Most real estate investors need some leverage when buying real estate properties to maximize their ROI. Financing an investment property through a bank or a hard money loan is one way to use that leverage. However, banks and institutional lenders have strict requirements on the kind of property they can finance. They also consider credit score and income source, making it very unlikely that all investors will qualify.
On the other hand, private lenders offer hard money loans with flexible lending terms. They accept most property types, including vacant homes, old structures, and even those that require costly renovations. With these loans, borrowers don’t need to have an impressive credit score, provided they can prove they have additional income sources.
If you’re interested in getting a private money loan, you may want to learn how these loans work, the lending requirements, risks, benefits, and everything in between. We have highlighted these and more below.
How Hard Money Lenders Qualify Borrowers
Like any other business, hard money lending comes with some challenges, and private money lenders want to hedge their risks. By qualifying borrowers against a set of requirements, lenders learn more about their potential clients. They also quantify the risks and choose those to award the loans. Here are the three main conditions that hard money lenders use to qualify borrowers.
Having the Required Down Payment
To get the private money lender to accept your investment deal, you must raise the required down payment. This will vary from 25% to 50% of the total cost of the property, depending on a couple of factors. For instance, most experienced lenders will require less down payment since they understand the market better and have their unique ways of minimizing risks. Some lenders will also raise the down payment if the deal isn’t as impressive, e.g., the property is old or has been vacant for several months.
Private lenders will give the borrower a specific time frame to raise the full down payment, failure to which they forfeit their investment opportunity. Failing to raise the down payment is often a red flag for the private money lenders whose money is always at risk in the hands of inexperienced investors.
Real Estate Experience
Every lender wants to work with an expert investor who understands the market as this minimizes the risk of losing money through bad deals. Private money lenders will ask borrowers a couple of questions to see if they have the much-needed industry experience. Some will even seek to prove that the investor has been in business for a specific number of years.
One way to check the borrowers’ experience is by looking at the number of investment properties in their portfolios. The lender can also request to know the borrowers’ mistakes throughout their investment journey, how they resolved it (if they did), and what they have learned along the way. This is enough to spot a veteran player in the real estate market.
Overall Financial Strength
While most private money lenders won’t require you to have an impressive credit score with consistent figures on the pay stubs, proof of financial stability is necessary. Most investors either have income-generating real estate or other income sources. Your lender will want to confirm that they can get back their money if your property fails to sell within the short repayment period.
Having Enough Cash Reserves
After paying the down payment towards the property and the lender has paid the rest, you’ll still be required to settle some out-of-pocket expenses. These include any fees that come with processing and closing the loan. Similarly, you may incur additional costs after taking ownership of the property. For instance, you may need to pay any outstanding homeowners’ association fees, property maintenance fees, property taxes, etc.
Are Hard Money Loans Right for You?
To answer this question, you need to understand the pros and cons of hard money loans. One benefit includes fast processing speeds, often taking one to two weeks to close the deal. You can also qualify for an investment loan with a bad credit score, and you can negotiate the rates and repayment period if you are a regular client.
That said, you can only use this loan for investment purposes due to the high-interest rates (7%-15%) and the short repayment period (12 to 18 months). And since you’ll be using the property as collateral, you risk losing it in case of a default.
In other words, private money loans are great for investors who have some experience in the real estate market. It’s also advisable to have a backup plan or a strategy for repaying the loan, just in case you landed on a bad deal.
Get Started With Hard Money Loans
The first step to getting started with private money loans is researching the best lenders in your locality. Feel free to ask other investors or friends to recommend the best hard money lenders they know. Afterward, check out the lenders’ industry experience, reputation, customer reviews, rates, terms, etc. The goal is to choose a reputed lender who will stick to their promise and are flexible enough to customize their services to suit your unique needs.