
However, since hard money lenders are private lenders, the loans they give are nearly always short-term loans that mature anywhere from one to five years.
Investors repay either the interest only, or a the interest and a portion of the principal, followed by a balloon payment when the loan matures. Investors typically use loans from hard money lenders as bridge loans, which means they are used to help the investor fund a property while in-between one stage or another.
For example, many investors approach hard money lenders when funding a renovation; they often expect to sell the property or refinance the main part of the loan, whereupon they’ll be able to repay the hard money lender as well.
Other investors use hard money loans to help with down payments, or to make up a shortfall in the original sale price.
Keep in mind that while interest rates will be different depending on where you are located and whether the lender is local or part of a regional chain, generally the interest rate charged by hard money lenders is higher than that offered by traditional lenders like banks or credit unions.
What to Look For In a Hard Money Lender
Any hard money lender you consider should have plenty of experience in lending. That’s not to say that you can’t approach friends or family for money, but it does mean that you’ll want to verify the reputation and level of experience before you approach a professional lender.
You can do this easily by checking the Better Business Bureau online, or asking around at a local Real Estate Investors association.
Once you’ve vetted potential lenders, it’s time to sit down and talk with them about why you think the property has profit potential. If the lender expresses interest in the property, don’t be so giddy with relief that you forget to dig deeper about their lending requirements.
23 Questions To Ask a Hard Money Lender
Here’s a list of helpful questions to have handy when you meet with a potential lender.
1.What is your real estate license ID?
2.What types of loans (e.g. bridge loans, construction loans, conventional) do you offer?
3.Do you fund renovations? How do you handle disbursement?
4.What size loans do you normally do?
5.How long of a loan term is available?
6.What are your net worth requirements? Liquidity requirements?
7.How much of a down payment do you require?
8.What would you call a stable asset?
9.What are your terms for a standard loan with regards to loan to value (LTV), interest rate, and amortization rate?
10.How many points do you charge?
11.Is this a recourse or non-recourse loan?
12.Will the loan be based on the after-repair value (ARV) or the current value?
13.How do you calculate the ARV?
14.Are points and interest included when you figure the LTV?
15.Do I need to have a minimum account balance, or reserves?
16.What percentage of the loan are the origination fees?
17.Do you prefer an independent appraisal, or do you use sales date only?
18.Do you have an estimate on how much third party reports (environmental reports, appraisal, structure reports) will cost?
19.Is there a loan application fee? (avoid this lender if there are)
20.How long does it usually take to close a loan after I finish the appraisal?
21.Are there any prepayment penalties if I decide to sell or refinance before the loan matures?
22.What are the penalty fees if the loan is past due?
23.Do you have testimonials or reviews from previous buyers who’ve taken out a loan with you?
This list is a fairly comprehensive list that will not only help you understand a particular lender, but will also make it easier to compare one lender with another.
With time, you’ll be able to easily gauge the suitability of a particular lender, which will make the entire process go faster, making your goal of building up a commercial real estate portfolio even easier.