How to Be a Hard Money Lender
By Steve Gillman - 2013
Making hard money loans gives you a high rate of return on
your cash. You have to do it properly to be safe, of course,
and you also need a lot of money to invest to do this.
What is "hard money"? This is a term used to describe
loans that are short-term loans that are made to real estate
investors, usually so they can purchase and rehab a property.
There is often a loan fee of as much as five percent or more
of the loan amount, which is paid up front or rolled into the
loan. An annual interest rate of fifteen percent or more is also
common. Why do they want these loans?
Hard money means speed and simplicity to the borrower, as
well as a funding source for properties that the banks won't
lend on. When using hard money lenders, an investor can tell
a seller "I can close for cash in a week." That gets
the seller's attention, especially if he has had offers that
have fallen through due to financing contingencies. The borrower
can also buy properties that are not currently up to code. You
can read all about this kind of lending and why it makes sense
on our page
about hard money borrowing.
Hard Money - How It Works
An investor can normally borrow 65% to 70% of the property
value from a hard money lender, but that percentage is not based
on the current value. As a hard money lender, you'll typically
loan money based on the ARV, or "after repair value"
(as determined by your appraiser -- have a good one). You'll
look at the property more than credit scores, another reason
investors will come to you. Let's look at an example.
Suppose an investor finds a beat-up house he can buy for $105,000.
He has a plan that when complete will bring it up to a market
value of $182,000. He figures it will take a month to complete,
and two months more to sell it. He comes to you, and you agree
that his projections seem reasonable. Your appraiser estimates
a $186,000 market value when the project is done.
You loan him 65% of the ARV, which amounts to $120,250. The
excess beyond the $105,000 purchase price (about $15,000) goes
into an escrow account, to be doled out as the repairs begin.
Notice that if this investor keeps his costs down, he might do
this whole project without any of his own cash invested.
The 4% loan fee you charge amounts to $4,810, and is added
to the loan balance. Thus, the investor owes you a total of $125,060.
You are charging him 15% interest, and he can pay just the interest
due each month, but the whole balance is due within one year.
If it takes longer than that and you have confidence in his plan,
you might do another loan after that.
We'll suppose that it takes two months to finish the house,
and two months to sell it. The investor gets $181,000 for it.
He paid $105,000, and he made a profit of $31,000 after a total
of $45,000 for all of his expenses. he is happy. Now let's look
at what part of those "expenses" went to you.
Part of the deal was that the buyer paid for the appraisal
and any other costs of closing the loan, so your total investment
was $120,250. This was repaid when the house sold, along with
the loan fee of $4,810. You also collected four months of interest
on the whole balance of $125,060 (the loan and the fee that was
also financed), which totals $6253. Your total profit then was
$11,063 on an four-month investment of $120,250. That's an annual
rate of return of 27.6%. How many banks make that on their loans?
Does $11,063 seem like a lot for the investor to pay for this
loan? It is, but the interest rate and other fees are irrelevant
if they allow him to make a good profit. He made $31,000 after
paying those expenses. In any case it makes sense that hard money
lenders get paid well to take risks that banks won't take. If
he screwed up the project, stopped paying, and you had to foreclose,
you might be selling a half-finished house for just enough to
get your money back.
Let's say you keep most of your money in these kinds of loans.
Since it isn't all invested all the time, and is making only
5% in the bank, you average just an 18% return. What does that
do to a $200,000 investment portfolio in 12 years? It makes it
into 1.6 million dollars. You can see why investors with cash
like to make hard money loans.
Note: To succeed at this kind of investing it helps
to have a lot of experience with real estate, or have a good
team of professionals who can help you out. You have to be able
to judge whether the story a borrower tells about the prospects
for a property is reasonable, whether the investor has the experience
necessary to properly complete the process, and if his expense
estimates make sense. An idea of what homes are worth is also
helpful, but if you are not familiar with a given area you can
get a good appraiser who can estimate an ARV for you.
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