When interest rates rise, it is not uncommon for commercial real estate (CRE) investors to look at other financing and mortgage options. One of those options is borrowing from a hard money lender. A hard money lender is generally a person or a group of investors who loan money for real estate, primarily as short-term bridge loans, that’s secured by the real property. Direct lenders use their own money to fund the loan and brokers match investors with private lenders.
Many factors play a role in seeking non-traditional commercial mortgages, including the lengthy, complicated paperwork, credit check process, and loan terms that banks and mortgage companies require, often pushing the closing date out 45 days or more. When purchasing triple net (NNN) lease properties, the length of time to closing can influence whether you or someone else gets a contract on a popular property.
Let’s take a look at why you might want to consider a hard money lender for your first or next NNN lease property investment and what questions to ask when the time comes.
Why Choose a Hard Money Lender?
When considering a hard money lender, you’ll be happy to know it is a much easier and faster transaction when compared to a bank, credit union, or mortgage broker. However, these loans are best as short-term loans as the interest rates are typically higher than market averages. You will repay either the interest only or the interest and a portion of the principal, followed by a balloon payment when the loan matures. Hard money loans are usually used as bridge loans to help you fund a property between one stage or another. Though these details are reason enough to consider borrowing from a hard money lender, here’s a rundown of the benefits.
Less stringent approval process. Private investors who provide hard money loans decide quickly whether they’ll loan you the money since lending is based on the property’s value rather than your personal financial position. The traditional mortgage underwriting process can be cumbersome and fall through late in the process.
Timing. Many investors prefer hard money lenders for the timing alone. Private investors can often turn around a loan in a week, which means if the timing is critical, then hard money lenders offer your best chance of closing a deal before another investor grabs the property.
The profit potential of the property rather than your credit score drives the loan. Another reason to consider a hard money lender is that they are more interested in the profit potential of the property rather than your credit history. Though the goal is for you to pay off the loan entirely, they see the potential value in reselling the property themselves if you should default.
The property serves as collateral. Since the property serves as collateral for the loan, investors make sure there is sufficient cash flow for you to meet your monthly debt obligations. People who wouldn’t otherwise get financing from a conventional lender due to a lack of personal collateral or net worth or those in foreclosure can often get a loan from a hard money lender if it’s for a high-quality property.
Can be easier to borrow if you’re new to real estate. If you’re just getting started in real estate investing, hard money brokers can be a good source of funding without having to meet with numerous people and jump through hurdles to secure the loan.
Possibly a more convenient option for renovations or business improvements. 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.
Might make more sense in an inflationary economy. In an inflationary economy, traditional mortgage companies and financial organizations enforce stricter rules and make it even more difficult to secure funding. If you’re in a position to pay the hard money loan back swiftly, then the higher interest rates shouldn’t be an issue.
The Cons of Using a Hard Money Lender
Though there are advantages to using a hard money lender, there are also a few cons or drawbacks.
Interest rates. As mentioned, interest rates are higher than average market rates, sometimes even higher subprime loan interest rates, but because they are temporary, the interest is not compounded as it would be for longer terms.
The short loan term. Loans are typically for one to three years, so you need to make sure the rent services the debt and/or the sale of the property you’ve borrowed against sells fast so you can pay it off quickly.
Credit score risk. Defaulting on a hard money loan can majorly impact your credit score, making it much more difficult to borrow in the future.
What to Look for in a Hard Money Lender
Any hard money lender you consider should have plenty of lending experience. That’s not to say 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 by checking the Better Business Bureau (BBB) online, asking a local Real Estate Association, or working with your buyer’s advisor to source a reputable lender.
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 into their lending requirements.
24 Questions to Ask a Hard Money Lender
Before you sign on the dotted line, it’s essential you understand the lender’s loan terms and 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 they need to put together a reserve that may not be available.
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 offer?
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 do you consider 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 is 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?
24. What is your commission structure and percentage?
This 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 hard money lender, which will make the entire process faster, making your goal of building up a commercial real estate portfolio even easier.
To Wrap it Up — A Hard Money Lender May be a Good Idea as Long as You Fully Understand the Terms of the Deal
One reason hard money loans are a good idea for some CRE investors is that they are very short-term and mostly based on the value of the property rather than the borrower’s creditworthiness. This can be advantageous in many scenarios, such as creating a business flipping real estate or trying to build a portfolio rapidly, especially when you aren’t a high-net-worth investor. Traditional lenders, such as banks, credit unions, and mortgage companies do not make hard money loans, so you’ll have to locate private individuals or investment companies known for taking on these higher-risk ventures.
Depending on what you want to use the money for — funding renovations or upgrades for resale or a bridge loan while you sell one investment to buy the other — the fast turnaround is beneficial. Keep in mind, there will be higher interest rates and commissions to pay, but those tend to be offset by paying off the loan quickly, usually within one to three years. To borrow from a hard money lender, always ask questions, do your due diligence, and be prepared to pay the loan off on time or before the due date so you don’t ruin your return on investment or your credit.
Have questions? Westwood Net Lease Advisors has answers. Our team has decades of experience helping buyers navigate the buying process and offers a nationwide network of reputable resources, including investors and lenders. Our buyer representation is free, from our initial conversation through closing and thereafter. Contact us today for a no-obligation discussion. 314-997-5227